2024-02070
[Federal Register Volume 89, Number 24 (Monday, February 5, 2024)]
[Proposed Rules]
[Pages 8026-8063]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-02070]
[[Page 8025]]
Vol. 89
Monday,
No. 24
February 5, 2024
Part III
Commodity Futures Trading Commission
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17 CFR Chapter I
Notice of Proposed Order and Request for Comment on an Application for
a Capital Comparability Determination Submitted on Behalf of Nonbank
Swap Dealers Subject to Capital and Financial Reporting Requirements of
the United Kingdom and Regulated by the United Kingdom Prudential
Regulation Authority; Proposed Rule
Federal Register / Vol. 89 , No. 24 / Monday, February 5, 2024 /
Proposed Rules
[[Page 8026]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Chapter I
Notice of Proposed Order and Request for Comment on an
Application for a Capital Comparability Determination Submitted on
Behalf of Nonbank Swap Dealers Subject to Capital and Financial
Reporting Requirements of the United Kingdom and Regulated by the
United Kingdom Prudential Regulation Authority
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed order and request for comment.
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SUMMARY: The Commodity Futures Trading Commission is soliciting public
comment on an application submitted by the Institute of International
Bankers, International Swaps and Derivatives Association, and
Securities Industry and Financial Markets Association requesting that
the Commission determine that the capital and financial reporting laws
and regulations of the United Kingdom applicable to CFTC-registered
swap dealers organized and domiciled in the United Kingdom, which are
licensed under the United Kingdom Financial Services and Markets Act
2000 as investment firms and designated for prudential supervision by
the United Kingdom Prudential Regulation Authority, provide sufficient
bases for an affirmative finding of comparability with respect to the
Commission's swap dealer capital and financial reporting requirements
adopted under the Commodity Exchange Act. The Commission is also
soliciting public comment on a proposed order providing for the
conditional availability of substituted compliance in connection with
the application.
DATES: Comments must be received on or before March 24, 2024.
ADDRESSES: You may submit comments, identified by ``UK-PRA Swap Dealer
Capital Comparability Determination,'' by any of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this proposed order and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods. To
avoid possible delays with mail or in-person deliveries, submissions
through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
https://comments.cftc.gov. You should submit only information that you
wish to make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act (``FOIA''), a petition for confidential
treatment of the exempt information may be submitted according to the
procedures established in Commission Regulation 145.9.\1\
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\1\ 17 CFR 145.9. Commission regulations referred to in this
release are found at 17 CFR chapter I, and are accessible on the
Commission's website: https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from https://comments.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the proposed determination and order will be retained in
the public comment file and will be considered as required under the
Administrative Procedure Act and other applicable laws, and may be
accessible under the FOIA.
FOR FURTHER INFORMATION CONTACT: Amanda L. Olear, Director, 202-418-
5283, cftc.gov">[email protected]; Thomas Smith, Deputy Director, 202-418-5495,
cftc.gov">[email protected]; Rafael Martinez, Associate Director, 202-418-5462,
cftc.gov">[email protected]; Liliya Bozhanova, Special Counsel, 202-418-6232,
cftc.gov">[email protected]; Joo Hong, Risk Analyst, 202-418-6221,
cftc.gov">[email protected]; Justin McPhee, Risk Analyst, 202-418-6223;
cftc.gov">[email protected], Market Participants Division; Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street NW,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION: The Commodity Futures Trading Commission
(``Commission'' or ``CFTC'') is soliciting public comment on an
application dated May 4, 2021 (the ``UK Application'') submitted by the
Institute of International Bankers, International Swaps and Derivatives
Association, and Securities Industry and Financial Markets Association
(together, the ``Applicants'').\2\ The Applicants request that the
Commission determine that registered nonbank swap dealers \3\
(``nonbank SDs'') organized and domiciled within the United Kingdom
(``UK''), which are licensed as investment firms and designated for
prudential supervision by the UK Prudential Regulation Authority
(``PRA'') (``PRA-designated UK nonbank SDs''), may satisfy certain
capital and financial reporting requirements under the Commodity
Exchange Act (``CEA'') \4\ by being subject to, and complying with,
comparable capital and financial reporting requirements under UK laws
and regulations.\5\ The Commission also is soliciting public comment on
a proposed order under which PRA-designated UK nonbank SDs would be
able, subject to defined conditions, to comply with certain CFTC
nonbank SD capital and financial reporting requirements in the manner
set forth in the proposed order.
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\2\ See Letter dated May 4, 2021 from Stephanie Webster, General
Counsel, Institute of International Bankers, Steven Kennedy, Global
Head of Public Policy, International Swaps and Derivatives
Association, and Kyle Brandon, Managing Director, Head of
Derivatives Policy, Securities Industry and Financial Markets
Association. The UK Application is available on the Commission's
website at: https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm.
\3\ As discussed in Section I.A. immediately below, the
Commission has the authority to impose capital requirements on
registered swap dealers (``SDs'') that are not subject to regulation
by a U.S. prudential regulator (i.e., nonbank SDs).
\4\ 7 U.S.C. 1 et seq. The CEA may be accessed through the
Commission's website at: https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm.
\5\ The Applicants also requested that the Commission determine
that nonbank SDs licensed as investment firms and prudentially
regulated by the UK Financial Conduct Authority (``FCA'') (``FCA-
regulated UK nonbank SDs'') may satisfy certain capital and
financial reporting requirements under the CEA by being subject to,
and complying with, comparable capital and financial reporting
requirements under UK laws and regulations. Due to the differences
between the capital and financial reporting regimes applicable to
PRA-designated UK nonbank SD and FCA-regulated UK nonbank SDs, the
Commission anticipates assessing the comparability of the rules
applicable to FCA-regulated UK nonbank SDs through a separate
capital comparability determination.
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I. Introduction
A. Regulatory Background--Swap Dealer and Major Swap Participant
Capital and Financial Reporting Requirements
Section 4s(e) of the CEA \6\ directs the Commission and
``prudential regulators'' \7\ to impose capital
[[Page 8027]]
requirements on all SDs and major swap participants (``MSPs'')
registered with the Commission.\8\ Section 4s(e) of the CEA also
directs the Commission and prudential regulators to adopt regulations
imposing initial and variation margin requirements on swaps entered
into by SDs and MSPs that are not cleared by a registered derivatives
clearing organization (``uncleared swaps'').
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\6\ 7 U.S.C. 6s(e).
\7\ The term ``prudential regulator'' is defined in the CEA to
mean the Board of Governors of the Federal Reserve System (``Federal
Reserve Board''); the Office of the Comptroller of the Currency; the
Federal Deposit Insurance Corporation; the Farm Credit
Administration; and the Federal Housing Finance Agency. See 7 U.S.C.
1a(39).
\8\ Subject to certain exceptions, the term ``swap dealer'' is
generally defined as any person that: (i) holds itself out as a
dealer in swaps; (ii) makes a market in swaps; (iii) regularly
enters into swaps with counterparties as an ordinary course of
business for its own account; or (iv) engages in any activity
causing the person to be commonly known in the trade as a dealer or
market maker in swaps. See 7 U.S.C. 1a(49). The term ``major swap
participant'' is generally defined as any person who is not an SD,
and: (i) subject to certain exclusions, maintains a substantial
position in swaps for any of the major swap categories as determined
by the Commission; (ii) whose outstanding swaps create substantial
counterparty exposure that could have serious adverse effects on the
financial stability of the U.S. banking system or financial markets;
or (iii) maintains a substantial position in outstanding swaps in
any major swap category as determined by the Commission. See 7
U.S.C. 1a(33).
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Section 4s(e) applies a bifurcated approach with respect to the
above Congressional directives, requiring each SD and MSP that is
subject to the regulation of a prudential regulator (``bank SD'' and
``bank MSP,'' respectively) to meet the minimum capital requirements
and uncleared swaps margin requirements adopted by the applicable
prudential regulator, and requiring each SD and MSP that is not subject
to the regulation of a prudential regulator (``nonbank SD'' and
``nonbank MSP,'' respectively) to meet the minimum capital requirements
and uncleared swaps margin requirements adopted by the Commission.\9\
Therefore, the Commission's authority to impose capital requirements
and margin requirements for uncleared swap transactions extends to
nonbank SDs and nonbank MSPs, including nonbanking subsidiaries of bank
holding companies regulated by the Federal Reserve Board.\10\
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\9\ 7 U.S.C. 6s(e)(2).
\10\ 7 U.S.C. 6s(e)(1) and (2).
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The prudential regulators implemented Section 4s(e) in 2015 by
amending existing capital requirements applicable to bank SDs and bank
MSPs to incorporate swap transactions into their respective bank
capital frameworks, and by adopting rules imposing initial and
variation margin requirements on bank SDs and bank MSPs that engage in
uncleared swap transactions.\11\ The Commission adopted final rules
imposing initial and variation margin obligations on nonbank SDs and
nonbank MSPs for uncleared swap transactions on January 6, 2016.\12\
The Commission also approved final capital requirements for nonbank SDs
and nonbank MSPs on July 24, 2020, which were published in the Federal
Register on September 15, 2020 with a compliance date of October 6,
2021 (``CFTC Capital Rules'').\13\
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\11\ See Margin and Capital Requirements for Covered Swap
Entities, 80 FR 74840 (Nov. 30, 2015).
\12\ See Margin Requirements for Uncleared Swaps for Swap
Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016).
\13\ See Capital Requirements of Swap Dealers and Major Swap
Participants, 85 FR 57462 (Sept. 15, 2020).
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Section 4s(f) of the CEA addresses SD and MSP financial reporting
requirements.\14\ Section 4s(f) of the CEA authorizes the Commission to
adopt rules imposing financial condition reporting obligations on all
SDs and MSPs (i.e., nonbank SDs, nonbank MSPs, bank SDs, and bank
MSPs). Specifically, Section 4s(f)(1)(A) of the CEA provides, in
relevant part, that each registered SD and MSP must make financial
condition reports as required by regulations adopted by the
Commission.\15\ The Commission's financial reporting obligations were
adopted with the Commission's nonbank SD and nonbank MSP capital
requirements, and have a compliance date of October 6, 2021 (``CFTC
Financial Reporting Rules'').\16\
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\14\ 7 U.S.C. 6s(f).
\15\ 7 U.S.C. 6s(f)(1)(A).
\16\ See 85 FR 57462.
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B. Commission Capital Comparability Determinations for Non-U.S. Nonbank
Swap Dealers and Non-U.S. Nonbank Major Swap Participants
Commission Regulation 23.106 establishes a substituted compliance
framework whereby the Commission may determine that compliance by a
non-U.S. domiciled nonbank SD or non-U.S. domiciled nonbank MSP with
its home country's capital and financial reporting requirements will
satisfy all or parts of the CFTC Capital Rules and all or parts of the
CFTC Financial Reporting Rules (such a determination referred to as a
``Capital Comparability Determination'').\17\ The availability of such
substituted compliance is conditioned upon the Commission issuing a
determination that the relevant foreign jurisdiction's capital adequacy
and financial reporting requirements, and related financial
recordkeeping requirements, for non-U.S. nonbank SDs and/or non-U.S.
nonbank MSPs are comparable to the corresponding CFTC Capital Rules and
CFTC Financial Reporting Rules. The Commission will issue a Capital
Comparability Determination in the form of a Commission order
(``Capital Comparability Determination Order'').\18\
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\17\ 17 CFR 23.106. Commission Regulation 23.106(a)(1) provides
that a request for a Capital Comparability Determination may be
submitted by a non-U.S. nonbank SD or a non-U.S. nonbank MSP, a
trade association or other similar group on behalf of its SD or MSP
members, or a foreign regulatory authority that has direct
supervisory authority over one or more non-U.S. nonbank SDs or non-
U.S. nonbank MSPs. In addition, Commission regulations provide that
any non-U.S. nonbank SD or non-U.S. nonbank MSP that is dually-
registered with the Commission as a futures commission merchant
(``FCM'') is subject to the capital requirements of Commission
Regulation 1.17 (17 CFR 1.17) and may not petition the Commission
for a Capital Comparability Determination. See 17 CFR 23.101(a)(5)
and (b)(4), respectively. Furthermore, non-U.S. bank SDs and non-
U.S. bank MSPs may not petition the Commission for a Capital
Comparability Determination with respect to their respective
financial reporting requirements under Commission Regulation
23.105(p) (17 CFR 23.105(p)). Commission staff has issued, however,
a time-limited no-action letter stating that the Market Participants
Division will not recommend enforcement action against a non-U.S.
bank SD that files with the Commission certain financial information
that is provided to its home country regulator in lieu of certain
financial reports required by Commission Regulation 23.105(p). See
CFTC Staff Letter 21-18, issued on August 31, 2021, and CFTC Staff
Letter 23-11, issued on July 10, 2023 (extending the expiration of
CFTC Staff Letter 21-18 until the earlier of October 6, 2025 or the
adoption of any revised financial reporting requirements applicable
to bank SDs under Regulation 23.105(p)). On December 15, 2023, the
Commission issued for public comment proposed amendments to
Regulation 23.105(p) addressing the financial reporting requirements
applicable to bank SDs in a manner consistent with the position
taken in CFTC Letters 21-18 and 23-11. See CFTC Press Release 8836-
23 issued on December 15, 2023, available at cftc.gov.
\18\ 17 CFR 23.106(a)(3).
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The Commission's approach for conducting a Capital Comparability
Determination with respect to the CFTC Capital Rules and the CFTC
Financial Reporting Rules is a principles-based, holistic approach that
focuses on whether the applicable foreign jurisdiction's capital and
financial reporting requirements achieve comparable outcomes to the
corresponding CFTC requirements.\19\ In this regard, the approach is
not a line-by-line assessment or comparison of a foreign jurisdiction's
regulatory requirements with the Commission's requirements.\20\ In
performing the analysis, the Commission recognizes that jurisdictions
may adopt differing approaches to achieving comparable outcomes, and
the Commission will focus on whether the foreign
[[Page 8028]]
jurisdiction's capital and financial reporting requirements are
comparable to the Commission's in purpose and effect, and not whether
they are comparable in every aspect or contain identical elements.
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\19\ See 85 FR 57462 at 57521.
\20\ Id.
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A person requesting a Capital Comparability Determination is
required to submit an application to the Commission containing: (i) a
description of the objectives of the relevant foreign jurisdiction's
capital adequacy and financial reporting requirements applicable to
entities that are subject to the CFTC Capital Rules and the CFTC
Financial Reporting Rules; (ii) a description (including specific legal
and regulatory provisions) of how the relevant foreign jurisdiction's
capital adequacy and financial reporting requirements address the
elements of the CFTC Capital Rules and CFTC Financial Reporting Rules,
including, at a minimum, the methodologies for establishing and
calculating capital adequacy requirements and whether such
methodologies comport with any international standards; and (iii) a
description of the ability of the relevant foreign regulatory authority
to supervise and enforce compliance with the relevant foreign
jurisdiction's capital adequacy and financial reporting requirements.
The applicant must also submit, upon request, such other information
and documentation as the Commission deems necessary to evaluate the
comparability of the capital adequacy and financial reporting
requirements of the foreign jurisdiction.\21\
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\21\ 17 CFR 23.106(a)(2).
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The Commission may consider all relevant factors in making a
Capital Comparability Determination, including: (i) the scope and
objectives of the relevant foreign jurisdiction's capital and financial
reporting requirements; (ii) whether the relevant foreign
jurisdiction's capital and financial reporting requirements achieve
comparable outcomes to the Commission's corresponding capital
requirements and financial reporting requirements; (iii) the ability of
the relevant foreign regulatory authority or authorities to supervise
and enforce compliance with the relevant foreign jurisdiction's capital
adequacy and financial reporting requirements; and (iv) any other facts
or circumstances the Commission deems relevant, including whether the
Commission and foreign regulatory authority or authorities have a
memorandum of understanding (``MOU'') or similar arrangement that would
facilitate supervisory cooperation.\22\
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\22\ See 17 CFR 23.106(a)(3) and 85 FR 57520-57522.
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In performing the comparability assessment for foreign nonbank SDs,
the Commission's review will include the extent to which the foreign
jurisdiction's requirements address: (i) the process of establishing
minimum capital requirements for nonbank SDs and how such process
addresses risk, including market risk and credit risk of the nonbank
SD's on-balance sheet and off-balance sheet exposures; (ii) the types
of equity and debt instruments that qualify as regulatory capital in
meeting minimum requirements; (iii) the financial reports and other
financial information submitted by a nonbank SD to its relevant
regulatory authority and whether such information provides the
regulatory authority with the means necessary to effectively monitor
the financial condition of the nonbank SD; and (iv) the regulatory
notices and other communications between a nonbank SD and its foreign
regulatory authority that address potential adverse financial or
operational issues that may impact the firm. With respect to the
ability of the relevant foreign regulatory authority to supervise and
enforce compliance with the foreign jurisdiction's capital adequacy and
financial reporting requirements, the Commission's review will include
a review of the foreign jurisdiction's surveillance program for
monitoring nonbank SDs' compliance with such capital adequacy and
financial reporting requirements, and the disciplinary process imposed
on firms that fail to comply with such requirements.
In performing the comparability assessment for foreign nonbank
MSPs,\23\ the Commission's review will include the extent to which the
foreign jurisdiction's requirements address: (i) the process of
establishing minimum capital requirements for a nonbank MSP and how
such process establishes a minimum level of capital to ensure the
safety and soundness of the nonbank MSP; (ii) the financial reports and
other financial information submitted by a nonbank MSP to its relevant
regulatory authority and whether such information provides the
regulatory authority with the means necessary to effectively monitor
the financial condition of the nonbank MSP; and (iii) the regulatory
notices and other communications between a nonbank MSP and its foreign
regulatory authority that address potential adverse financial or
operational issues that may impact the firm. With respect to the
ability of the relevant foreign regulatory authority to supervise and
enforce compliance with the foreign jurisdiction's capital adequacy and
financial reporting requirements, the Commission's review will include
a review of the foreign jurisdiction's surveillance program for
monitoring nonbank MSPs' compliance with such capital adequacy and
financial reporting requirements, and the disciplinary process imposed
on firms that fail to comply with such requirements.
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\23\ Commission Regulation 23.101(b) requires a nonbank MSP to
maintain positive tangible net worth. There are no MSPs currently
registered with the Commission. 17 CFR 23.101(b).
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Commission Regulation 23.106 further provides that the Commission
may impose any terms or conditions that it deems appropriate in issuing
a Capital Comparability Determination.\24\ Any specific terms or
conditions with respect to capital adequacy or financial reporting
requirements will be set forth in the Commission's Capital
Comparability Determination Order. As a general condition to all
Capital Comparability Determination Orders, the Commission expects to
require notification from applicants of any material changes to
information submitted by the applicants in support of a comparability
finding, including, but not limited to, changes in the relevant foreign
jurisdiction's supervisory or regulatory regime.
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\24\ See 17 CFR 23.106(a)(5).
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The Commission's capital adequacy and financial reporting
requirements are designed to address and manage risks that arise from a
firm's operation as a SD or MSP. Given their functions, both sets of
requirements and rules must be applied on an entity-level basis
(meaning that the rules apply on a firm-wide basis, irrespective of the
type of transactions involved) to effectively address risk to the firm
as a whole. Therefore, in order to rely on a Capital Comparability
Determination, a nonbank SD or nonbank MSP domiciled in the foreign
jurisdiction and subject to supervision by the relevant regulatory
authority (or authorities) in the foreign jurisdiction must file a
notice with the Commission of its intent to comply with the applicable
capital adequacy and financial reporting requirements of the foreign
jurisdiction set forth in the Capital Comparability Determination in
lieu of all or parts of the CFTC Capital Rules and/or CFTC Financial
Reporting Rules.\25\ Notices must be filed electronically with the
Commission's
[[Page 8029]]
Market Participants Division (``MPD'').\26\ The filing of a notice by a
non-U.S. nonbank SD or non-U.S. nonbank MSP provides MPD staff, acting
pursuant to authority delegated by the Commission,\27\ with the
opportunity to engage with the firm and to obtain representations that
it is subject to, and complies with, the laws and regulations cited in
the Capital Comparability Determination and that it will comply with
any listed conditions. MPD will issue a letter under its delegated
authority from the Commission confirming that the non-U.S. nonbank SD
or non-U.S. nonbank MSP may comply with foreign laws and regulations
cited in the Capital Comparability Determination in lieu of complying
with the CFTC Capital Rules and the CFTC Financial Reporting Rules upon
MPD's determination that the firm is subject to and complies with the
applicable foreign laws and regulations, is subject to the jurisdiction
of the applicable foreign regulatory authority (or authorities), and
can meet any conditions in the Capital Comparability Determination.
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\25\ 17 CFR 23.106(a)(4).
\26\ Notices must be filed in electronic form to the following
email address: cftc.gov">[email protected].
\27\ See 17 CFR 140.91(a)(11).
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Each non-U.S. nonbank SD and/or non-U.S. nonbank MSP that receives,
in accordance with the applicable Commission Capital Comparability
Determination Order, confirmation from the Commission that it may
comply with a foreign jurisdiction's capital adequacy and/or financial
reporting requirements will be deemed by the Commission to be in
compliance with the corresponding CFTC Capital Rules and/or CFTC
Financial Reporting Rules.\28\ Accordingly, if a nonbank SD or a
nonbank MSP fails to comply with the foreign jurisdiction's capital
adequacy and/or financial reporting requirements, the Commission may
initiate an action for a violation of the corresponding CFTC Capital
Rules and or CFTC Financial Reporting Rules.\29\ In addition, a non-
U.S. nonbank SD or non-U.S. nonbank MSP that receives confirmation of
its ability to use substituted compliance remains subject to the
Commission's examination and enforcement authority.\30\ A finding of a
violation by a foreign jurisdiction's regulatory authority is not a
prerequisite for the exercise of such examination and enforcement
authority by the Commission.
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\28\ 17 CFR 23.106(a)(4).
\29\ Id.
\30\ Id.
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The Commission will consider an application for a Capital
Comparability Determination to be a representation by the applicant
that the laws and regulations of the foreign jurisdiction that are
submitted in support of the application are finalized and in force,
that the description of such laws and regulations is accurate and
complete, and that, unless otherwise noted, the scope of such laws and
regulations encompasses the relevant non-U.S. nonbank SDs and/or non-
U.S. nonbank MSPs domiciled in the foreign jurisdiction.\31\ A non-U.S.
nonbank SD or non-U.S. nonbank MSP that is not legally required to
comply with a foreign jurisdiction's laws or regulations determined to
be comparable in a Capital Comparability Determination may not
voluntarily comply with such laws or regulations in lieu of compliance
with the CFTC Capital Rules or the CFTC Financial Reporting Rules. Each
non-U.S. nonbank SD or non-U.S. nonbank MSP that seeks to rely on a
Capital Comparability Determination Order is responsible for
determining whether it is subject to the foreign laws and regulations
found comparable in the Capital Comparability Determination and the
Capital Comparability Determination Order.
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\31\ The Commission has provided the Applicants with an
opportunity to review for accuracy and completeness, and comment on,
the Commission's description of relevant UK laws and regulations on
which this proposed Capital Comparability Determination is based.
The Commission relies on this review and any corrections received
from the Applicants in making its proposal. Thus, to the extent that
the Commission relies on an inaccurate description of foreign laws
and regulations submitted by the Applicants, the comparability
determination may not be valid.
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C. Application for a Capital Comparability Determination for PRA-
Designated UK Nonbank Swap Dealers
The Applicants submitted the UK Application requesting that the
Commission issue a Capital Comparability Determination finding that a
PRA-designated UK nonbank SD's compliance with the capital requirements
of the UK and the financial reporting requirements of the UK, as
specified in the UK Application and applicable to PRA-designated UK
nonbank SDs, satisfies corresponding CFTC Capital Rules and the CFTC
Financial Reporting Rules applicable to a nonbank SD under sections
4s(e)-(f) of the CEA and Commission Regulations 23.101 and 23.105.\32\
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\32\ UK Application, p. 1. There are currently no MSPs
registered with the Commission, and the Applicants have not
requested that the Commission issue a Capital Comparability
Determination concerning UK nonbank MSPs. Accordingly, the
Commission's Capital Comparability Determination and proposed
Capital Comparability Determination Order do not address UK nonbank
MSPs.
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To be designated for prudential supervision by the PRA, a UK-
domiciled investment firm must be authorized, or have requested
authorization, to deal in investments as principal.\33\ For an
investment firm that is authorized, or has requested authorization, to
deal in investments as principal, the PRA may designate the firm for
prudential supervision if the PRA determines that the dealing
activities of the firm should be a PRA-regulated activity. The PRA
considers the following in determining whether an investment firm
should be subject to PRA supervision: (i) the assets of the investment
firm; and (ii) where the investment firm is a member of a group, (a)
the assets of other firms within the group that are authorized, or have
sought authorization, to deal in investments as principal, (b) whether
any other member of the group is subject to prudential supervision by
the PRA, and (c) whether the investment firm's activities have, or
might have, a material impact on the ability of the PRA to advance any
of its objectives in relation to PRA-authorized person in its
group.\34\ The PRA also must consult with the FCA before designating a
person for prudential supervision.\35\
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\33\ Article 3(1) and (2) of The Financial Services and Markets
Act 2000 (PRA-regulated Activities) Order 2013.
\34\ Id., Article 3(4).
\35\ Id., Article 3(6).
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The PRA also has issued a Statement of Policy providing further
detail regarding the factors that are considered in assessing an
investment firm for prudential supervision.\36\ The factors include:
(i) whether the firm's balance sheet exceeds an average of GBP 15
billion total gross assets over four quarters; (ii) where the
investment firm is part of a group, whether the sum of the balance
sheets of all firms within the group that are authorized, or have
requested authorization, to deal in investments as principals exceeds
an average of GBP 15 billion over four quarters; and/or (iii) where the
firm is part of a group subject to PRA supervision, whether the
investment firm's revenues, balance sheet and risk taking is
significant relative to the group's revenues, balance sheet, and risk-
taking.\37\ There are currently six PRA-designated UK nonbank SDs
registered with the Commission:
[[Page 8030]]
Citigroup Global Markets Limited, Goldman Sachs International, Merrill
Lynch International, Morgan Stanley & Co. International Plc, MUFG
Securities EMEA Plc, and Nomura International Plc.
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\36\ See PRA, Statement of Policy, Designation of Investment
Firms for Prudential Supervision by the Prudential Regulation
Authority, December 2021, available here: https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/statement-of-policy/2021/designation-of-investment-firms-for-prudential-supervision-by-the-pra-december-2021.pdf?la=en&hash=007EB17EDF2FA84714D372095F9E03627355776F.
\37\ Id., at p. 5.
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The Applicants represent that the capital and financial reporting
framework applicable to PRA-designated UK nonbank SDs is primarily
based on the framework established by the European Union's (``EU'')
Capital Requirements Regulation \38\ and Capital Requirements
Directive,\39\ which set forth capital and financial reporting
requirements applicable to ``credit institutions'' \40\ and
``investment firms.'' \41\ CRR, as a regulation, is directly applicable
in all member states of the EU (``EU Member States'') and was,
therefore, binding law in the UK during the UK's membership in the
EU.\42\ CRD, as a directive, was required to be transposed into EU
Member States' national law, including UK law.\43\ With regard to PRA-
designated UK nonbank SDs, the UK implemented CRD primarily through a
series of regulations, including the Capital Requirements Regulations
2013 \44\ and the Capital Requirements (Capital Buffers and Macro-
prudential Measures) Regulations 2014,\45\ and the rules of the
PRA.\46\
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\38\ Regulation (EU) No 575/2013 of the European Parliament and
of the Council of 26 June 2013 on prudential requirements for credit
institutions and amending Regulation (EU) No 648/2012 (``Capital
Requirements Regulation'' or ``CRR'').
\39\ Directive 2013/36/EU of the European Parliament and of the
Council of 26 June 2013 on access to the activity of credit
institutions and the prudential supervision of credit institutions,
amending Directive 2002/87/EC and repealing Directives 2006/48/EC
and 2006/49/EC (``Capital Requirements Directive'' or ``CRD'').
\40\ The term ``credit institution'' is defined as an entity
whose business consists of taking deposits and other repayable funds
from the public and granting credits. CRR, Article 4(1), as
applicable in the UK. For a reference to CRR provisions applicable
in the UK, see infra notes 49 and 50.
\41\ The term ``investment firm'' is defined as an entity
authorized under Directive 2014/65/EU of the European Parliament and
of the Council of 15 May 2014 on markets in financial instruments
and amending Directive 2002/92/EC and Directive 2011/61/EU
(``Markets in Financial Instruments Directive'' or ``MiFID''), and
whose regular business is the provision of one or more investment
services to third parties and/or the performance of one or more
investment-related activities on a professional basis, which
includes dealing in derivatives for its own account. CRR, Article
4(1)(2) cross-referencing Article 4(1)(1) of MiFID.
\42\ Consolidated Version of the Treaty on the Functioning of
the European Union, OJ (C 326) 171, Oct. 26, 2012 (``TFEU''),
Article 288.
\43\ Id., Article 288 (stating that a directive is binding as to
the result to be achieved upon each EU Member State to which the
directive is addressed, and further provides, however, that each EU
Member State elects the form and method of implementing the
directive). In this connection, EU Member States were required to
implement and start applying amendments to CRD, introduced by
Directive (EU) 2019/878 of the European Parliament and of the
Council of 20 May 2019 amending Directive 2013/36/EU as regards
exempted entities, financial holding companies, mixed financial
holding companies, remuneration, supervisory measures and powers and
capital conservation measures (``CRD V'') by December 29, 2020. Some
CRD V provisions were subject to delayed implementation deadlines of
June 28, 2021 and January 1, 2022. CRD V, Article 2.
\44\ Capital Requirements Regulations 2013, Statutory Instrument
2013 No. 3115 (``Capital Requirements Regulations 2013'').
\45\ Capital Requirements (Capital Buffers and Macro-prudential
Measures) Regulations 2014, Statutory Instrument 2014 No. 894
(``Capital Requirements (Capital Buffers and Macro-prudential
Measures) Regulations 2014'').
\46\ The PRA's rules (``PRA Rulebook'') are available here:
https://www.prarulebook.co.uk/.
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Following the UK's withdrawal from EU membership (``Brexit''), EU
laws that were in effect and applicable as of December 31, 2020, were
retained in UK law subject to certain non-substantive amendments
seeking to reflect the UK's new position outside of the EU.\47\ As
such, directly applicable EU law, such as CRR, was converted into
domestic UK law and UK legislation implementing EU directives, such as
CRD, was preserved. The UK subsequently adopted additional changes,
generally consistent with amendments introduced by the EU to CRR, CRD
and other relevant EU provisions,\48\ and incorporated certain CRR
provisions in the PRA Rulebook.\49\ The CRR provisions as applicable in
the UK are referred hereafter as ``UK CRR.'' \50\ The UK capital and
financial reporting framework also comprises UK-specific requirements
in respect of certain matters. Requirements applicable to PRA-
designated UK nonbank SDs are included in the PRA Rulebook. In
addition, Commission Delegated Regulation (EU) 2015/61,\51\ which
supplements UK CRR with regard to liquidity coverage requirement for
credit institutions, applies to PRA-designated UK nonbank SDs and
imposes separate liquidity requirements to these firms.\52\
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\47\ See, An Act to Repeal the European Communities Act 1972 and
make other provisions in connection with the withdrawal of the
United Kingdom from the EU (2018 c.16) (``European Union
(Withdrawal) Act 2018'').
\48\ See PRA, Policy Statement 21/21--The UK Leverage Framework,
October 2021, available here: https://www.bankofengland.co.uk/prudential-regulation/publication/2021/june/changes-to-the-uk-leverage-ratio-framework, and Policy Statement 22/21--Implementation
of Basel standards: Final rules, October 2021, available here:
https://www.bankofengland.co.uk/prudential-regulation/publication/2021/october/implementation-of-basel-standards.
\49\ Pursuant to the Financial Services and Markets Act 2023
(``FSMA 2023''), the UK revoked CRR and replaced it with: (i) PRA
rules adopted under Section 144 of the Financial Services and
Markets Act 2000 (``FSMA'') and (ii) UK regulations, adopted under
Section 4 of FSMA 2023, restating CRR provisions.
\50\ The UK CRR is available here: https://www.legislation.gov.uk/eur/2013/575/contents. The provisions that
were incorporated in the PRA Rulebook are no longer part of UK CRR
and appear instead in the PRA Rulebook.
\51\ Commission Delegated Regulation (EU) 2015/61 of 10 October
2014 to supplement Regulation (EU) No 575/2013 of the European
Parliament and the Council with regard to liquidity coverage
requirement for Credit Institutions (``Liquidity Coverage Delegated
Regulation'').
\52\ See PRA Rulebook, CRR Firms, Liquidity Coverage
Requirement--UK Designated Investment Firms Part.
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The Applicants also represent that in addition to UK CRR and the
PRA Rulebook, the Banking Act 2009 and its related secondary
legislation, through which the UK transposed the Bank Recovery and
Resolution Directive (``BRRD''), include relevant UK capital
requirements.\53\ Specifically, pursuant to the Banking Act 2009 and
its secondary legislation, the Bank of England, in its role as
resolution authority, requires certain investment firms, including PRA-
designated UK nonbank SDs, to satisfy a firm-specific minimum
requirement for own funds and eligible liabilities (``MREL'').\54\
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\53\ Directive 2014/59/EU of the European Parliament and of the
Council of 15 May 2014 establishing a framework for the recovery and
resolution of credit institutions and investment firms and amending
Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC,
2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/
36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of
the European Parliament and of the Council. See UK Application, p.
7.
\54\ Banking Act 2009, Section 3A(4) and (4B); Bank Recovery and
Resolution (No 2) Order 2014, Statutory Instrument No. 3348 (``Bank
Recovery and Resolution (No 2) Order 2014''), Part 9.
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UK CRR, Capital Requirements Regulations 2013, Capital Requirements
(Capital Buffers and Macro-prudential Measures) Regulations 2014,
Liquidity Coverage Delegated Regulation, the Banking Act 2009 and its
secondary legislation, and relevant parts of the PRA Rulebook are
referred to hereafter as the ``UK PRA Capital Rules.''
The Applicants further represent that with respect to supervisory
financial reporting, the framework applicable to PRA-designated UK
nonbank SDs is also based on the EU requirements. In addition, the
framework comprises PRA-specific rules for matters not addressed by the
EU-based requirements. Specifically, Commission Implementing Regulation
(EU) 680/2014,\55\ which was initially retained in UK law following
Brexit, supplemented CRR with implementing technical standards (``CRR
Reporting ITS'')
[[Page 8031]]
specifying, among other things, uniform formats and frequencies for the
financial and capital requirements reporting required under CRR.\56\
CRR Reporting ITS included templates for the common reporting
(``COREP'') and the financial reporting (``FINREP'') that specify the
contents of the EU-based supervisory reporting requirements. As part of
the regulatory reforms that followed Brexit and sought to implement
Basel III standards, the PRA incorporated the entire body of the UK
version of COREP and FINREP requirements into the PRA Rulebook to
create a single source for reporting requirements for firms.\57\ For
PRA-designated UK nonbank SDs that are not subject to the EU-based
FINREP requirements, the PRA Rulebook includes PRA-specific
requirements.\58\
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\55\ Commission Implementing Regulation (EU) 680/2014 of 16
April 2014 laying down implementing technical standards with regard
to supervisory reporting of institutions according to Regulation
(EU) No 575/2013 of the European Parliament and of the Council.
\56\ UK Application, p. 24 and Responses to Staff Questions
dated October 5, 2023.
\57\ PRA Rulebook, CRR Firms, Reporting (CRR) Part.
\58\ PRA Rulebook, CRR Firms, Regulatory Reporting Part.
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The Applicants also represent that the Companies Act 2006 contains
provisions related to financial reporting, including a mandate that
entities of a certain size be required to prepare annual audited
financial statements and a strategic report.\59\ UK CRR, relevant
provisions of the PRA Rulebook, and relevant provisions of the
Companies Act 2006, are collectively referred to hereafter as the ``UK
PRA Financial Reporting Rules.''
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\59\ UK Application, p.7. Companies Act 2006, Part 15 and 16.
The Companies Act 2006 is available here: https://www.legislation.gov.uk/ukpga/2006/46/contents.
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The Applicants also note that the U.S. Securities and Exchange
Commission (``SEC'') has issued orders permitting an SEC-registered
nonbank security-based swap dealer domiciled in the UK (``UK nonbank
SBSD'') \60\ to satisfy SEC capital \61\ and financial reporting
requirements via substituted compliance with applicable UK capital and
financial reporting.\62\ The UK Order conditioned substituted
compliance for capital requirements on a UK nonbank SBSD complying with
specified laws and regulations, including relevant parts of UK CRR and
the PRA Rulebook, and also maintaining total liquid assets in an amount
that exceeds the UK nonbank SBSD's total liabilities by at least $100
million and by at least $20 million after applying certain deductions
to the value of the liquid assets to reflect market, credit, and other
potential risks to the value of the assets.\63\
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\60\ All six of the PRA-designated UK nonbank SDs currently
registered with the Commission are also UK nonbank SBSDs.
\61\ Section 15F(e)(1)(B) of the Exchange Act (15 U.S.C. 78o-10)
directs the SEC to adopt capital rules for security-based swap
dealers (``SBSDs'') that do not have a prudential regulator.
\62\ See Order Granting Conditional Substituted Compliance in
Connection with Certain Requirements Applicable to Non-U.S.
Security-Based Swap Dealers and Major Security-Based Swap
Participants Subject to Regulation in the United Kingdom, 86 FR
43318 (July 30, 2021) (``Final UK Order''); Amended and Restated
Order Granting Conditional Substituted Compliance in Connection with
Certain Requirements Applicable to Non-U.S. Security-Based Swap
Dealers and Major Security-Based Swap Participants Subject to
Regulation in the Federal Republic of Germany; Amended Orders
Addressing Non-U.S. Security-Based Swap Entities Subject to
Regulation in the French Republic or the United Kingdom; and Order
Extending the Time to Meet Certain Conditions Relating to Capital
and Margin, 86 FR 59797 (Oct. 28, 2021) (``Amended UK Order,''
together with the Final UK Order, ``UK Order''); and Order
Specifying the Manner and Format of Filing Unaudited Financial and
Operational Information by Security-Based Swap Dealers and Major
Security-Based Swap Participants that are not U.S. Persons and are
Relying on Substituted Compliance with Respect to Rule 18a-7, 86 FR
59208 (Oct. 26, 2021) (``SEC Order on Manner and Format of Filing
Unaudited Financial and Operational Information'').
\63\ The conditioning of the UK substituted compliance order on
UK nonbank SBSDs maintaining liquid assets in an amount that exceeds
the UK nonbank SBSD's total liabilities by at least $100 million and
by at least $20 million after applying certain deductions to the
value of the liquid assets reflects that the SEC's capital rule for
nonbank SBSDs is a liquidity-based requirement and that the SEC
capital requirements are not based on the Basel bank capital
standards. See 17 CFR 240.18a-1(a)(1) (requiring a SBSD to maintain,
in relevant part, net capital of $20 million or, if approved to use
capital models, $100 million of tentative net capital and $20
million of net capital).
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II. General Overview of Commission and UK PRA Nonbank Swap Dealer
Capital Rules
A. General Overview of the CFTC Nonbank Swap Dealer Capital Rules
The CFTC Capital Rules provide nonbank SDs with three alternative
capital approaches: (i) the Tangible Net Worth Capital Approach (``TNW
Approach''); (ii) the Net Liquid Assets Capital Approach (``NLA
Approach''); and (iii) the Bank-Based Capital Approach (``Bank-Based
Approach'').\64\
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\64\ 17 CFR 23.101.
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Nonbank SDs that are ``predominantly engaged in non-financial
activities'' may elect the TNW Approach.\65\ The TNW Approach requires
a nonbank SD to maintain a level of ``tangible net worth'' \66\ equal
to or greater than the higher of: (i) $20 million plus the amount of
the nonbank SD's ``market risk exposure requirement'' \67\ and ``credit
risk exposure requirement'' \68\ associated with the nonbank SD's swap
and related hedge positions that are part of the nonbank SD's swap
dealing activities; (ii) 8 percent of the nonbank SD's ``uncleared swap
margin'' amount; \69\ or (iii) the amount of capital required by a
registered futures association of which the nonbank SD is a member.\70\
The TNW Approach is intended to ensure the safety and soundness of a
qualifying nonbank SD by requiring the firm to maintain a minimum level
of tangible net worth that is based on the nonbank SD's swap dealing
activities to provide a sufficient level of capital to absorb losses
resulting from its swap dealing and other business activities.
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\65\ 17 CFR 23.101(a)(2). The term ``predominantly engaged in
non-financial activities'' is defined in Commission Regulation
23.100 and generally provides that: (i) the nonbank SD's, or its
parent entity's, annual gross financial revenues for either of the
previous two completed fiscal years represents less than 15 percent
of the nonbank SD's or the nonbank SD's parent's, annual gross
revenues for all operations (i.e., commercial and financial) for
such years; and (ii) the nonbank SD's, or its parent entity's, total
financial assets at the end of its two most recently completed
fiscal years represents less than 15 percent of the nonbank SD's, or
its parent's, total consolidated financial and nonfinancial assets
as of the end of such years. 17 CFR 23.100.
\66\ The term ``tangible net worth'' is defined in Commission
Regulation 23.100 and generally means the net worth (i.e., assets
less liabilities) of a nonbank SD, computed in accordance with
applicable accounting principles, with assets further reduced by a
nonbank SD's recorded goodwill and other intangible assets. 17 CFR
23.100.
\67\ The terms ``market risk exposure'' and ``market risk
exposure requirement'' are defined in Commission Regulation 23.100
and generally mean the risk of loss in a financial position or
portfolio of financial positions resulting from movements in market
prices and other factors. 17 CFR 23.100. Market risk exposure is the
sum of: (i) general market risks including changes in the market
value of a particular asset that results from broad market
movements, which may include an additive for changes in market value
under stressed conditions; (ii) specific risk, which includes risks
that affect the market value of a specific instrument but do not
materially alter broad market conditions; (iii) incremental risk,
which means the risk of loss on a position that could result from
the failure of an obligor to make timely payments of principal and
interest; and (iv) comprehensive risk, which is the measure of all
material price risks of one or more portfolios of correlation
trading positions.
\68\ The term ``credit risk exposure requirement'' is defined in
Commission Regulation 23.100 and generally reflects the amount at
risk if a counterparty defaults before the final settlement of a
swap transaction's cash flows. 17 CFR 23.100.
\69\ The term ``uncleared swap margin'' is defined in Commission
Regulation 23.100 to generally mean the amount of initial margin
that a nonbank SD would be required to collect from each
counterparty for each outstanding swap position of the nonbank SD.
17 CFR 23.100. A nonbank SD must include all swap positions in the
calculation of the uncleared swap margin amount, including swaps
that are exempt or excluded from the scope of the Commission's
uncleared swap margin regulations. A nonbank SD must compute the
uncleared swap margin amount in accordance with the Commission's
margin rules for uncleared swaps. See 17 CFR 23.154.
\70\ The National Futures Association (``NFA'') is currently the
only entity that is a registered futures association. The Commission
will refer to NFA in this document when referring to the
requirements or obligations of a registered futures association.
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The TNW approach requires a nonbank SD to compute its market risk
exposure requirement and credit risk
[[Page 8032]]
exposure requirement using standardized capital charges set forth in
SEC Rule 18a-1 \71\ that are applicable to entities registered with the
SEC as SBSDs or standardized capital charges set forth in Commission
Regulation 1.17 applicable to entities registered as FCMs or entities
dually-registered as an FCM and nonbank SD.\72\ Nonbank SDs that have
received Commission or NFA approval pursuant to Commission Regulation
23.102 may use internal models to compute market risk and/or credit
risk capital charges in lieu of the SEC or CFTC standardized capital
charges.\73\
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\71\ 17 CFR 240.18a-1.
\72\ 17 CFR 23.101(a)(2)(ii)(A).
\73\ Id.
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A nonbank SD that elects the NLA Approach is required to maintain
``net capital'' in an amount that equals or exceeds the greater of: (i)
$20 million; (ii) 2 percent of the nonbank SD's uncleared swap margin
amount; or (iii) the amount of capital required by NFA.\74\ The NLA
Approach is intended to ensure the safety and soundness of a nonbank SD
by requiring the firm to maintain at all times at least one dollar of
highly liquid assets to cover each dollar of the nonbank SD's
liabilities.
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\74\ 17 CFR 23.101(a)(1)(ii)(A). ``Net capital'' consists of a
nonbank SD's highly liquid assets (subject to haircuts) less all of
the firm's liabilities, excluding certain qualified subordinated
debt. See 17 CFR 240.18a-1 for the calculation of ``net capital.''
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A nonbank SD is required to reduce the value of its highly liquid
assets by the market risk exposure requirement and/or the credit risk
exposure requirement in computing its net capital.\75\ A nonbank SD
that does not have Commission or NFA approval to use internal models
must compute its market risk exposure requirement and/or credit risk
exposure requirement using the standardized capital charges contained
in SEC Rule 18a-1 as modified by the Commission's rule.\76\
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\75\ See 17 CFR 240.18a-1(c) and (d).
\76\ See 17 CFR 23.101(a)(1)(ii).
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A nonbank SD that has obtained Commission or NFA approval, may use
internal market risk and/or credit risk models to compute market risk
and/or credit risk capital charges in lieu of the standardized capital
charges.\77\ A nonbank SD that is approved to use internal market risk
and/or credit risk models is further required to maintain a minimum of
$100 million of ``tentative net capital.'' \78\
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\77\ See 17 CFR 23.102.
\78\ 17 CFR 23.101(a)(1)(ii)(A)(1). The term ``tentative net
capital'' is defined in Commission Regulation 23.101(a)(1)(ii)(A)(1)
by reference to SEC Rule 18a-1 and generally means a nonbank SD's
net capital prior to deducting market risk and credit risk capital
charges.
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The Commission's NLA Approach is consistent with the SEC's SBSD
capital rule, and is based on the Commission's capital rule for FCMs
and the SEC's capital rule for securities broker-dealers (``BDs''). The
quantitative and qualitative requirements for NLA Approach internal
market and credit risk models are also consistent with the quantitative
and qualitative requirements of the Commission's Bank-Based Approach as
described below.
The Commission's Bank-Based Approach for computing regulatory
capital for nonbank SDs is based on certain capital requirements
imposed by the Federal Reserve Board for bank holding companies.\79\
The Bank-Based Approach also is consistent with the Basel Committee on
Banking Supervision's (``BCBS'') international framework for bank
capital requirements.\80\ The Bank-Based Approach requires a nonbank SD
to maintain regulatory capital equal to or in excess of each of the
following requirements: (i) $20 million of common equity tier 1
capital; (ii) an aggregate of common equity tier 1 capital, additional
tier 1 capital, and tier 2 capital (including qualifying subordinated
debt) equal to or greater than 8 percent of the nonbank SD's risk-
weighted assets (provided that common equity tier 1 capital comprises
at least 6.5 percent of the 8 percent minimum requirement); (iii) an
aggregate of common equity tier 1 capital, additional tier 1 capital,
and tier 2 capital equal to or greater than 8 percent of the nonbank
SD's uncleared swap margin amount; and (iv) an amount of capital
required by NFA.\81\ The Bank-Based Approach is intended to ensure that
the safety and soundness of a nonbank SD by requiring the firm to
maintain at all times qualifying capital in an amount sufficient to
absorb unexpected losses, expenses, decrease in firm assets, or
increases in firm liabilities without the firm becoming insolvent.
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\79\ See 17 CFR 23.101(a)(1)(i).
\80\ The BCBS is the primary global standard-setter for the
prudential regulation of banks and provides a forum for cooperation
on banking supervisory matters. Institutions represented on the BCBS
include the Federal Reserve Board, the European Central Bank,
Deutsche Bundesbank, Bank of England, Bank of France, Bank of Japan,
Banco de Mexico, and Bank of Canada. The BCBS framework is available
at https://www.bis.org/basel_framework/index.htm.
\81\ 17 CFR 23.101(a)(1)(i).
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The terms used in the Commission's Bank-Based Approach are defined
by reference to regulations of the Federal Reserve Board.\82\
Specifically, the term ``common equity tier 1 capital'' is defined for
purposes of the CFTC Capital Rules to generally mean the sum of a
nonbank SD's common stock instruments and any related surpluses,
retained earnings, and accumulated other comprehensive income.\83\ The
term ``additional tier 1 capital'' is defined to include equity
instruments that are subordinated to claims of general creditors and
subordinated debt holders, but contain certain provisions that are not
available to common stock, such as the right of nonbank SD to call the
instruments for redemption or to convert the instruments to other forms
of equity.\84\ The term ``tier 2 capital'' is defined to include
certain types of instruments that include both debt and equity
characteristics (e.g., certain perpetual preferred stock instruments
and subordinated term debt instruments).\85\ Subordinated debt also
must meet certain requirements to qualify as tier 2 capital, including
that the term of the subordinated debt instrument is for a minimum of
one year (with the exception of approved revolving subordinated debt
agreements which may have a maturity term that is less than one year),
and the debt instrument is an effective subordination of the rights of
the lender to receive any payment, including accrued interest, to other
creditors.\86\
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\82\ Id. Commission Regulation 23.101(a)(1)(i) references
Federal Reserve Board Rule 217.20 for purposes of defining the terms
used in establishing the minimum capital requirements under the
Bank-Based Approach. 17 CFR 23.101(a)(1)(i) and 12 CFR 217.20.
\83\ See 12 CFR 217.20(b).
\84\ See 12 CFR 217.20(c).
\85\ See 12 CFR 217.20(d).
\86\ The subordinated debt must meet the requirements set forth
in SEC Rule 18a-1d (17 CFR 240.18a-1d). See 17 CFR
23.101(a)(1)(i)(B) providing that the subordinated debt used by a
nonbank SD to meet its minimum capital requirement under the Bank-
Based Approach must satisfy the conditions for subordinated debt
under SEC Rule 18a-1d.
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Common equity tier 1 capital, additional tier 1 capital, and tier 2
capital are unencumbered and generally long-term or permanent forms of
capital that help ensure that a nonbank SD will be able to absorb
losses resulting from its operations and maintain confidence in the
nonbank SD as a going concern. In addition, in setting an equity ratio
requirement, this limits the amount of asset growth and leverage a
nonbank SD can incur, as a nonbank SD must fund its asset growth with a
certain percentage of regulatory capital.
A nonbank SD also must compute its risk-weighted assets using
standardized capital charges or, if approved, internal models. Risk-
weighting assets involves adjusting the notional or carrying value of
each asset based on the inherent risk of the asset. Less risky assets
are
[[Page 8033]]
adjusted to lower values (i.e., have less risk-weight) than more risky
assets. As a result, nonbank SDs are required to hold lower levels of
regulatory capital for less risky assets and higher levels of
regulatory capital for riskier assets.
Nonbank SDs not approved to use internal models to risk-weight
their assets must compute market risk capital charges using the
standardized charges contained in Commission Regulation 1.17 and SEC
Rule 18a-1, and must compute their credit risk charges using the
standardized capital charges set forth in regulations of the Federal
Reserve Board for bank holding companies in subpart D of 12 CFR part
217.\87\
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\87\ See 17 CFR 23.101(a)(1)(i)(B) and the definition of the
term BHC risk-weighted assets in 17 CFR 23.100.
---------------------------------------------------------------------------
Standardized market risk charges are computed under Commission
Regulation 1.17 and SEC Rule 18a-1 by multiplying, as appropriate to
the specific asset schedule, the notional value or market value of the
nonbank SD's proprietary financial positions (such as swaps, security-
based swaps, futures, equities, and U.S. Treasuries) by fixed
percentages set forth in the Regulation or Rule.\88\ Standardized
credit risk charges require the nonbank SD to multiply on-balance sheet
and off-balance sheet exposures (such as receivables from
counterparties, debt instruments, and exposures from derivatives) by
predefined percentages set forth in the applicable Federal Reserve
Board regulations contained in subpart D of 12 CFR part 217.
---------------------------------------------------------------------------
\88\ See 17 CFR 1.17(c)(5) and 17 CFR 240.15c3-1(c)(2).
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A nonbank SD also may apply to the Commission or NFA for approval
to use internal models to compute market risk exposure and/or credit
risk exposure for purposes of determining its total risk-weighted
assets.\89\ Nonbank SDs approved to use internal models for the
calculation of credit risk or market risk, or both, must follow the
model requirements set forth in Federal Reserve Board regulations for
bank holding companies codified in subpart E and F, respectively, of 12
CFR part 217. Credit risk and market risk capital charges computed with
internal models require the estimation of potential losses, with a
certain degree of likelihood, within a specified time period, of a
portfolio of assets. Internal models allow for consideration of
potential co-movement of prices across assets in the portfolio, leading
to offsets of gains and losses. Internal credit risk models can also
further include estimation of the likelihood of default of
counterparties.
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\89\ See 17 CFR 23.102.
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B. General Overview of UK PRA Capital Rules for PRA-Designated UK
Nonbank SDs
The Applicants state that the UK PRA Capital Rules impose bank-like
capital requirements on a PRA-designated UK nonbank SD that are
consistent with the BCBS framework for international bank-based capital
standards.\90\ The Applicants further state that the UK PRA Capital
Rules are intended to require each PRA-designated UK nonbank SD to hold
a sufficient amount of qualifying equity capital and subordinated debt
based on the PRA-designated UK nonbank SD's activities, to absorb
decreases in the value of firm assets, increases in the value of firm
liabilities, and to cover losses from business activities, including
possible counterparty defaults and margin collateral shortfalls
associated with swap dealing activities, without the firm becoming
insolvent.\91\
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\90\ See UK Application, p. 12.
\91\ See UK Application, pp. 7 and 12.
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The UK PRA Capital Rules require each PRA-designated UK nonbank SD
to hold and maintain regulatory capital in the form of qualifying
common equity tier 1 capital, additional tier 1 capital, and tier 2
capital in an aggregate amount that equals or exceeds 8 percent of the
PRA-designated UK nonbank SD's total risk exposure amount, which is
calculated as a sum of the firm's risk-weighted assets and
exposures.\92\ Common equity tier 1 capital must comprise a minimum of
4.5 percent of the 8 percent capital ratio,\93\ and tier 1 capital
(which is the aggregate of common equity tier 1 capital and additional
tier 1 capital) must comprise a minimum of 6 percent of the total 8
percent capital ratio.\94\ Tier 2 capital may comprise a maximum of 2
percent of the total 8 percent capital ratio.\95\
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\92\ UK CRR, Articles 26, 28, 50-52, 61-63 and 92.
\93\ Id., Article 92(1)(a).
\94\ Id., Article 92(1)(b).
\95\ Id., Article 92(1)(c) (providing that the total capital
ratio must be equal to or greater than 8 percent, with a minimum
common equity and additional tier 1 capital comprising at least 6
percent of the 8 percent minimum requirement). In addition to the
requirement to maintain minimum capital ratios, a PRA-designated UK
nonbank SD must maintain at all times capital resources equal to or
in excess of GBP 750,000. PRA Rulebook, CRR Firms, Definition of
Capital Part, Chapter 12 Base Capital Resource Requirement, Rule
12.1.
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Under the UK PRA Capital Rules, common equity tier 1 capital is
composed of common equity capital instruments, retained earnings,
accumulated other comprehensive income, and other reserves of the PRA-
designated UK nonbank SD.\96\ Additional tier 1 capital is composed of
capital instruments other than common equity and retained earnings
(i.e., common equity tier 1 capital), and includes certain long-term
convertible debt securities.\97\ Tier 2 capital instruments, which
provide an additional layer of supplementary capital, include other
reserves, hybrid capital instruments, and certain subordinated
debt.\98\
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\96\ UK CRR, Articles 26 and 28. Retained earnings, accumulated
other comprehensive income and other reserves qualify as common
equity tier 1 capital only where the funds are available to the PRA-
designated UK nonbank SD for unrestricted and immediate use to cover
risks or losses as such risks or losses occur. See UK CRR, Article
26(1).
\97\ Id., Articles 51-52.
\98\ Id., Articles 62-63.
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To qualify as tier 2 regulatory capital, capital instruments and
subordinated debt must meet certain conditions including that: (i) the
capital instruments are issued by the PRA-designated UK nonbank SD and
are fully paid-up; (ii) the capital instruments are not purchased by
the PRA-designated UK nonbank SD or its subsidiaries; (iii) the claims
on the principal amount of the capital instruments rank below any claim
from instruments that are ``eligible liabilities,'' \99\ meaning that
they are effectively subordinated to claims of all non-subordinated
creditors of the PRA-designated UK nonbank SD; (iv) the capital
instruments have an original maturity of at least five years; and (v)
the provisions governing the capital instruments do not include any
incentive for the principal amount to be redeemed or repaid by the PRA-
designated UK nonbank SD prior to the capital instruments' respective
maturities.\100\
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\99\ ``Eligible liabilities'' are non-capital instruments,
including instruments that are directly issued by the PRA-designated
UK nonbank SD and fully paid up with remaining maturities of at
least a year. Bank Recovery and Resolution (No. 2) Order 2014,
Article 123. In addition, the liabilities cannot be owned, secured,
or guaranteed, by the PRA-designated UK nonbank SD itself, and the
PRA-designated UK nonbank SD cannot have either directly or
indirectly funded their purchase. Id.
\100\ UK CRR, Article 63 (listing the conditions that capital
instruments must meet to qualify as tier 2 instruments) and Bank
Recovery and Resolution (No. 2) Order 2014, Article 123. See also
infra note 121.
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In addition to the requirement to maintain total regulatory capital
in an amount equal to or in excess of 8 percent of its risk-weighted
assets, the UK PRA Capital Rules also require a PRA-designated UK
nonbank SD to maintain a capital conservation buffer composed
exclusively of common equity tier 1 capital in an amount equal to 2.5
percent of the firm's total risk-
[[Page 8034]]
weighted assets.\101\ The common equity tier 1 capital used to meet the
2.5 percent capital conservation buffer must be separate and
independent of the 4.5 percent of common equity tier 1 capital used to
meet the 8 percent core capital requirement.\102\
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\101\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 2
Capital Conservation Buffer, Rule 2.1.
\102\ Id. In effect, the UK PRA Capital Rules require a PRA-
designated UK nonbank SD to hold common equity tier 1 capital equal
to or in excess of 7 percent of the firm's risk-weighted assets, and
total capital equal to or in excess of 10.5 percent of the firm's
risk-weighted assets.
In addition, a PRA-designated nonbank SD may also be subject to
a firm-specific countercyclical capital buffer, whose rate consists
of the weighted average of the countercyclical buffer rates that
apply to exposures in the jurisdictions where the firm's relevant
credit exposures are located. The rate for each jurisdiction is
determined by the UK Financial Policy Committee or a third country
countercyclical buffer authority, as applicable. See PRA Rulebook,
CRR Firms, Capital Buffers Part, Chapter 3 Countercyclical Capital
Buffer, Rule 3.1., and Capital Requirements (Capital Buffers and
Macro-prudential Measures) Regulations 2014, Articles 7-20. The sum
of the capital conservation buffer and the countercyclical buffer is
referred to as the ``combined buffer.'' PRA Rulebook, CRR Firms,
Capital Buffers Part, Chapter 1 Application and Definitions, Rule
1.2. To meet these additional capital buffer requirements, the PRA-
designated UK nonbank SD must maintain a level of common equity tier
1 capital that is in addition to the common equity tier 1 capital
required to meet its core capital requirement of 4.5 percent of its
risk-weighted assets and the common equity tier 1 capital required
to meet its capital conservation buffer. See PRA Rulebook, CRR
Firms, Capital Buffers Part, Chapter 1 Application and Definitions,
Rule 1.2, and Capital Buffers Part, Chapter 4 Capital Conservation
Measures, Rule 4.1. In practice, the countercyclical buffer rate in
the UK, as of July 2023, is 2 percent of risk-weighted assets.
Several EU Member States of relevance to the UK have also
implemented countercyclical capital buffers with rates ranging from
0.5 percent to 2.5 percent of risk-weighted assets. The
countercyclical capital buffer rate is published by the Bank of
England, and is available at: https://bankofengland.co.uk/financial-stability/the-countercyclical-capital-buffer.
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The UK PRA Capital Rules also impose a 3.25 percent leverage ratio
floor on PRA-designated UK nonbank SDs that hold significant amounts of
non-UK assets, as an additional element to the capital
requirements.\103\ Specifically, a PRA-designated UK nonbank SD that
has non-UK assets equal to or greater than GBP 10 billion is required
to maintain an aggregate amount of common equity tier 1 capital and
additional tier 1 capital equal to or in excess of 3.25 percent of the
firm's on-balance sheet and off-balance sheet exposures, including
exposures on uncleared swaps but excluding certain exposures to central
banks, without regard to any risk-weighting.\104\ The leverage ratio is
a non-risk based minimum capital requirement that is intended to
prevent a PRA-designated UK nonbank SD from engaging in excessive
leverage, and complements the risk-based minimum capital requirement
that is based on the PRA-designated UK nonbank SD's risk-weighted
assets.
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\103\ PRA Rulebook, CRR Firms, Leverage Ratio--Capital
Requirements and Buffers Part, Chapter 1 Application and Definitions
and Chapter 3 Minimum Leverage Ratio. The Applicants represented
that the six PRA-designated UK nonbank SDs currently registered with
the Commission are subject to a leverage ratio floor requirement.
See Responses to Staff Questions dated October 5, 2023.
\104\ Total exposures are required to be computed in accordance
with PRA Rulebook, CRR Firms, Leverage Ratio (CRR) Part, Chapter 3
Leverage Ratio (Part Seven CRR), Article 429 et seq. A PRA-
designated UK nonbank SD may also be subject to a countercyclical
leverage ratio buffer of common equity tier 1 capital equal to the
firm's institution-specific countercyclical capital buffer rate
multiplied by 35 percent, multiplied by the firm's total exposures.
PRA Rulebook, CRR Firms, Leverage Ratio--Capital Requirements and
Buffers Part, Chapter 4 Countercyclical Leverage Ratio Buffer.
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As noted above, the amount of regulatory capital that a PRA-
designated UK nonbank SD is required to hold is determined by
calculating the firm's total risk exposure, which requires the PRA-
designated UK nonbank SD to risk-weight its on-balance sheet and off-
balance sheet assets and exposures using specified standardized weights
or, if approved for use by the PRA, internal model-based
methodologies.\105\ Risk-weighting assets and exposures involves
adjusting the notional or carrying value of each asset and risk
exposure based on the inherent risk of the asset or exposure. Less
risky assets and exposures are adjusted to lower values (i.e., have
less weight) than more risky assets or exposures. As a result, PRA-
designated UK nonbank SDs are required to hold lower levels of
regulatory capital for less risky assets and exposures and higher
levels of regulatory capital for riskier assets and exposures. The
categories of risk charges that a PRA-designated UK nonbank SD must
include in determining its total risk exposure include charges
reflecting: (i) market risk; (ii) credit risk; (iii) settlement risk;
(iv) CVA risk of OTC derivative instruments; and (v) operational
risk.\106\ The methods for calculating such risk charges are based on
the BCBS framework.\107\
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\105\ With regulator permission, PRA-designated UK nonbank SDs
may use internal models to calculate credit risk (UK CRR, Article
143), including certain counterparty credit risk exposures (UK CRR,
Article 283), operational risk (UK CRR, Article 312(2)), market risk
(UK CRR, Article 363), and credit valuation adjustment risk (``CVA
risk'') of over-the-counter (``OTC'') derivatives instruments (UK
CRR, Article 383). The permission to use, and continue using,
internal models is subject to strict criteria and supervisory
oversight by the PRA.
\106\ UK CRR, Article 92(3).
\107\ UK Application, pp. 12-15.
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Standardized market risk charges are generally calculated by
multiplying the notional or carrying amount of net positions or of
adjusted net positions by risk-weighting factors, which are based on
the underlying market risk of each asset or exposure. The sum of the
calculated amounts comprises the portion of the risk exposure amount
attributable to market risk.\108\ Standardized credit risk charges are
generally calculated by multiplying the notional or carrying value of
the PRA-designated UK nonbank SD's on-balance sheet and off-balance
sheet assets and exposures by clearly defined risk-weighting factors,
which are based on the underlying credit risk of each asset or
exposure. The sum of the calculated amounts comprises the portion of
the risk exposure amount attributable to credit risk.\109\
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\108\ UK CRR, Articles 326-361.
\109\ Id., Articles 111-134 and PRA Rulebook, CRR Firms,
Standardised Approach and Internal Ratings Based Approach to Credit
Risk (CRR) Part, Chapter 3 Credit Risk (Part Three Title Two
Chapters Two and Three CRR), Article 132.
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Settlement risk charges are intended to account for the price
difference to which a PRA-designated UK nonbank SD is exposed if its
transactions remain unsettled after the respective transaction's due
delivery date.\110\ CVA risk charges reflect the current market value
of the credit risk of the counterparty to the PRA-designated UK nonbank
SD in an OTC derivatives transaction.\111\ Operational risk charges
reflect the risk of loss resulting from inadequate or failed internal
processes, people and systems or from external events, and includes
legal risk.\112\
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\110\ UK CRR, Article 378.
\111\ Id., Article 381.
\112\ Id., Article 4(1)(52).
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As noted above, PRA-designated UK nonbank SDs may use internal
model-based methodologies to calculate certain categories of risk
charges in lieu of standardized charges if they have obtained the
requisite regulatory approval.\113\ The UK PRA Capital Rules set out
quantitative and qualitative requirements that internal models must
meet in order to obtain and maintain approval.\114\ Quantitative and
qualitative requirements address, among other issues, governance,
validation, monitoring, and review. Modeled risk charges generally
require the estimation of potential losses, with a certain degree of
likelihood, within a specified time
[[Page 8035]]
period, of a portfolio of assets.\115\ Internal models allow for
consideration of potential co-movement of prices across assets in the
portfolio, leading to offsets of gains and losses. Credit risk models
can also further include estimation of the likelihood of default of
counterparties.
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\113\ Id., Articles 143 (credit risk), 283 (counterparty credit
risk); 312(2) (operational risk), 363 (market risk), and 383 (CVA
risk).
\114\ See e.g., UK CRR, Articles 144, 283; 321-322 and 365-369.
\115\ The UK PRA Capital Rules require PRA-designated UK nonbank
SDs with internal model approval for market risk to use a VaR model
with a 99 percent, one-tailed confidence interval with: (i) price
change equivalent to 10 business-day movement in rates and prices;
(ii) effective historical observation periods of at least one year;
and (iii) at least monthly data set updates. See UK CRR, Article
365(1). PRA-designated UK nonbank SDs approved to use internal
ratings-based credit risk models must support the assessment of
credit risk, the assignment of exposures to rating grades or pools,
and the quantification of default and loss estimates that have been
developed for a certain type of exposures, among other conditions.
See UK CRR, Articles 142-144. In addition, when PRA-designated UK
nonbank SDs are approved to use a model to calculate counterparty
credit risk exposures for OTC derivatives transactions, the model
must specify the forecasting distribution for changes in the market
value of a netting set attributable to joint changes in relevant
market variables and calculate the exposure value for the netting
set at each of the future dates on the basis of the joint changes in
the market variables. See UK CRR, Article 284. PRA-designated
nonbank SDs allowed to follow the ``advanced method'' of calculating
CVA risk charges for OTC derivatives transactions must also use an
internal market risk model to simulate changes in the credit spreads
of counterparties, applying a 99 percent confidence interval and a
10-day equivalent holding period. See UK CRR, Article 383. Finally,
PRA-designated UK nonbank SDs using ``advanced measurement
approaches'' based on their own measurement systems to compute
operational risk exposures must calculate capital requirements as
comprising both expected loss and unexpected loss and capture
potentially severe tail events, achieving a sound standard
comparable to a 99.9 confidence interval over a one-year period. See
UK CRR, Article 322.
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Furthermore, the UK PRA Capital Rules also impose separate
requirements on an PRA-designated UK nonbank SD to address liquidity
risk. More specifically, PRA-designated UK nonbank SDs are subject to
the liquidity coverage requirement applicable under UK CRR to credit
institutions.\116\ The liquidity coverage requirement provides that
PRA-designated UK nonbank SDs must hold liquid assets in an amount
sufficient to cover liquidity outflows (less liquidity inflows) under
stressed conditions over a period of 30 days.\117\ For purposes of the
liquidity coverage requirement, the term ``stressed'' means a sudden or
severe deterioration in the solvency or liquidity position of a firm
due to changes in market conditions or idiosyncratic factors as a
result of which there is a significant risk that the firm becomes
unable to meet its commitments as they become due within the next 30
days.\118\
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\116\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part and PRA
Rulebook, CRR Firms, Liquidity Coverage Requirement--UK Designated
Investment Firms Part.
\117\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 412(1).
\118\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 411(10).
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In addition, Article 413 of UK CRR, which has been incorporated
into the PRA Rulebook, establishes a general requirement that firms
ensure that long-term obligations and off-balance sheet items are
adequately met with a diverse set of funding instruments that are
stable under both normal and stressed conditions.\119\
---------------------------------------------------------------------------
\119\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 413(1).
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In addition, the Bank of England, in its capacity of resolution
authority,\120\ requires that PRA-designated UK nonbank SDs satisfy a
firm-specific MREL pursuant to provisions of the Banking Act 2009 and
the Bank Recovery and Resolution (No. 2) Order 2014, which transposed
BRRD.\121\ The MREL requirement is separate from the minimum capital
requirements imposed on PRA-designated UK nonbank SDs under UK CRR and
PRA Rulebook and is designed to ensure that PRA-designated UK nonbank
SDs maintain at all times sufficient eligible instruments to facilitate
resolution consistently with the resolution objectives under the
preferred resolution strategy.\122\ Specifically, the MREL is intended
to permit loss absorption, where appropriate, such that the PRA-
designated UK nonbank SD's capital ratio could be restored to the level
necessary for compliance with its capital requirements.\123\ The Bank
of England calculates a firm's baseline MREL as the sum of two
component: a loss absorption amount and a recapitalization amount.\124\
The loss absorption amount is equal to a firm's capital requirements
plus its capital buffers.\125\ The Bank of England has some discretion
to adjust the amount. The MREL amount varies depending on the entity's
size, funding model, and risk profile, among other considerations.\126\
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\120\ In application of BRRD, Article 3, EU Member States
designate resolution authorities that are empowered to apply the
resolution tools and exercise the resolution powers described in
BRRD. In the UK, the resolution authority is the Bank of England.
\121\ Banking Act 2009, Section 3A(4) and (4B) and the Bank
Recovery and Resolution (No. 2) Order 2014, Part 9. Eligible
liabilities include, among others items, instruments that are
directly issued by the PRA-designated UK nonbank SD and fully paid
up with remaining maturities of at least a year. See Bank Recovery
and Resolution (No. 2) Order 2014, Part 9, Article 123(4). In
addition, the liabilities cannot arise from a derivative, be owned,
secured or guaranteed by the PRA-designated UK nonbank SD itself,
and the PRA-designated UK nonbank SD cannot have either directly or
indirectly funded its purchase. Id.
\122\ The Bank of England's Approach to Setting a Minimum
Requirement for Own Funds and Eligible Liabilities (MREL), Statement
of Policy, 3 December 2021, at 3, available at: https://www.bankofengland.co.uk/-/media/boe/files/paper/2021/mrel-statement-of-policy-december-2021-updating-2018.pdf. See also The Minimum
Requirement for Own Funds and Eligible Liabilities (MREL)--Buffers
and Threshold Conditions, Supervisory Statement 16/16, 28 December
2020, available at: https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/supervisory-statement/2020/ss1616-update-dec-2020.pdf.
\123\ Bank Recovery and Resolution (No. 2) Order 2014, Part 9,
Article 123(6).
\124\ See The Bank of England's Approach to Setting a Minimum
Requirement for Own Funds and Eligible Liabilities (MREL), Statement
of Policy, Dec. 3, 2021, at 5.
\125\ Id. The reference to ``capital requirements'' in this
context means the amount of capital the PRA thinks the firm should
maintain at all times under PRA Rulebook, CRR Firms, Internal
Capital Adequacy Assessment.
\126\ Bank Recovery and Resolution (No. 2) Order 2014, Part 9,
Article 123(6).
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III. Commission Analysis of the Comparability of the UK PRA Capital
Rules and UK PRA Financial Reporting Rules With CFTC Capital Rules and
CFTC Financial Reporting Rules
The following section provides a description and comparative
analysis of the regulatory requirements of the UK PRA Capital Rules and
UK PRA Financial Reporting Rules to the CFTC Capital Rules and CFTC
Financial Reporting Rules. Immediately following a description of the
requirement(s) of the CFTC Capital Rules or the CFTC Financial
Reporting Rules for which a comparability determination was requested
by the Applicants, the Commission provides a description of the UK's
corresponding laws, regulations, or rules. The Commission then provides
a comparative analysis of the UK PRA Capital Rules or the UK PRA
Financial Reporting Rules with the corresponding CFTC Capital Rules or
CFTC Financial Reporting Rules and identifies any material differences
between the respective rules.
The Commission performed this proposed Capital Comparability
Determination by assessing the comparability of the UK PRA Capital
Rules for PRA-designated UK nonbank SDs as set forth in the UK
Application with the Commission's Bank-Based Approach. For clarity, the
Commission did not assess the comparability of the UK PRA Capital Rules
to the Commission's TNW Approach or NLA Approach as the Commission
understands that PRA-designated UK nonbank SDs, as of the date of the
UK Application, are subject to bank-based capital requirements pursuant
to the UK
[[Page 8036]]
PRA Capital Rules. In addition, as noted above, due to the differences
between the capital and financial reporting regimes applicable to PRA-
designated UK nonbank SD and FCA-regulated UK nonbank SDs, the
Commission anticipates assessing the comparability of the rules
applicable to FCA-regulated UK nonbank SDs through a separate capital
comparability determination.\127\ Accordingly, when the Commission
makes a preliminary determination herein regarding the comparability of
the UK PRA Capital Rules with the CFTC Capital Rules, the determination
solely pertains to the comparability of the UK PRA Capital Rules as
applicable to PRA-designated UK nonbank SD with the Bank-Based Approach
under the CFTC Capital Rules.
---------------------------------------------------------------------------
\127\ See supra note 5.
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As described below, it is proposed that any material changes to the
UK PRA Capital Rules would require notification to the Commission.
Therefore, if there are subsequent material changes to the UK PRA
Capital Rules to include, for example, another capital approach, the
Commission will review and assess the impact of such changes on the
Capital Comparability Determination Order as it is then in effect, and
may amend or supplement the Order.\128\
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\128\ The Commission also may amend or supplement the Capital
Comparability Determination Order to address any material changes to
the CFTC Capital Rules and CFTC Financial Reporting Rules that are
adopted after a final Order is issued.
The Commission is aware that the UK PRA is considering changes
to the PRA Capital Rules to implement Basel 3.1 standards. See PRA,
PS17/23--Implementation of the Basel 3.1 Standards Near-Final Part
1, December 12, 2023, available here: https://www.bankofengland.co.uk/news/2023/december/pra-publishes-first-of-two-policy-statements-for-basel-3-1-standards-implementation. If the
UK PRA proceeds with the implementation of the Basel 3.1 standards
as proposed, the regulatory changes would be applicable after July
1, 2025 with a 4.5-year transitional period ending on January 1,
2030. The Commission will monitor progress on the UK PRA's proposed
regulatory changes and may amend or supplement the Capital
Comparability Determination Order, as appropriate, after a final
Order is issued. As noted, the Commission proposes to require
notification of any material changes to the UK PRA Capital Rules,
including any Basel 3.1 implementing provisions.
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In addition, although the BCBS bank capital standards establish
minimum capital standards that are consistent with the requirements of
the Commission's Bank-Based Approach, the Commission notes that
consistency with the international standards is not determinative of a
finding of comparability with the CFTC Capital Rules. In the
Commission's view, a foreign jurisdiction's consistency with the BCBS
international bank capital standards is an element in the Commission's
comparability assessment, but, in and of itself, it may not be
sufficient to demonstrate comparability with the CFTC Capital Rules
without an assessment of the individual elements of the foreign
jurisdiction's capital framework.
Capital and financial reporting regimes are complex structures
comprised of a number of interrelated regulatory components.
Differences in how jurisdictions approach and implement these regimes
are expected, even among jurisdictions that base their requirements on
the principles and standards set forth in the BCBS international bank
capital framework. Therefore, the Commission's comparability
determination involves a detailed assessment of the relevant
requirements of the foreign jurisdiction and whether those
requirements, viewed in the aggregate, lead to an outcome that is
comparable to the outcome of the CFTC's corresponding requirements.
Consistent with this approach, the Commission has grouped the CFTC
Capital Rules and CFTC Financial Reporting Rules into the key
categories that focus the analysis on whether the UK PRA capital and
financial reporting requirements are comparable to the Commission's SD
requirements in purpose and effect, and not whether the UK PRA
requirements meet every aspect or contain identical elements as the
Commission's requirements.
Specifically, as discussed in detail below, the Commission used the
following key categories in its review: (i) the quality of the equity
and debt instruments that qualify as regulatory capital, and the extent
to which the regulatory capital represents committed and permanent
capital that would be available to absorb unexpected losses or
counterparty defaults; (ii) the process of establishing minimum capital
requirements for a PRA-designated UK nonbank SD and how such process
addresses market risk and credit risk of the firm's on-balance sheet
and off-balance sheet exposures; (iii) the financial reports and other
financial information submitted by a PRA-designated nonbank SD to the
PRA to effectively monitor the financial condition of the firm; and
(iv) the regulatory notices and other communications between the PRA-
designated UK nonbank SD and the PRA that detail potential adverse
financial or operational issues that may impact the firm. The
Commission also reviewed the manner in which compliance by a PRA-
designated UK nonbank SD with the UK PRA Capital Rules and UK PRA
Financial Reporting rules is monitored and enforced. The Commission
invites public comment on all aspects of the UK Application and on the
Commission's proposed Capital Comparability Determination discussed
below.
A. Regulatory Objectives of CFTC Capital Rules and CFTC Financial
Reporting Rules and UK PRA Capital Rules and UK PRA Financial Reporting
Rules
1. Regulatory Objectives of CFTC Capital Rules and CFTC Financial
Reporting Rules
The regulatory objectives of the CFTC Capital Rules and the CFTC
Financial Reporting Rules are to further the Congressional mandate to
ensure the safety and soundness of nonbank SDs to mitigate the greater
risk to nonbank SDs and the financial system arising from the use of
swaps that are not cleared.\129\ A primary function of the nonbank SD's
capital is to protect the solvency of the firm from decreases in the
value of firm assets, increases in the value of firm liabilities, and
from losses, including losses resulting from counterparty defaults and
margin collateral failures, by requiring the firm to maintain an
appropriate level of quality capital, including qualifying subordinated
debt, to absorb such losses without becoming insolvent. With respect to
swap positions, capital and margin perform complementary risk
mitigation functions by protecting nonbank SDs, containing the amount
of risk in the financial system as a whole, and reducing the potential
for contagion arising from uncleared swaps.
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\129\ See 7 U.S.C. 6s(e)(3)(A).
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The objective of the CFTC Financial Reporting Rules is to provide
the Commission with the means to monitor and assess a nonbank SD's
financial condition, including the nonbank SD's compliance with minimum
capital requirements. The CFTC Financial Reporting Rules are designed
to provide the Commission and NFA, which, along with the Commission,
oversees nonbank SDs' compliance with Commission regulations, with a
comprehensive view of the financial health and activities of the
nonbank SD. The Commission's rules require nonbank SDs to file
financial information, including periodic unaudited and annual audited
financial statements, specific financial position information, and
notices of certain events that may indicate a potential financial or
operational issue that may adversely impact the nonbank SD's ability to
meet its obligations to counterparties and other creditors in the
[[Page 8037]]
swaps market, or impact the firm's solvency.\130\
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\130\ See 17 CFR 23.105.
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2. Regulatory Objective of UK PRA Capital Rules and UK PRA Financial
Reporting Rules
The regulatory objective of the UK PRA Capital Rules is to ensure
the safety and soundness of PRA-designated UK nonbank SDs.\131\ The UK
PRA Capital Rules are designed to preserve the financial stability and
solvency of a PRA-designated UK nonbank SD by requiring the firm to
maintain a sufficient amount of qualifying equity capital and
subordinated debt based on the PRA-designated UK nonbank SD's
activities to absorb decreases in the value of firm assets, increases
in the value of firm liabilities, and to cover losses from business
activities, including possible counterparty defaults and margin
collateral shortfalls associated with the firm's swap dealing
activities.\132\ The UK PRA Capital Rules are also designed to ensure
that the PRA-designated UK nonbank SDs have sufficient liquidity to
meet their financial obligations to counterparties and other creditors
in a distress scenario by requiring each firm to hold an amount of
liquid assets to ensure that the firm could face any possible imbalance
between liquidity inflows and outflows under gravely stressed
conditions over a period of 30 days \133\ and to hold a diversity of
stable funding instruments sufficient to meet long-term obligations
under both normal and stressed conditions.\134\
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\131\ See PRA, The Prudential Regulation Authority's Approach to
Banking Supervision, July 2023, available here: https://www.bankofengland.co.uk/prudential-regulation/publication/pras-approach-to-supervision-of-the-banking-and-insurance-sectors.
\132\ Id.
\133\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 412 (Liquidity Coverage
Requirement). Liquid assets primarily include cash, exposures to
central banks, government-backed assets and other highly liquid
assets with high credit quality. PRA Rulebook, CRR Firms, Liquidity
(CRR) Part, Chapter 4 Liquidity (Part Six CRR), Article 416
(Reporting on Liquid Assets).
\134\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 413 (Stable Funding Requirement).
Stable funding instruments include common equity tier 1 capital
instruments, additional tier 1 capital instruments, tier 2 capital
instruments, and other preferred shares and capital instruments in
excess of the tier 2 allowable amount with an effective maturity of
one year or greater. PRA Rulebook, CRR Firms Liquidity (CRR) Part,
Chapter 4 Liquidity (Part Six CRR), Article 427 (Reporting on Stable
Funding).
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With respect to financial reporting, the objective of the UK PRA
Financial Reporting Rules is to enable the PRA to assess the financial
condition and safety and soundness of PRA-designated UK nonbank
SDs.\135\ The UK PRA Financial Reporting Rules aim to achieve this
objective by requiring a PRA-designated nonbank SD to provide financial
reports and other financial position and capital information to the PRA
on a regular basis.\136\ The financial reporting by a PRA-designated UK
nonbank SD provides the PRA with information necessary to effectively
monitor the PRA-designated UK nonbank SD's overall financial condition
and its ability to meet its regulatory obligations as a nonbank SD.
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\135\ See generally PRA, The Prudential Regulation Authority's
Approach to Banking Supervision, July 2023, available here: https://www.bankofengland.co.uk/prudential-regulation/publication/pras-approach-to-supervision-of-the-banking-and-insurance-sectors.
\136\ PRA Rulebook, CRR Firms, Reporting (CRR) Part.
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3. Commission Analysis
The Commission has reviewed the UK Application and the relevant UK
laws and regulations, and has preliminarily determined that the overall
objectives of the UK PRA Capital Rules and CFTC Capital Rules are
comparable in that both sets of rules are intended to ensure the safety
and soundness of nonbank SDs by establishing a regulatory regime that
requires nonbank SDs to maintain a sufficient amount of qualifying
regulatory capital to absorb losses, including losses from swaps and
other trading activities, and to absorb decreases in the value of firm
assets and increases in the value of firm liabilities without the
nonbank SDs becoming insolvent. The UK PRA Capital Rules and CFTC
Capital Rules are also based on, and consistent with, the BCBS
international bank capital framework, which is designed to ensure that
banking entities hold sufficient levels of capital to absorb losses and
decreases in the value of assets without the banks becoming insolvent.
The Commission further preliminarily believes that the UK PRA
Financial Reporting Rules have comparable objectives with the CFTC
Financial Reporting Rules as both sets of rules require nonbank SDs to
file and/or publish, as applicable, periodic financial reports,
including unaudited financial reports and an annual audited financial
report, detailing their financial operations and demonstrating their
compliance with minimum capital requirements, with the goal of
providing the PRA and the CFTC staff with information necessary to
comprehensively assess the financial condition of a nonbank SD on an
ongoing basis. In addition, to achieve this objective, the financial
reports further provide the CFTC and the PRA with information regarding
potential changes in a nonbank SD's risk profile by disclosing changes
in account balances reported over a period of time. Such changes in
account balances may indicate that the nonbank SD has entered into new
lines of business, has increased its activity in an existing line of
business relative to other activities, or has terminated a previous
line of business.
The prompt and effective monitoring of the financial condition of
nonbank SDs through the receipt and review of periodic financial
reports supports the Commission and the PRA in meeting their respective
objectives of ensuring the safety and soundness of nonbank SDs. In
connection with these objectives, the early identification of potential
financial issues provides the Commission and the PRA with an
opportunity to address such issues with the nonbank SD before the
issues develop to a state where the financial condition of the firm is
impaired such that it may no longer hold a sufficient amount of
qualifying regulatory capital to absorb decreases in the value of firm
assets or increases in the value of firm liabilities, or to cover
losses from the firm's business activities, including the firm's swap
dealing activities and obligations to swap counterparties.
The Commission invites public comment on its analysis above,
including comment on the UK Application and relevant UK laws and
regulations.
B. Nonbank Swap Dealer Qualifying Capital
1. CFTC Capital Rules: Qualifying Capital Under Bank-Based Approach
The CFTC Capital Rules require a nonbank SD electing the Bank-Based
Approach to maintain regulatory capital in the form of common equity
tier 1 capital, additional tier 1 capital, and tier 2 capital in
amounts that meet certain stated minimum requirements set forth in
Commission Regulation 23.101.\137\ Common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital are composed of certain
defined forms of equity of the nonbank SD, including common stock,
retained earnings, and qualifying subordinated debt.\138\ The
Commission's requirement for a nonbank SD to maintain a minimum amount
of defined qualifying capital and subordinated debt is intended to
[[Page 8038]]
ensure that the firm maintains a sufficient amount of regulatory
capital to absorb decreases in the value of the firm's assets and
increases in the value of the firm's liabilities, and to cover losses
resulting from the firm's swap dealing and other activities, including
possible counterparty defaults and margin collateral shortfalls,
without the firm becoming insolvent.
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\137\ See 17 CFR 23.101(a)(1)(i).
\138\ The terms ``common equity tier 1 capital,'' ``additional
tier 1 capital,'' and ``tier 2 capital'' are defined in the bank
holding company regulations of the Federal Reserve Board. See 12 CFR
217.20.
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Common equity tier 1 capital is generally composed of an entity's
common stock instruments and any related surpluses, retained earnings,
and accumulated other comprehensive income, and is a more conservative
or permanent form of capital than additional tier 1 and tier 2
capital.\139\ Additional tier 1 capital is generally composed of equity
instruments such as preferred stock and certain hybrid securities that
may be converted to common stock if triggering events occur.\140\ Total
tier 1 capital is composed of common equity tier 1 capital and further
includes additional tier 1 capital.\141\ Tier 2 capital includes
certain types of instruments that include both debt and equity
characteristics such as qualifying subordinated debt.\142\
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\139\ 12 CFR 217.20.
\140\ Id.
\141\ Id.
\142\ Id.
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Subordinated debt must meet certain conditions to qualify as tier 2
capital under the CFTC Capital Rules. Specifically, subordinated debt
instruments must have a term of at least one year (with the exception
of approved revolving subordinated debt agreements which may have a
maturity term that is less than one year), and contain terms that
effectively subordinate the rights of lenders to receive any payments,
including accrued interest, to other creditors of the firm.\143\
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\143\ The subordinated debt must meet the requirements set forth
in SEC Rule 18a-1d (17 CFR 240.18a-1d). See 17 CFR
23.101(a)(1)(i)(B) (providing that the subordinated debt used by a
nonbank SD to meet its minimum capital requirement under the Bank-
Based Approach must satisfy the conditions for subordinated debt
under SEC Rule 18a-1d).
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Common equity tier 1 capital, additional tier 1 capital, and tier 2
capital are permitted to be included in a nonbank SD's regulatory
capital and used to meet the firm's minimum capital requirement due to
their characteristics of being permanent forms of capital that are
subordinate to the claims of other creditors, which ensures that a
nonbank SD will have this regulatory capital to absorb decreases in the
value of the firm's assets and increases in the value of the firm's
liabilities, and to cover losses from business activities, including
swap dealing activities, without the firm becoming insolvent.
2. UK PRA Capital Rules: Qualifying Capital
The UK PRA Capital Rules require a PRA-designated nonbank SD to
maintain an amount of regulatory capital (i.e., equity capital and
qualifying subordinated debt) equal to or greater than 8 percent of the
PRA-designated UK nonbank SD's total risk exposure, which is calculated
as the sum of the firm's: (i) capital charges for market risk; (ii)
risk-weighted exposure amounts for credit risk; (iii) capital charges
for settlement risk; (iv) CVA risk of OTC derivatives instruments; and
(v) capital charges for operational risk.\144\ The UK Capital Rules
limit the composition of regulatory capital to common equity tier 1
capital, additional tier 1 capital, and tier 2 capital in a manner
consistent with the BCBS bank capital framework.\145\ In this regard,
the UK PRA Capital Rules provide that a PRA-designated UK nonbank SD's
regulatory capital may be composed of: (i) common equity tier 1 capital
instruments, which generally include the PRA-designated UK nonbank SD's
common equity, retained earnings, and accumulated other comprehensive
income; \146\ (ii) additional tier 1 capital instruments, which include
other forms of capital instruments and certain long-term convertible
debt instruments; \147\ and (iii) tier 2 capital instruments, which
includes other reserves, hybrid capital instruments, and certain
qualifying subordinated term debt.\148\
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\144\ UK CRR, Article 92.
\145\ Id.
\146\ UK CRR, Articles 26 and 28. Capital instruments that
qualify as common equity tier 1 capital under the UK PRA Capital
Rules include instruments that: (i) are issued directly by the PRA-
designated UK nonbank SD; (ii) are paid in full and not funded
directly or indirectly by the PRA-designated UK nonbank SD; and
(iii) are perpetual. In addition, the principal amount of the
instruments may not be reduced or repaid, except in the liquidation
of the PRA-designated UK nonbank SD.
\147\ Id., Articles 51-52. To qualify as additional tier 1
capital, the instruments must meet certain conditions including: (i)
the instruments are issued directly by the PRA-designated UK nonbank
SD and paid in full; (ii) the instruments are not owned by the PRA-
designated UK nonbank SD or its subsidiaries; (iii) the purchase of
the instruments is not funded directly or indirectly by the PRA-
designated UK nonbank SD; (iv) the instruments rank below tier 2
instruments in the event of the insolvency of the PRA-designated UK
nonbank SD; (v) the instruments are not secured or guaranteed by the
PRA-designated UK nonbank SD or an affiliate; (vi) the instruments
are perpetual and do not include an incentive for the PRA-designated
UK nonbank SD to redeem them; and (vii) distributions under the
instruments are pursuant to defined terms and may be cancelled under
the full discretion of the PRA-designated UK nonbank SD.
\148\ Id., Articles 62-63.
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Furthermore, subordinated debt instruments must meet certain
conditions to qualify as tier 2 regulatory capital under the UK PRA
Capital Rules, including that the: (i) loans are not granted by the
PRA-designated UK nonbank SD or its subsidiaries; (ii) claims on the
principal amount of the subordinated loans under the provisions
governing the subordinated loan agreement rank below any claim from
eligible liabilities instruments (i.e., certain non-capital
instruments), meaning that they are effectively subordinated to claims
of all non-subordinated creditors of the PRA-designated UK nonbank SD;
(iii) subordinated loans are not secured, or subject to a guarantee
that enhances the seniority of the claim, by the PRA-designated UK
nonbank SD, its subsidiaries, or affiliates; (iv) loans have an
original maturity of at least five years; and (v) provisions governing
the loans do not include any incentive for the principal amount to be
repaid by the PRA-designated UK nonbank SD prior to the loans'
maturity.\149\
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\149\ UK CRR, Article 63.
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A PRA-designated UK nonbank SD must also maintain a capital
conservation buffer equal to 2.5 percent of the firm's total risk
exposure in addition to the requirement to maintain qualifying
regulatory capital in excess of 8 percent of its total risk
exposure.\150\ The 2.5 percent capital conservation buffer must be met
with common equity tier 1 capital.\151\ Common equity tier 1 capital,
as noted above, is limited to the
[[Page 8039]]
PRA-designated UK nonbank SD's common equity, retained earnings, and
accumulated other comprehensive income, and represents a more permanent
form of capital than equity instruments that qualify as additional tier
1 capital and tier 2 capital.
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\150\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 2
Capital Conservation Buffer, Rule 2.1. In addition, a PRA-designated
nonbank SD may also be subject to a firm-specific countercyclical
capital buffer, which requires the PRA-designated UK nonbank SD to
hold an additional amount of common equity tier 1 capital equal to
its total risk-weighted assets multiplied by the weighted average of
the countercyclical buffer rates that apply to exposures in the
jurisdictions where the firm's relevant credit exposures are
located. The rate for each jurisdiction is determined by the UK
Financial Policy Committee or a third country countercyclical buffer
authority, as applicable. See PRA Rulebook, CRR Firms, Capital
Buffers Part, Chapter 3 Countercyclical Capital Buffer, Rule 3.1.,
and Capital Requirements (Capital Buffers and Macro-prudential
Measures) Regulations 2014, Articles 7-20. In practice, the
countercyclical buffer rate in the UK, as of July 2023, is 2 percent
of risk-weighted assets. The countercyclical capital buffer rate is
published by the Bank of England, and is available at: https://bankofengland.co.uk/financial-stability/the-countercyclical-capital-buffer. Several EU Member States of relevance to the UK have also
implemented countercyclical capital buffers with rates ranging from
0.5 percent to 2.5 percent of risk-weighted assets.
\151\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 2
Capital Conservation Buffer, Rule 2.1.
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The UK PRA Capital Rules also impose different ratios for the
various components of regulatory capital that are consistent with the
BCBS bank capital framework.\152\ In this regard, the UK PRA Capital
Rules provide that a PRA-designated UK nonbank SD's minimum regulatory
capital must satisfy the following requirements: (i) common equity tier
1 capital ratio of 4.5 percent of the firm's total risk exposure
amount; (ii) total tier 1 capital (i.e., common equity tier 1 capital
plus additional tier 1 capital) ratio of 6 percent of the firm's total
risk exposure amount; and (iii) total capital (i.e., an aggregate
amount of common equity tier 1 capital, additional tier 1 capital, and
tier 2 capital) ratio of 8 percent of the firm's total risk exposure
amount. As noted above, a PRA-designated UK nonbank SD must also
maintain a capital conservation buffer of 2.5 percent of its total risk
exposure amount that must be met with common equity tier 1
capital.\153\ With the addition of the capital conservation buffer,
each PRA-designated UK nonbank SD is required to maintain minimum
regulatory capital that equals or exceeds 10.5 percent of the firm's
total risk exposure amount, with common equity tier 1 capital
comprising at least 7 percent of the 10.5 percent minimum regulatory
capital requirement.\154\
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\152\ UK CRR, Article 92(1).
\153\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 2
Capital Conservation Buffer, Rule 2.1.
\154\ The countercyclical capital buffer is not included in the
analysis given that it is firm-specific and its rate depends on the
location of the firm's exposures.
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Common equity tier 1 capital, additional tier 1 capital, and tier 2
capital are permitted to be included in a PRA-designated UK nonbank
SD's regulatory capital and used to meet the firm's minimum capital
requirement due to their characteristics of being permanent forms of
capital that are subordinate to the claims of other creditors, which
ensures that a PRA-designated UK nonbank SD will have this regulatory
capital to absorb decreases in the value of the firm's assets and
increases in the value of the firm's liabilities, and to cover losses
from business activities, including swap dealing activities, without
the firm becoming insolvent.
3. Commission Analysis
The Commission has reviewed the UK Application and the relevant UK
laws and regulations, and has preliminarily determined that the UK PRA
Capital Rules are comparable in purpose and effect to the CFTC Capital
Rules with regard to the types and characteristics of a nonbank SD's
equity that qualifies as regulatory capital in meeting its minimum
requirements. The UK PRA Capital Rules and the CFTC Capital Rules for
nonbank SDs both require a nonbank SD to maintain a quantity of high-
quality capital and permanent capital, all defined in a manner that is
consistent with the BCBS international bank capital framework, that
based on the firm's activities and on-balance sheet and off-balance
sheet exposures, is sufficient to absorb losses and decreases in the
value of the firm's assets and increases in the value of the firm's
liabilities without resulting in the firm becoming insolvent.
Specifically, equity instruments that qualify as common equity tier 1
capital and additional tier 1 capital under the UK PRA Capital Rules
and the CFTC Capital Rules have similar characteristics (e.g., the
equity must be in the form of high-quality, committed and permanent
capital) and the equity instruments generally have no priority in
distribution of firm assets or income with respect to other
shareholders or creditors of the firm, which makes the equity available
to a nonbank SD to absorb unexpected losses, including counterparty
defaults.\155\
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\155\ Compare 12 CFR 217.20(b) (defining capital instruments
that qualify as common equity tier 1 capital under the rules of the
Federal Reserve Board) and 12 CFR 217.20(c) (defining capital
instruments that qualify as additional tier 1 capital under the
rules of the Federal Reserve Board) with UK CRR, Articles 26 and 28
(defining items and capital instruments that qualify as common
equity tier 1 capital under the UK PRA Capital Rules) and UK CRR,
Article 52 (defining capital instruments that qualify as additional
tier 1 capital under the UK PRA Capital Rules).
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In addition, the Commission has preliminarily determined that the
conditions imposed on subordinated debt instruments under the UK PRA
Capital Rules and the CFTC Capital Rules are comparable and are
designed to ensure that the subordinated debt has qualities that
support its recognition by a nonbank SD as equity for regulatory
capital purposes. Specifically, in both sets of rules, the conditions
include a requirement that the debt holders have effectively
subordinated their claims for repayment of the debt to the claims of
other creditors of the nonbank SD.\156\
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\156\ Compare 17 CFR 240.18a-1d with UK CRR, Article 63(d).
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Having reviewed the UK Application and the relevant UK laws and
regulations, the Commission has made a preliminary determination that
the UK PRA Capital Rules and CFTC Capital Rules impose comparable
requirements on PRA-designated UK nonbank SDs with respect to the types
and characteristics of equity capital that must be used to meet minimum
regulatory capital requirements. The Commission invites public comment
on its analysis above, including comment on the UK Application and
relevant UK laws and regulations.
C. Nonbank Swap Dealer Minimum Capital Requirement
1. CFTC Capital Rules: Nonbank SD Minimum Capital Requirement
The CFTC Capital Rules require a nonbank SD electing the Bank-Based
Approach to maintain regulatory capital that satisfies each of the
following criteria: (i) an amount of common equity tier 1capital of at
least $20 million; (ii) an aggregate of common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital in an amount equal to or
in excess of 8 percent of the nonbank SD's uncleared swap margin
amount; (iii) an aggregate amount of common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital equal to or greater than
8 percent of the nonbank SD's total risk-weighted assets, provided that
common equity tier 1 capital comprises at least 6.5 percent of the 8
percent; and (iv) the amount of capital required by the NFA.\157\
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\157\ See 17 CFR 23.101(a)(1)(i). NFA has adopted the CFTC
minimum capital requirements for nonbank SDs, but has not adopted
additional capital requirements at this time.
---------------------------------------------------------------------------
Prong (i) above requires each nonbank SD electing the Bank-Based
Approach to maintain a minimum of $20 million of common equity tier 1
capital to operate as a nonbank SD. The requirement that each nonbank
SD electing the CFTC Bank-Based Approach maintain a minimum of $20
million of common equity tier 1 capital is also consistent with the
minimum capital requirement for nonbank SDs electing the NLA Approach
and the TNW Approach.\158\ The Commission adopted this minimum
requirement as it believed that the role a nonbank SD performs in the
financial
[[Page 8040]]
markets by engaging in swap dealing activities warranted a minimum
level of capital, stated as a fixed dollar amount that does not
fluctuate with the level of the firm's dealing activities to help
ensure the safety and soundness of the nonbank SD.\159\
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\158\ Nonbank SDs electing the NLA Approach are subject to a
minimum capital requirement that includes a fixed minimum dollar
amount of net capital of $20 million. See 17 CFR
23.101(a)(1)(ii)(A)(1). Nonbank SDs electing the TNW Approach are
required to maintain levels of tangible net worth that equals or
exceeds $20 million plus the amount of the nonbank SDs' market risk
and credit risk associated with the firms' dealing activities. See
17 CFR 23.101(a)(2)(ii)(A).
\159\ See, e.g., 85 FR 57492.
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Prong (ii) above is a minimum capital requirement that is based on
the amount of uncleared margin for swap transactions entered into by
the nonbank SD and is computed on a counterparty by counterparty basis.
The requirement for a nonbank SD to maintain minimum capital equal to
or greater than 8 percent of the firm's uncleared swap margin provides
a capital floor based on a measure of the risk and volume of the swap
positions, and the number of counterparties and the complexity of
operations, of the nonbank SD. The intent of the minimum capital
requirement based on a percentage of the nonbank SD's uncleared swap
margin was to establish a minimum capital requirement that would help
ensure that the nonbank SD meets all of its obligations as a SD to
market participants, and to cover potential operational risk, legal
risk, and liquidity risk in addition to the risks associated with its
trading portfolio.\160\
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\160\ See 85 FR 57462.
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Prong (iii) above is a minimum capital requirement that is based on
the Federal Reserve Board's capital requirements for bank holding
companies and is consistent with the BCBS international capital
framework for banking institutions. As noted above, a nonbank SD under
prong (iii) must maintain an aggregate of common equity tier 1 capital,
additional tier 1 capital, and tier 2 capital in an amount equal to or
greater than 8 percent of the nonbank SD's total risk-weighted assets,
with common equity tier 1 capital comprising at least 6.5 percent of
the 8 percent. Risk-weighted assets are a nonbank SD's on-balance sheet
and off-balance sheet exposures, including proprietary swap, security-
based swap, equity, and futures positions, weighted according to risk.
The Bank-Based Approach requires each nonbank SD to maintain regulatory
capital in an amount that equals or exceeds 8 percent of the firm's
total risk-weighted assets to help ensure that the nonbank SD's level
of capital is sufficient to absorb decreases in the value of the firm's
assets and increases in the value of the firm's liabilities, and to
cover unexpected losses resulting from business activities, including
uncollateralized defaults from swap counterparties, without the nonbank
SD becoming insolvent.
A nonbank SD must compute its risk-weighted assets using
standardized market risk and/or credit risk charges, unless the nonbank
SD has been approved by the Commission or NFA to use internal
models.\161\ For standardized market risk charges, the Commission
incorporates by reference the standardized market risk charges set
forth in Commission Regulation 1.17 for FCMs and SEC Rule 18a-1 for
nonbank SBSDs.\162\ The standardized market risk charges under
Commission Regulation 1.17 and SEC Rule 18a-1 are calculated as a
percentage of the market value or notional value of the nonbank SD's
marketable securities and derivatives positions, with the percentages
applied to the market value or notional value increasing as the
expected or anticipated risk of the positions increases.\163\ The
resulting total market risk exposure amount is multiplied by a factor
of 12.5 to cancel the effect of the 8 percent multiplication factor
applied to all of the nonbank SD's risk-weighted assets, which
effectively requires a nonbank SD to hold qualifying regulatory capital
equal to or greater than 100 percent of the amount of its market risk
exposure.\164\
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\161\ See 17 CFR 23.101(a)(1)(i)(B) and the definition of the
term BHC equivalent risk-weighted assets in 17 CFR 23.100.
\162\ See paragraph (3) of the definition of the term BHC
equivalent risk-weighted assets in 17 CFR 23.100.
\163\ See 17 CFR 240.18a-1(c)(1).
\164\ See 17 CFR 23.100 (Definition of BHC equivalent risk-
weighted assets). As noted, a nonbank SD is required to maintain
qualifying capital (i.e., an aggregate of common equity tier 1
capital, additional tier 1 capital, and tier 2 capital) in an amount
that exceeds 8 percent of its market risk-weighted assets and
credit-risk-weighted assets. The regulations, however, require the
nonbank SD to effectively maintain qualifying capital in excess of
100 percent of its market risk-weighted assets by requiring the
nonbank SD to multiply its market-risk-weighted assets by 12.5.
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With respect to standardized credit risk charges for exposures from
non-derivatives positions, a nonbank SD computes its on-balance sheet
and off-balance sheet exposures in accordance with the standardized
credit risk charges adopted by the Federal Reserve Board and set forth
in subpart D of 12 CFR 217 as if the SD itself were a bank holding
company subject to subpart D.\165\ Standardized credit risk charges are
computed by multiplying the amount of the exposure by defined
counterparty credit risk factors that range from 0 percent to 150
percent.\166\ A nonbank SD with off-balance sheet exposures is required
to calculate a credit risk charge by multiplying each exposure by a
credit conversion factor that ranges from 0 percent to 100 percent,
depending on the type of exposure.\167\ In addition to the risk-
weighted assets for general credit risk, a nonbank SD calculating risk
charges under subpart D of 12 CFR 217 must also calculate risk-weighted
assets for unsettled transactions involving securities, foreign
exchange instruments, and commodities that have a risk of delayed
settlement or delivery.
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\165\ See 17 CFR 23.101(a)(1)(i)(B) and paragraph (1) of the
definition of the term BHC equivalent risk-weighted assets in 17 CFR
23.100.
\166\ See 17 CFR 217.32. Lower credit risk factors are assigned
to entities with lower credit risk and higher credit risk factors
are assigned to entities with higher credit risk. For example, a
credit risk factor of 0% is applied to exposures to the U.S.
government, the Federal Reserve Bank, and U.S. government agencies
(see 12 CFR 217.32 (a)(1)), and a credit risk factor of 100% is
assigned to an exposure to foreign sovereigns that are not members
of the Organization of Economic Co-operation and Development (see 12
CFR 217.32(a)(2)).
\167\ See 17 CFR 217.33.
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A nonbank SD may compute standardized credit risk charges for
derivatives positions, including uncleared swaps and non-cleared
security-based swaps, using either the current exposure method
(``CEM'') or the standardized approach for measuring counterparty
credit risk (``SA-CCR'').\168\ Both CEM and SA-CCR are non-model,
rules-based, approaches to calculating counterparty credit risk
exposures for derivatives positions. Credit risk exposure under CEM is
the sum of: (i) the current exposure (i.e., the positive mark-to-
market) of the derivatives contract; and (ii) the potential future
exposure, which is calculated as the product of the notional principal
amount of the derivatives contract multiplied by a standard credit risk
conversion factor set forth in the rules of the Federal Reserve
Board.\169\ Credit risk exposure under SA-CCR is defined as the
exposure at default amount of a derivatives contract, which is computed
by multiplying a factor of 1.4 by the sum of: (i) the replacement costs
of the contract (i.e., the positive mark-to market); and (ii) the
potential future exposure of the contract.\170\
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\168\ See 17 CFR 217.34. See also, Commission Regulation 23.100
(17 CFR 23.100) defining the term BHC risk-weighted assets, which
provides that a nonbank SD that does not have model approval may use
either CEM or SA-CCR to compute its exposures for over-the-counter
derivative contracts without regard to the status of its affiliate
entities with respect to the use of a calculation approach under the
Federal Reserve Board's capital rules.
\169\ See 12 CFR 217.34.
\170\ See 12 CFR 217.132(c).
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A nonbank SD may also obtain approval from the Commission or NFA to
use internal models to compute market risk and/or credit risk charges
in lieu of the standardized charges. A nonbank SD seeking approval to
use an internal model is required to submit an
[[Page 8041]]
application to the Commission or NFA.\171\ The application is required
to include, among other things, a list of categories of positions that
the nonbank SD holds in its proprietary accounts and a brief
description of the methods that the nonbank SD will use to calculate
market risk and/or credit risk charges for such positions, as well as a
description of the mathematical models used to compute market risk and
credit risk charges.
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\171\ See 17 CFR 23.102(c).
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A nonbank SD approved by the Commission or NFA to use internal
models to compute market risk is required to comply with subpart F of
the Federal Reserve Board's Part 217 regulations (``Subpart F'').\172\
Subpart F is based on models that are consistent with the BCBS Basel
2.5 capital framework.\173\ The Commission's qualitative and
quantitative requirements for internal capital models are also
comparable to the SEC's existing internal capital model requirements
for broker-dealers in securities and SBSDs,\174\ which are broadly
based on the BCBS Basel 2.5 capital framework.
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\172\ See paragraph (4) of the definition of BHC equivalent
risk-weighted assets in 17 CFR 23.100.
\173\ Compare 17 CFR 23.100 (providing for a nonbank SD that is
approved to use internal models to calculate market and credit risk
to calculate its risk-weighted assets using subparts E and F of 12
CFR part 217), subpart F of 12 CFR, 17 CFR 23.101(a)(1)(ii)
(providing for an SD that elects the Net Liquid Assets Approach to
calculate its net capital in accordance with Rule 18a-1), and 17 CFR
23.102(a), with Basel Committee on Banking Supervision, Revisions to
the Basel II Market Risk Framework (2011), https://www.bis.org/publ/bcbs193.pdf (describing the revised internal model approach under
Basel 2.5).
\174\ The SEC internal model requirements for SBSDs are listed
in 17 CFR 240.18a-1(d).
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A nonbank SD approved to use internal models to compute credit risk
charges is required to perform such computation in accordance with
subpart E of the Federal Reserve Board's Part 217 regulations \175\ as
if the SD itself were a bank holding company subject to subpart E.\176\
The internal credit risk modeling requirements are also based on the
Basel 2.5 capital framework and the Basel 3 capital framework. A
nonbank SD that computes its credit risk charges using internal models
must multiply the resulting capital requirement by a factor of
12.5.\177\
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\175\ 12 CFR 217 subpart E.
\176\ See 85 FR 57462 at 57496.
\177\ 12 CFR 217.131(e)(1)(iii), 217.131(e)(2)(iv), and
217.132(d)(9)(iii).
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In adopting the final Bank-Based Approach rules, the Commission
also noted that in choosing an alternative calculation, the nonbank SD
must adopt the entirety of the alternative. As such, if the nonbank SD
is calculating its risk-weighted assets using the regulations in
subpart E of 12 CFR 217, the nonbank SD must include charges reflecting
all categories of risk-weighted assets applicable under these
regulations, which include among other things, charges for operational
risk, CVA of OTC derivatives contracts, and unsettled transactions
involving securities, foreign exchange instruments, and commodities
that have a risk of delayed settlement or delivery.\178\ The capital
charge for operational risk and CVA of OTC derivatives contracts
calculated in accordance with subpart E of 12 CFR 217 must also be
multiplied by a factor of 12.5.\179\
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\178\ Settlement risk for OTC derivatives contracts is addressed
as part of the counterparty-credit risk calculation methodology
described in 12 CFR 217.132.
\179\ 12 CFR 217.162(c) (operational risk) and 217.132(e)(4)
(CVA of OTC derivative contracts).
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Under the Basel 2.5 capital framework, nonbank SDs have flexibility
in developing their internal models, but must follow certain minimum
standards. Internal market risk and credit risk models must follow a
Value-at-Risk (``VaR'') structure to compute, on a daily basis, a 99th
percentile, one-tailed confidence interval for the potential losses
resulting from an instantaneous price shock equivalent to a 10-day
movement in prices (unless a different time-frame is specifically
indicated). The simulation of this price shock must be based on a
historical observation period of minimum length of one year, but there
is flexibility on the method used to render simulations, such as
variance-covariance matrices, historical simulations, or Monte Carlo.
The Commission and the Basel standards for internal models also
have requirements on the selection of appropriate risk factors as well
as on data quality and update frequency.\180\ One specific concern is
that internal models must capture the non-linear price characteristics
of options positions, including but not limited to, relevant
volatilities at different maturities.\181\
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\180\ See 17 CFR appendix A to subpart E of part 23(i)(2)(iii),
and Basel Committee on Banking Supervision, Revisions to the Basel
II Market Risk Framework (2011), paragraph 718(Lxxvi)(e), available
at: https://www.bis.org/publ/bcbs193.pdf.
\181\ The Commission's requirement is set forth in paragraph
(i)(2)(iv)(A) of appendix A to subpart E of 17 CFR part 23. See
also, Basel Committee on Banking Supervision, Revisions to the Basel
II Market Risk Framework (2011), paragraph 718(Lxxvi)(h), available
at: https://www.bis.org/publ/bcbs193.pdf.
---------------------------------------------------------------------------
In addition, BCBS standards for market risk models include a series
of additive components for risks for which the broad VaR is ill-suited
or that may need targeted calculation. These include the calculation of
a Stressed VaR measure (with the same specifications as the VaR, but
calibrated to historical data from a continuous 12-month period of
significant financial stress relevant to the firm's portfolio); a
Specific Risk measure (which includes the effect of a specific
instrument); an Incremental Risk measure (which addresses changes in
the credit rating of a specific obligor which may appear as a reference
in an asset); and a Comprehensive Risk measure (which addresses risk of
correlation trading positions).
2. UK PRA Capital Rules: PRA-Designated UK Nonbank Swap Dealer Minimum
Capital Requirements
The UK PRA Capital Rules impose bank-like capital requirements on a
PRA-designated UK nonbank SD that, consistent with the BCBS
international bank capital framework, require the PRA-designated UK
nonbank SD to hold a sufficient amount of qualifying equity capital and
subordinated debt based on the PRA-designated UK nonbank SD's
activities to absorb decreases in the value of firm assets and
increases in the value of the firm's liabilities, and to cover losses
from its business activities, including possible counterparty defaults
and margin collateral shortfalls associated with the firm's swap
dealing activities, without the firm becoming insolvent. Specifically,
the UK PRA Capital Rules require each PRA-designated UK nonbank SD to
maintain sufficient levels of capital to satisfy the following capital
ratios, expressed as a percentage of the PRA-designated UK nonbank SD's
total risk exposure amount (i.e., the sum of the PRA-designated UK
nonbank SD's risk-weighted assets and exposures): (i) a common equity
tier 1 capital ratio of 4.5 percent; \182\ (ii) a tier 1 capital ratio
of 6 percent; \183\ and (iii) a total capital ratio of 8 percent.\184\
The UK PRA Capital Rules further require a PRA-designated UK nonbank SD
to maintain a capital conservation buffer composed of common equity
capital tier 1 capital in amount equal to 2.5 percent of the firm's
total risk exposure.\185\ The common equity tier 1 capital used to
[[Page 8042]]
meet the capital conservation buffer must be separate and in addition
to the 4.5 percent of common equity tier 1 capital that the PRA-
designated UK nonbank is required to maintain in meeting its core 8
percent capital requirement.\186\ Thus, a PRA-designated UK nonbank SD
is required to maintain regulatory capital equal to at least 10.5
percent of its total risk exposure amount, with common equity tier 1
capital comprising at least 7 percent of the regulatory capital (4.5
percent of the core capital plus the 2.5 percent capital conservation
buffer).
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\182\ UK CRR, Article 92(1)(a).
\183\ Id., Article 92(1)(b). Tier 1 capital is the sum of the
PRA-designated UK nonbank SD's common equity tier 1 capital and
additional tier 1 capital.
\184\ Id., Article 92(1)(c). The total capital is the sum of the
PRA-designated UK nonbank SD's tier 1 capital and tier 2 capital.
\185\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 2
Capital Conservation Buffer, Rule 2.1.
\186\ Id. A PRA-designated UK nonbank SD may also be required to
maintain a countercyclical capital buffer composed of common equity
tier 1 capital equal to the firm's total risk exposure multiplied by
an institution-specific countercyclical buffer rate. The
institution-specific countercyclical capital buffer rate is
determined by calculating the weighted average of the
countercyclical buffer rates that apply in the jurisdictions in
which the PRA-designated UK nonbank SD has relevant credit
exposures. See PRA Rulebook, CRR Firms, Capital Buffers Part,
Chapter 3 Countercyclical Capital Buffer. The rate for each
jurisdiction is determined by the UK Financial Policy Committee or a
third country countercyclical buffer authority, as applicable. See
PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 3
Countercyclical Capital Buffer, Rule 3.1., and Capital Requirements
(Capital Buffers and Macro-prudential Measures) Regulations 2014,
Articles 7-20. In practice, the countercyclical buffer rate in the
UK, as of July 2023, is 2 percent of risk-weighted assets. The
countercyclical capital buffer rate is published by the Bank of
England, and is available at: https://bankofengland.co.uk/financial-stability/the-countercyclical-capital-buffer. Several EU Member
States of relevance to the UK have also implemented countercyclical
capital buffers with rates ranging from 0.5 percent to 2.5 percent
of risk-weighted assets.
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A PRA-designated UK nonbank SD's total risk exposure amount is
calculated as the sum of the firm's: (i) capital requirements for
market risk; (ii) risk-weighted exposure amounts for credit risk; (iii)
capital requirements for settlement risk; (iv) capital requirements for
CVA risk of OTC derivatives instruments; and (v) capital requirements
for operational risk.\187\ Capital charges for market risk and risk-
weighted exposures for credit risk are computed based on the PRA-
designated UK nonbank SD's on-balance sheet and off-balance sheet
exposures, including proprietary swap, security-based swap, equity, and
futures positions, weighted according to risk.\188\ Settlement risk
capital charges reflect the price difference to which a PRA-designated
UK nonbank SD is exposed if its transactions in debt instruments,
equity, foreign currency, and commodities remain unsettled after the
respective product's due delivery date.\189\ CVA is an adjustment to
the mid-market value of the portfolio of OTC derivative transactions
with a counterparty and reflects the current market value of the credit
risk of the counterparty to the PRA-designated UK nonbank SD.\190\
Operational risk capital charges reflect the risk of loss resulting
from inadequate or failed internal processes, people and systems or
from external events, and includes legal risk.\191\
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\187\ UK CRR, Article 92(3).
\188\ To compute capital requirements for market risk, PRA-
designated UK nonbank SDs are required to calculate capital charges
for all trading book positions and non-trading book positions that
are subject to foreign exchange or commodity risk. See UK CRR,
Article 325. The risk-weighted exposure amounts for credit risk
include: (i) risk-weighted exposure amounts for credit risk and
dilution risk in respect of all the business activities of the PRA-
designated UK nonbank SD, excluding risk-weighted exposure amounts
from the trading book business of the firm; and (ii) risk-weighted
exposure amounts for counterparty risk arising from the trading book
business for certain derivatives transactions, repurchase
agreements, securities or commodities lending or borrowing
transactions, margin lending or long settlement transactions. See UK
CRR, Article 92(3)(a) and (f).
\189\ UK CRR, Article 378. Settlement risk is calculated as 8
percent, 50 percent, 75 percent, or 100 percent of the price
difference for transactions that are not settled within 5 to 15
business days, 16 to 30 business days, 31 to 45 business days, or 46
or more business days, respectively, from the due settlement date.
\190\ Id., Article 381.
\191\ Id., Article 4(1)(52).
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To compute its total risk exposure amount, a PRA-designated UK
nonbank SDs is also required to multiply the capital requirements for
market risk, settlement risk, CVA risk, and operational risk,
calculated in accordance with the UK PRA Capital Rules, by a factor of
12.5, which effectively requires a PRA-designated UK nonbank SD to hold
qualifying regulatory capital equal to or greater than the full amount
of the relevant risk exposures.\192\ The formulae for calculating risk-
weighted exposure amounts for credit risk also include a 12.5
multiplication factor.\193\
---------------------------------------------------------------------------
\192\ Id., Article 92(4).
\193\ Id., Article 153 et seq.
---------------------------------------------------------------------------
Consistent with the Commission's Bank-Based Approach and the BCBS
capital framework, the UK PRA Capital Rules require PRA-designated UK
nonbank SDs to compute market risk exposures and credit risk exposures
using a standardized approach or, if approved by the PRA, internal risk
models.\194\ In addition, UK PRA Capital Rules, consistent with the
BCBS capital framework, require PRA-designated UK nonbank SDs to
compute capital charges for CVA risk and operational risk using
standardized approaches, unless approved to use internal models by the
PRA.\195\
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\194\ With the permission of the PRA, a PRA-designated UK
nonbank SD may use internal models to calculate market risk (see UK
CRR, Article 363) and credit risk (see UK CRR, Articles 143 and
283).
\195\ See UK CRR, Articles 382-384 for CVA risk calculations;
and Article 312(2) for operational risk.
---------------------------------------------------------------------------
PRA-designated UK nonbank SDs calculate standardized market risk
charges generally by multiplying the notional or carrying amount of net
positions by risk-weighting factors, which are based on the underlying
market risk of each asset or exposure and increase as the expected risk
of the positions increase. Market risk requirements for debt
instruments and equity instruments are calculated separately under the
standardized approach, and are each calculated as the sum of specific
risk and general risk of the positions.\196\ Securitizations are
treated as debt instruments for market risk requirements,\197\ whereas
derivative positions are generally treated as exposures on their
underlying assets,\198\ with options being delta-adjusted.\199\
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\196\ Id., Article 326.
\197\ Id. See also UK CRR, Articles 334-340 (provisions related
to debt instruments) and 341-343 (provisions related to equities).
\198\ Id., Articles 328-330, 358.
\199\ Id., Article 329.
---------------------------------------------------------------------------
The UK PRA Capital Rules also require PRA-designated UK nonbank SDs
to include in their risk-weighted assets market risk exposures to
certain foreign currency and gold positions. Specifically, a PRA-
designated UK nonbank SD with net positions in foreign exchange and
gold that exceed 2 percent of the firm's total capital must calculate
capital requirements for foreign exchange risk.\200\ The capital
requirement for foreign exchange risk under the standardized approach
is 8 percent of the PRA-designated UK nonbank SD's net positions in
foreign exchange and gold.\201\
---------------------------------------------------------------------------
\200\ Id., Article 351.
\201\ Id.
---------------------------------------------------------------------------
The UK PRA Capital Rules further require PRA-designated UK nonbank
SDs to include exposures to commodity positions in calculating the
firm's risk-weighted assets. The standardized calculation of commodity
risk exposures may follow one of three approaches depending on type of
position or exposure. The first is the sum of a flat percentage rate
for net positions, with netting allowed among tightly defined sets,
plus another flat percentage rate for the gross position.\202\ The
other two standardized approaches are based on maturity-ladders, where
unmatched portions of each maturity band (i.e., portions that do not
net out to zero) are charged at a step-up rate in comparison
[[Page 8043]]
to the base charges for matched portions.\203\
---------------------------------------------------------------------------
\202\ Id., Article 360.
\203\ Id., Articles 359 and 361.
---------------------------------------------------------------------------
With respect to credit risk, the UK PRA Capital Rules require a
PRA-designated UK nonbank SD to calculate its standardized credit risk
exposure in a manner aligned with the Commission's Bank-Based Approach
and the BCBS framework by taking the carrying value or notional value
of each of the PRA-designated UK nonbank SD's on-balance sheet and off-
balance sheet exposures, making certain additional credit risk
adjustments, and then applying specific risk-weights based on the type
of counterparty and the asset's credit quality.\204\ For instance,
credit exposures to the ECB, the UK government, and the Bank of England
carry a zero percent risk-weight; exposures to other central
governments and central banks may carry risk-weights between 0 and 150,
depending on the credit rating available for the central government or
central bank; and exposures to banks, PRA-designated investment firms,
or other businesses may carry risk-weights between 20 percent and 150
percent depending on the credit ratings available for the entity or,
for exposures to banks and investment firms, for the central government
of the jurisdiction in which the entity is incorporated.\205\ If no
credit rating is available, the PRA-designated UK nonbank SD must
generally apply a 100 percent risk-weight, meaning the total accounting
value of the exposure is used.\206\
---------------------------------------------------------------------------
\204\ Id., Articles 111 and 113(1).
\205\ Id., Articles 114-122.
\206\ Id., Articles 121(2) and 122(2).
---------------------------------------------------------------------------
With respect to counterparty credit risk for derivatives
transactions and certain other agreements that give rise to bilateral
credit risk, the UK PRA Capital Rules require a PRA-designated UK
nonbank SD that is not approved to use credit risk models to calculate
its exposure using the standardized approach for counterparty credit
risk (i.e., SA-CCR),\207\ which is one of the methods that a nonbank SD
may use to calculate its credit risk exposure under a derivatives
transaction pursuant to the Commission's Bank-Based Approach.\208\ The
exposure amount under the SA-CCR is computed, under both the UK PRA
Capital Rules and the Commission's Bank-Based Approach, as the sum of
the replacement cost of the contract and the potential future exposure
of the contract, multiplied by a factor of 1.4.\209\
---------------------------------------------------------------------------
\207\ UK CRR, Articles 92(3)(f) and PRA Rulebook, CRR Firms,
Counterparty Credit Risk (CRR) Part, Chapter 3 Counterparty Credit
Risk (Part Three, Title Two, Chapter Six CRR). PRA-designated UK
nonbank SDs with smaller-sized derivatives business may also use a
``simplified standardized approach to counterparty credit risk'' or
an ``original exposure method'' as simpler methods for calculating
exposure values. PRA Rulebook, CRR Firms, Counterparty Credit Risk
(CRR) Part, Chapter 3 Counterparty Credit Risk (Part Three, Title
Two, Chapter Six CRR), Articles 281-282. To use either of these
alternative methods, an entity's on-and off-balance sheet
derivatives business must be equal or less than 10 percent of the
entity's total assets and GBP 260 million or 5 percent of the
entity's total assets and GBP 88 million, respectively. PRA
Rulebook, CRR Firms, Counterparty Credit Risk (CRR) Part, Chapter 3
Counterparty Credit Risk (Part Three, Title Two, Chapter Six CRR),
Article 273a.
\208\ 12 CFR 217.34.
\209\ PRA Rulebook, CRR Firms, Counterparty Credit Risk (CRR)
Part, Chapter 3 Counterparty Credit Risk (Part Three, Title Two,
Chapter Six CRR), Article 274 and 12 CFR 217.132(c).
---------------------------------------------------------------------------
UK PRA Capital Rules also require a PRA-designated UK nonbank SD to
calculate capital requirements for settlement risk.\210\ Consistent
with the BCBS framework, the capital charge for settlement risk for
transactions settled on a delivery-versus-payment basis is computed by
multiplying the price difference to which a PRA-designated UK nonbank
SD is exposed as a result of an unsettled transaction by a percentage
factor that varies from 8 percent to 100 percent based on the number of
working days after the due settlement date during which the transaction
remains unsettled.\211\ The CFTC's Bank-Based Approach provides for a
similar calculation methodology for risk-weighted asset amounts for
unsettled transactions involving securities, foreign exchange
instruments, and commodities.\212\
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\210\ UK CRR, Article 378 (indicating that if transactions in
which debt instruments, equities, foreign currencies and commodities
excluding repurchase transactions and securities or commodities
lending and securities or commodities borrowing are unsettled after
their due delivery dates, a PRA-designated UK nonbank SD must
calculate the price difference to which it is exposed).
\211\ Id. The price difference to which a PRA-designated UK
nonbank SD is exposed is the difference between the agreed
settlement price for an instrument (i.e., a debt instrument, equity,
foreign currency or commodity) and the instrument's current market
value, where the difference could involve a loss for the firm. UK
CRR, Article 378.
\212\ 17 CFR 23.100 (definition of BHC equivalent risk-weighted
assets), 12 CFR 217.38 and 12 CFR 217.136.
---------------------------------------------------------------------------
Consistent with the BCBS framework, a PRA-designated UK nonbank SD
is also required to calculate capital charges for CVA risk for OTC
derivative instruments \213\ to reflect the current market value of the
credit risk of the counterparty to the PRA-designated UK nonbank
SD.\214\ CVA can be calculated following similar methodologies as those
described in subpart E of the Federal Reserve Board's part 217
regulations.\215\
---------------------------------------------------------------------------
\213\ UK CRR, Article 382 (1). CVA risk charges need not be
calculated for credit derivatives recognized to reduce risk-weighted
exposure amounts for credit risk. Id.
\214\ Id., Article 381. CVA is defined to exclude debit
valuation adjustment.
\215\ See UK CRR, Articles 383-384 and 12 CFR 217.132(e)(5) and
(6). Under the CFTC's Bank-Based Approach, nonbank SDs calculating
their credit risk-weighted assets using the regulations in subpart D
of the Federal Reserve Board's part 217 regulations, do not
calculate CVA of OTC derivatives instruments.
---------------------------------------------------------------------------
A PRA-designated UK nonbank SD's total risk exposure amount also
includes operational risk charges. Consistent with the BCBS framework,
PRA-designated UK nonbank SDs may calculate standardized operational
risk charges using either one of two approaches--the Basic Indicator
Approach or the Standardized Approach.\216\ Both the Basic Indicator
Approach and the Standardized Approach use as a calculation basis the
three-year average of the ``relevant indicator,'' which is the sum of
certain items on the statement of income/loss (i.e., the firm's net
interest income and net non-interest income). Under the Basic Indicator
Approach, PRA-designated UK nonbank SDs are required to multiply the
relevant indicator by a factor of 15 percent. When using the
Standardized Approach, firms need to allocate the relevant indicator
into eight business lines specified by regulation (e.g., trading and
sales; retail brokerage; corporate finance) and multiply the
corresponding portion by a percentage factor ranging from 12 to 18
percent depending on the business line. The capital requirements for
operational risk are calculated as the sum of the individual business
lines' charges.
---------------------------------------------------------------------------
\216\ UK CRR, Article 312 and PRA Rulebook, CRR Firms,
Operational Risk (CRR) Part.
---------------------------------------------------------------------------
As noted above, if approved by the PRA, a PRA-designated UK nonbank
SD may use internal models to calculate its market risk charges, credit
risk charges, including counterparty credit risk charges, CVA risk
charges, and operational risk charges in lieu of using a standardized
approach.\217\ To obtain permission, a PRA-designated UK nonbank SD
must demonstrate to the satisfaction of the PRA that it meets
[[Page 8044]]
certain conditions for the use of models.\218\
---------------------------------------------------------------------------
\217\ UK CRR, Articles 143 (credit risk), 283 (counterparty
credit risk), 312 (operational risk), 363 (market risk) and 383 (CVA
risk). PRA-designated UK nonbank SDs are not permitted, however, to
calculated counterparty credit risk charges using internal models
when calculating large exposures. PRA Rulebook, CRR Firms, Large
Exposures (CRR) Part, Chapter 4 Large Exposures (Part Four CRR),
Article 390.
\218\ UK CRR, Articles 143, 283, 312(2) and 363(1).
---------------------------------------------------------------------------
With respect to market risk, the PRA may grant a PRA-designated UK
nonbank SD permission to use internal models to calculate one or more
of the following risk categories: (i) general risk of equity
instruments, (ii) specific risk of equity instruments, (iii) general
risk of debt instruments, (iv) specific risk of debt instruments, (v)
foreign exchange risk, or (vi) commodities risk,\219\ along with
interest rate risk on derivatives.\220\ To obtain approval to use a
market risk model, a PRA-designated UK nonbank SD must meet conditions
related to specified model elements and controls including risk and
stressed risk calculations,\221\ back-testing and multiplication
factors,\222\ risk measurement requirements,\223\ governance and
qualitative requirements,\224\ internal validation,\225\ and specific
requirements by risk categories.\226\ A PRA-designated UK nonbank SD
approved to use models must also obtain approval from the PRA to
implement a material change to the model or make a material extension
to the use of the model.\227\ The UK PRA Capital Rules' market risk
model-based methodology is based on the Basel 2.5 standard \228\ and
incorporates relevant aspects of the BCBS framework in terms of
requiring PRA-designated UK nonbank SDs with model approval to use a
VaR model with a 99 percent, one-tailed confidence level with: (i)
price changes equivalent to a 10-business day movement in rates and
prices, (ii) effective historical observation periods of at least one
year, and (iii) at least monthly data set updates.\229\ The UK PRA
Capital Rules also include a framework for governance that includes
requirements related to the implementation of independent risk
management,\230\ senior management's involvement in the risk-control
process,\231\ establishment of procedures for monitoring and ensuring
compliance with a documented set of internal policies and
controls,\232\ and the conducting of independent review of the models
as part of the internal audit process.\233\
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\219\ Id., Article 363(1).
\220\ Id., Article 331(1), using sensitivity models.
\221\ Id., Articles 364-365.
\222\ Id., Article 366.
\223\ Id., Article 367.
\224\ Id., Article 368.
\225\ Id., Article 369.
\226\ Id., Articles 364-377.
\227\ Id., Article 363(3).
\228\ Compare UK CRR, Articles 362-377 with Revisions to the
Basel II Market Risk Framework.
\229\ UK CRR, Article 365(1).
\230\ Id., Articles 368 (1)(b).
\231\ Id., Articles 368 (1)(c).
\232\ Id., Articles 368 (1)(e).
\233\ Id., Articles 368 (1)(h).
---------------------------------------------------------------------------
With regulatory permission, PRA-designated UK nonbank SDs may also
use models to calculate credit risk exposures.\234\ Credit risk models
may include internal ratings based on the estimation of default
probabilities and loss given default, consistent with the BCBS
framework and subject to similar model risk management guidelines.\235\
To obtain approval for the use of internal ratings-based models, a PRA-
designated UK nonbank SD must meet requirements related to, among other
things, the structure of its rating systems and its criteria for
assigning exposures to grades and pools within a rating system, the
parameters of risk quantification, the validation of internal
estimates, and the internal governance and oversight of the rating
systems and estimation processes.\236\
---------------------------------------------------------------------------
\234\ Id., Article 143.
\235\ Id.
\236\ Id., Articles 170-177 (rating systems), 178-184 (risk
quantification), 185 (validation of internal estimates), and 189-191
(internal governance and oversight).
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In addition, subject to regulatory approval, PRA-designated UK
nonbank SDs may use internal models to calculate counterparty credit
risk exposures for derivatives, securities financing, and long
settlement transactions.\237\ The prerequisites for approval for such
models include requirements related to the establishment and
maintenance of a counterparty credit risk management framework, stress
testing, the integrity of the modelling process, the risk management
system, and validation.\238\ The UK PRA Capital Rules' internal
counterparty credit risk model-based methodology is also based on the
Basel 2.5 standard.\239\ The UK PRA Capital Rules allow for the
estimation of expected exposure as a measure of the average of the
distribution of exposures at a particular future date,\240\ with
adjustments to the period of risk, as appropriate to the asset and
counterparty.
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\237\ Id., Article 283. As noted above, however, PRA-designated
UK nonbank SDs are not permitted to calculate counterparty credit
risk charges using internal models when calculating large exposures.
PRA Rulebook, CRR Firms, Large Exposures (CRR) Part, Chapter 4 Large
Exposures (Part Four CRR), Article 390.
\238\ Id., Articles 283-294.
\239\ Compare UK CRR, Article 362-377 with Revisions to the
Basel II Market Risk Framework.
\240\ UK CRR, Article 272(19), 283-285.
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PRA-designated UK nonbank SDs may also obtain regulatory permission
to use ``advanced measurement approaches'' based on their own
operational risk measurement systems, to calculate capital charges for
operational risk. To obtain such permission, PRA-designated UK nonbank
SDs must meet qualitative and quantitative standards, as well as
general risk management standards set forth in the UK PRA Capital
Rules.\241\ Specifically, among other qualitative standards, PRA-
designated UK nonbank SDs must meet requirements related to the
governance and documentation of their operational risk management
processes and measurement systems.\242\ In addition, PRA-designated UK
nonbank SDs must meet quantitative standards related to process, data,
scenario analysis, business environment and internal control factors
laid down in the UK PRA Capital Rules.\243\
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\241\ UK CRR, Article 312(1), cross-referencing UK CRR, Articles
321 and 322; PRA Rulebook, CRR Firms, General Organizational
Requirements Part, Rules 2.1 and 2.2; and PRA Rulebook, CRR Firms,
Internal Liquidity Adequacy Assessment Part.
\242\ UK CRR, Article 321.
\243\ Id., Article 322.
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As an additional element to the capital requirements, the UK PRA
Capital Rules further impose a 3.25 percent leverage ratio floor on
PRA-designated UK nonbank SDs that hold significant amounts of non-UK
assets.\244\ Specifically, a PRA-designated UK nonbank SD that has non-
UK assets equal to or greater than GBP 10 billion is required to
maintain an aggregate amount of common equity tier 1 capital and
additional tier 1 capital equal to or in excess of 3.25 percent of the
firm's on-balance sheet and off-balance sheet exposures, including
exposures on uncleared swaps but excluding certain exposures to central
banks, without regard to any risk-weighting.\245\ For the purposes of
complying with the leverage ratio requirement, at least 75 percent of
the firm's tier 1 capital must consist of common equity tier 1
capital.\246\ The leverage ratio is a non-risk based minimum capital
requirement that is intended to prevent a PRA-designated
[[Page 8045]]
UK nonbank SD from engaging in excessive leverage, and complements the
risk-based minimum capital requirement that is based on the PRA-
designated UK nonbank SD's risk-weighted assets.
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\244\ PRA Rulebook, CRR Firms, Leverage Ratio--Capital
Requirements and Buffers Part, Chapter 1 Application and Definitions
and Chapter 3 Minimum Leverage Ratio.
\245\ Total exposures are required to be computed in accordance
with PRA Rulebook, CRR Firms, Leverage Ratio (CRR) Part, Chapter 3
Leverage Ratio (Part Seven CRR), Article 429 et seq. A PRA-
designated UK nonbank SD may also be subject to a countercyclical
leverage ratio buffer of common equity tier 1 capital equal to the
firm's institution-specific countercyclical capital buffer rate
multiplied by 35 percent, multiplied by the firm's total exposures.
PRA Rulebook, CRR Firms, Leverage Ratio--Capital Requirements and
Buffers Part, Chapter 4 Countercyclical Leverage Ratio Buffer.
\246\ PRA Rulebook, CRR Firms, Leverage Ratio--Capital
Requirements and Buffers Part, Chapter 3 Minimum Leverage Ratio,
Rule 3.2.
---------------------------------------------------------------------------
Furthermore, the UK PRA Capital Rules also impose a separate
liquidity coverage requirement on a PRA-designated UK nonbank SD to
address liquidity risk. The liquidity coverage requirement provides
that PRA-designated UK nonbank SDs must hold liquid assets in an amount
sufficient to cover liquidity outflows (less liquidity inflows) under
stressed conditions over a period of 30 days.\247\ For purposes of the
liquidity coverage requirement, the term ``stressed'' means a sudden or
severe deterioration in the solvency or liquidity position of a firm
due to changes in market conditions or idiosyncratic factors as a
result of which there is a significant risk that the firm becomes
unable to meet its commitments as they become due within the next 30
days.\248\ In addition, Article 413 of UK CRR, which has been
incorporated into the PRA Rulebook, establishes a general requirement
that firms ensure that long-term obligations and off-balance sheet
items are adequately met with a diverse set of funding instruments that
are stable under both normal and stressed conditions.\249\
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\247\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 412(1).
\248\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 411(10).
\249\ PRA Rulebook, CRR Firms, Liquidity (CRR) Part, Chapter 4
Liquidity (Part Six CRR), Article 413(1).
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The UK PRA Capital Rules also require PRA-designated UK nonbank SDs
to maintain at all times a minimum base capital requirement of GBP
750,000.\250\
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\250\ PRA Rulebook, CRR Firms, Definition of Capital Part,
Chapter 12 Base Capital Resource Requirement, Rule 12.1.
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3. Commission Analysis
The Commission has reviewed the UK Application and the relevant UK
laws and regulations, and has preliminarily determined that the UK PRA
Capital Rules are comparable in purpose and effect to the CFTC Capital
Rules with regard to the establishment of the nonbank SD's minimum
capital requirement and the calculation of the nonbank SD's amount of
regulatory capital to meet that requirement.\251\ Although there are
differences between the UK PRA Capital Rules and the CFTC Capital
Rules, as discussed below, the Commission preliminarily believes that
the UK PRA Capital Rules and the CFTC Capital Rules are designed to
ensure the safety and soundness of a nonbank SD and, subject to the
proposed conditions discussed below, will achieve comparable outcomes
by requiring the firm to maintain a minimum level of qualifying
regulatory capital, including subordinated debt, to absorb losses from
the firm's business activities, including swap dealing activities, and
decreases in the value of the firm's assets and increases in the value
of the firm's liabilities, without the nonbank SD becoming insolvent.
The Commission's preliminary finding of comparability is based on a
comparative analysis of the three minimum capital requirements
thresholds of the CFTC Capital Rules' Bank-Based Approach (i.e., the
three prongs recited in Section III.C.1. above) and the respective
elements of the UK PRA Capital Rules' requirements, as discussed below.
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\251\ The Commission notes that pursuant to Article 7 of UK CRR,
the PRA may exempt an entity subject to UK CRR from the applicable
capital requirements, provided certain conditions are met. In such
case, the relevant requirements would apply to the entity's parent
entity, on a consolidated basis. The Commission's assessment does
not cover the application of Article 7 of UK CRR and therefore an
entity that benefits from an exemption under Article 7 of UK CRR
would not qualify for substituted compliance under the Capital
Comparability Determination Order.
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a. Fixed Amount Minimum Capital Requirement
CFTC Capital Rules and the UK PRA Capital Rules both require
nonbank SDs to hold a minimum amount of regulatory capital that is not
based on the risk-weighted assets of the firms. Prong (i) of the CFTC
Capital Rules requires each nonbank SD electing the Bank-Based Approach
to maintain a minimum of $20 million of common equity tier 1 capital.
The CFTC's $20 million fixed-dollar minimum capital requirement is
intended to ensure that each nonbank SD maintains a level of regulatory
capital, without regard to the level of the firm's dealing and other
activities, sufficient to meet its obligations to swap market
participants given the firm's status as a CFTC-registered nonbank SD
and to help ensure the safety and soundness of the nonbank SD.\252\ The
UK PRA Capital Rules also contain a requirement that a PRA-designated
UK nonbank SD maintain a fixed amount of minimum initial capital of GBP
750,000.\253\
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\252\ 85 FR 57492.
\253\ PRA Rulebook, CRR Firms, Definition of Capital Part,
Chapter 12 Base Capital Resource Requirement, Rule 12.1.
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The Commission recognizes that the $20 million fixed-dollar minimum
capital required under the CFTC Capital Rules is substantially higher
than the GBP 750,000 minimum base capital required under the UK PRA
Capital Rules and the Commission preliminarily believes that the $20
million represents a more appropriate level of minimum capital to help
ensure the safety and soundness of the nonbank SD that is engaging in
uncleared swap transactions. Accordingly, the Commission is proposing
to condition the Capital Comparability Determination Order to require
each PRA-designated UK nonbank SD to maintain, at all times, a minimum
level of $20 million regulatory capital in the form of common equity
tier 1 items as defined in Article 26 of UK CRR.\254\ The proposed
condition would require each PRA-designated UK nonbank SD to maintain
an amount of common equity tier 1 capital denominated in British pound
that is equivalent to the $20 million in U.S. dollars.\255\ The
Commission is also proposing that a PRA-designated UK nonbank SD may
convert the pound-denominated common equity tier 1 capital amount to
the U.S. dollar equivalent based on a commercially reasonable and
observable exchange rate.
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\254\ The Commission notes that the proposed requirement that
PRA-designated UK nonbank SDs maintain a minimum level of $20
million of common equity tier 1 capital is consistent with
conditions set forth in the proposed Capital Comparability
Determination Orders for Japan, Mexico, and the EU, respectively.
See, Notice of Proposed Order and Request for Comment on an
Application for a Capital Comparability Determination from the
Financial Services Agency of Japan, 87 FR 48092 (Aug. 8, 2022)
(``Proposed Japan Order''); Notice of Proposed Order and Request for
Comment on an Application for a Capital Comparability Determination
Submitted on behalf of Nonbank Swap Dealers subject to Regulation by
the Mexican Comision Nacional Bancaria y de Valores, 87 FR 76374
(Dec. 13, 2022) (``Proposed Mexico Order''); and Notice of Proposed
Order and Request for Comment on an Application for a Capital
Comparability Determination Submitted on Behalf of Nonbank Swap
Dealers Domiciled in the French Republic and Federal Republic of
Germany and Subject to Capital and Financial Reporting Requirements
of the European Union (June 27, 2023) (``Proposed EU Order'').
\255\ Each of the six current PRA-designated UK nonbank SDs
currently maintains common equity tier 1 capital in excess of $20
million based on financial filings made with the Commission.
Therefore, the Commission does not anticipate that the proposed
condition would have any material impact on the PRA-designated UK
nonbank SDs currently registered with the Commission. Nonetheless,
the Commission requests comment on the proposed condition.
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b. Minimum Capital Requirement Based on Risk-Weighted Assets
Prong (iii) of the CFTC Capital Rules requires each nonbank SD to
maintain an aggregate of common equity tier 1 capital, additional tier
1 capital, and tier 2 capital in an amount equal to or
[[Page 8046]]
greater than 8 percent of the nonbank SD's total risk-weighted assets,
with common equity tier 1 capital comprising at least 6.5 percent of
the 8 percent.\256\ Risk-weighted assets are a nonbank SD's on-balance
sheet and off-balance sheet market risk and credit risk exposures,
including exposures associated with proprietary swap, security-based
swap, equity, and futures positions, weighted according to risk. The
requirements and capital ratios set forth in prong (iii) are based on
the Federal Reserve Board's capital requirements for bank holding
companies and are consistent with the BCBS international bank capital
adequacy framework. The requirement for each nonbank SD to maintain
regulatory capital in an amount that equals or exceeds 8 percent of the
firm's total risk-weighted assets is intended to help ensure that the
nonbank SD's level of capital is sufficient to absorb decreases in the
value of the firm's assets and increases in the value of the firm's
liabilities, and to cover unexpected losses resulting from the firm's
business activities, including losses resulting from uncollateralized
defaults from swap counterparties, without the nonbank SD becoming
insolvent.
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\256\ 17 CFR 23.101(a)(1)(B).
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The UK PRA Capital Rules contain capital requirements for PRA-
designated UK nonbank SDs that the Commission preliminarily believes
are comparable to the requirements contained in prong (iii) of the CFTC
Capital Rules. Specifically, the UK PRA Capital Rules require a PRA-
designated UK nonbank SD to maintain: (i) common equity tier 1 capital
equal to at least 4.5 percent of the PRA-designated UK nonbank SD's
total risk exposure amount; (ii) total tier 1 capital (i.e., common
equity tier 1 capital plus additional tier 1 capital) equal to at least
6 percent of the PRA-designated UK nonbank SD's total risk exposure
amount; and (iii) total capital (i.e., an aggregate amount of common
equity tier 1 capital, additional tier 1 capital, and tier 2 capital)
equal to at least 8 percent of the PRA-designated UK nonbank SD's total
risk exposure amount.\257\ In addition, the UK PRA Capital Rules
further require each PRA-designated UK nonbank SD to maintain an
additional capital conservation buffer equal to 2.5 percent of the PRA-
designated UK nonbank SD's total risk exposure amount, which must be
met with common equity tier 1 capital.\258\ Thus, a PRA-designated UK
nonbank SD is effectively required to maintain total qualifying
regulatory capital in an amount equal to or in excess of 10.5 percent
of the market risk, credit risk, CVA risk, settlement risk and
operational risk of the firm (i.e., total capital requirement of 8
percent of risk-weighted assets and an additional 2.5 percent of risk-
weighted assets as a capital conservation buffer), which is higher than
the 8 percent required of nonbank SDs under prong (iii) of the CFTC
Capital Rules.\259\
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\257\ UK CRR, Article 92(1).
\258\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 2
Capital Conservation Buffer.
\259\ UK CRR, Article 92(1) and PRA Rulebook, CRR Firms, Capital
Buffers Part, Chapter 2 Capital Conservation Buffer.
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The Commission also preliminarily believes that the UK PRA Capital
Rules and the CFTC Capital Rules are comparable with respect to the
calculation of capital charges for market risk and credit risk
(including as it relates to aspects of settlement risk and CVA risk),
in determining the nonbank SD's risk-weighted assets. More
specifically, with respect to the calculation of market risk charges
and general credit risk charges, both regimes require a nonbank SD to
use standardized approaches to compute market and credit risk, unless
the firms are approved to use internal models. The standardized
approaches follow the same structure that is now the common global
standard: (i) allocating assets to categories according to risk and
assigning each a risk-weight; (ii) allocating counterparties according
to risk assessments and assigning each a risk factor; (iii) calculating
gross exposures based on valuation of assets; (iv) calculating a net
exposure allowing offsets following well-defined procedures and subject
to clear limitations; (v) adjusting the net exposure by the market
risk-weights; and (vi) finally, for credit risk exposures, multiplying
the sum of net exposures to each counterparty by their corresponding
risk factor.
Internal market risk and credit risk models under the UK PRA
Capital Rules and the CFTC Capital Rules are based on the BCBS
framework and contain comparable quantitative and qualitative
requirements, covering the same risks, though with slightly different
categorization, and including comparable model risk management
requirements. As both rule sets address the same types of risk, with
similar allowed methodologies and under similar controls, the
Commission preliminarily believes that these requirements are
comparable.
The Commission also preliminarily believes that the UK PRA Capital
Rules and CFTC Capital Rules are comparable in that nonbank SDs are
required to account for operational risk in computing their minimum
capital requirements. In this connection, the UK PRA Capital Rules
require a PRA-designated UK nonbank SD to calculate an operational risk
exposure as a component of the firm's total risk exposure amount.\260\
PRA-designated UK nonbank SDs may use either a standardized approach
or, if the PRA-designated UK nonbank SD has obtained regulatory
permission, an internal approach based on the firm's own measurement
systems, to calculate their capital charges for operational risk. The
CFTC Capital Rules address operational risk both as a stand-alone,
separate minimum capital requirement that a nonbank SD is required to
meet under prong (ii) of the Bank-Based Approach \261\ and as a
component of the calculation of risk-weighted assets for nonbank SDs
that use subpart E of the Federal Reserve Board's Part 217 regulations
to calculate their credit risk-weighted assets via internal
models.\262\
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\260\ UK CRR, Article 92(3).
\261\ Specifically, as further discussed below, prong (ii) of
the CFTC Capital Rules' Bank-Based Approach requires a nonbank SD to
maintain regulatory capital in an amount equal to or greater than 8
percent of the firm's total uncleared swaps margin amount associated
with its uncleared swap transactions to address potential
operational, legal, and liquidity risks. 17 CFR 101(a)(i)(C). The
term ``uncleared swap margin'' is defined by Commission Regulation
23.100 as the amount of initial margin, computed in accordance with
the Commission's margin rules for uncleared swaps, that a nonbank SD
would be required to collect from each counterparty for each
outstanding swap position of the nonbank SD. 17 CFR 23.100 and
23.154. A nonbank SD must include all swap positions in the
calculation of the uncleared swap margin amount, including swaps
that are exempt or excluded from the scope of the Commission's
margin regulations for uncleared swaps pursuant to Commission
Regulation 23.150, exempt foreign exchange swaps or foreign exchange
forwards, or netting set of swaps or foreign exchange swaps, for
each counterparty, as if that counterparty was an unaffiliated swap
dealer. 17 CFR 23.100 and 23.150. Furthermore, in computing the
uncleared swap margin amount, a nonbank SD may not exclude any de
minis thresholds contained in Commission Regulation 23.151. 17 CFR
23.100 and 23.151.
\262\ 17 CFR 23.101(a)(1)(i) and 17 CFR 23.100 (definition of
BHC equivalent risk-weighted assets).
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c. Minimum Capital Requirement Based on the Uncleared Swap Margin
Amount
As noted above, prong (ii) of the CFTC Capital Rules' Bank-Based
Approach requires a nonbank SD to maintain regulatory capital in an
amount equal to or greater than 8 percent of the firm's total uncleared
swaps margin amount associated with its uncleared swap transactions to
address potential operational, legal, and liquidity risks.
The UK PRA Capital Rules differ from the CFTC Capital Rules in that
they do not impose a capital requirement on PRA-designated UK nonbank
SDs based
[[Page 8047]]
on a percentage of the margin for uncleared swap transactions. The
Commission notes, however, that the UK PRA Capital Rules impose capital
and liquidity requirements that may compensate for the lack of direct
analogue to the 8 percent uncleared swap margin requirement.
Specifically, as discussed above, under the UK PRA Capital Rules, the
total risk exposure amount is computed as the sum of the PRA-designated
UK nonbank SD's capital charges for market risk, credit risk,
settlement risk, CVA risk of OTC derivatives instruments, and
operational risk.\263\ Notably, the UK PRA Capital Rules require that
PRA-designated UK nonbank SDs, including firms that do not use internal
models, calculate capital charges for operational risk as a separate
component of the total risk exposure amount. The UK PRA Capital Rules
also impose separate liquidity requirements designed to ensure that the
PRA-designated UK nonbank SDs can meet both short- and long-term
obligations, in addition to the general requirement to maintain
processes and systems for the identification of liquidity risk.\264\ In
comparison, the Commission requires nonbank SDs to maintain a risk
management program covering liquidity risk, among other risk
categories, but does not have a distinct liquidity requirement.\265\
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\263\ UK CRR, Article 92(3).
\264\ More specifically, the UK PRA Capital Rules impose
separate liquidity buffers and ``stable funding'' requirements
designed to ensure that PRA-designated UK nonbank SDs can cover both
long-term obligations and short-term payment obligations under
stressed conditions for 30 days. PRA Rulebook, CRR Firms, Liquidity
(CRR) Part, Chapter 4 Liquidity (Part Six CRR), Article 412-413. In
addition, PRA-designated UK nonbank SDs are required to maintain
robust strategies, policies, processes, and systems for the
identification of liquidity risk over an appropriate set of time
horizons, including intra-day. PRA Rulebook, CRR Firms, Internal
Liquidity Adequacy Assessment Part.
\265\ Specifically, CFTC Regulation 23.600(b) requires each SD
to establish, document, maintain, and enforce a system of risk
management policies and procedures designed to monitor and manage
the risks related to swaps, and any products used to hedge swaps,
including futures, options, swaps, security-based swaps, debt or
equity securities, foreign currency, physical commodities, and other
derivatives. The elements of the SD's risk management program are
required to include the identification of risks and risk tolerance
limits with respect to applicable risks, including operational,
liquidity, and legal risk, together with a description of the risk
tolerance limits set by the SD and the underlying methodology in
written policies and procedures. 17 CFR 23.600.
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As such, the Commission preliminarily believes the inclusion of an
operational risk charge in the PRA-designated UK nonbank SD's total
risk exposure amount in all circumstances, and the existence of
separate liquidity requirements, will achieve a comparable outcome to
the Commission's requirement for nonbank SDs to hold regulatory capital
in excess of 8 percent of its uncleared swap margin amount. In that
regard, the Commission, in establishing the requirement that a nonbank
SD must maintain a level of regulatory capital in excess of 8 percent
of the uncleared swap margin amount associated with the firm's swap
transactions, stated that the intent of the requirement was to
establish a method of developing a minimum amount of required capital
for a nonbank SD to meet its obligations as an SD to market
participants, and to cover potential operational, legal, and liquidity
risks.\266\
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\266\ See 85 FR 57462 at 57485.
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d. Preliminary Finding of Comparability
Based on a principles-based, holistic assessment, the Commission
has preliminarily determined, subject to the proposed condition below,
and further subject to its consideration of public comments to the
proposed Capital Comparability Determination and Order, that the
purpose and effect of the UK PRA Capital Rules and the CFTC Capital
Rules are comparable. In this regard, the UK PRA Capital Rules and the
CFTC Capital Rules are both designed to require a nonbank SD to
maintain a sufficient amount of qualifying regulatory capital and
subordinated debt to absorb losses resulting from the firm's business
activities, and decreases in the value of firm assets, without the
nonbank SD becoming insolvent.
The Commission invites comment on the UK Application, the relevant
UK laws and regulations, and the Commission's analysis above regarding
its preliminary determination that, subject to the $20 million minimum
capital requirement, the UK PRA Capital Rules and the CFTC Capital
Rules are comparable in purpose and effect and achieve comparable
outcomes with respect to the minimum regulatory capital requirements
and the calculation of regulatory capital for nonbank SDs. The
Commission also specifically seeks public comment on the question of
whether the requirements under the UK PRA Capital Rules that PRA-
designated UK nonbank SDs calculate an operational risk exposure as
part of the firm's total risk exposure amount and meet separate
liquidity requirements are sufficiently comparable in purpose and
effect to the Commission's requirement for a nonbank SD to hold
regulatory capital equal to or greater than 8 percent of its uncleared
swap margin amount.
D. Nonbank Swap Dealer Financial Reporting Requirements
1. CFTC Financial Recordkeeping and Reporting Rules for Nonbank Swap
Dealers
The CFTC Financial Reporting Rules impose financial recordkeeping
and reporting requirements on nonbank SDs. The CFTC Financial Reporting
Rules require each nonbank SD to prepare and keep current ledgers or
similar records summarizing each transaction affecting the nonbank SD's
asset, liability, income, expense, and capital accounts.\267\ The
nonbank SD's ledgers and similar records must be prepared in accordance
with generally accepted accounting principles as adopted in the United
States (``U.S. GAAP''), except that if the nonbank SD is not otherwise
required to prepare financial statements in accordance with U.S. GAAP,
the nonbank SD may prepare and maintain its accounting records in
accordance with International Financial Reporting Standards (``IFRS'')
issued by the International Accounting Standards Board.\268\
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\267\ 17 CFR 23.105(b).
\268\ Id.
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The CFTC Financial Reporting Rules also require each nonbank SD to
prepare and file with the Commission and with NFA periodic unaudited
and annual audited financial statements.\269\ A nonbank SD that elects
the TNW Approach is required to file unaudited financial statements
within 17 business days of the close of each quarter, and its annual
audited financial statements within 90 days of its fiscal year-
end.\270\ A nonbank SD that elects the NLA Approach or the Bank-Based
Approach is required to file unaudited financial statements within 17
business days of the end of each month, and to file its annual audited
financial statements within 60 days of its fiscal year-end.\271\
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\269\ 17 CFR 23.105(d) and (e).
\270\ 17 CFR 23.105(d)(1) and (e)(1).
\271\ Id.
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The CFTC Financial Reporting Rules provide that a nonbank SD's
unaudited financial statements must include: (i) a statement of
financial condition; (ii) a statement of income/loss; (iii) a statement
of changes in liabilities subordinated to claims of general creditors;
(iv) a statement of changes in ownership equity; (v) a statement
demonstrating compliance with and calculation of the applicable
regulatory requirement; and (vi) such further material information
necessary to make the required statements not misleading.\272\ The
annual audited
[[Page 8048]]
financial statements must include: (i) a statement of financial
condition; (ii) a statement of income/loss; (iii) a statement of cash
flows; (iv) a statement of changes in liabilities subordinated to
claims of general creditors; (v) a statement of changes in ownership
equity; (vi) a statement demonstrating compliance with and calculation
of the applicable regulatory capital requirement; (vii) appropriate
footnote disclosures; and (viii) a reconciliation of any material
differences from the unaudited financial report prepared as of the
nonbank SD's year-end date.\273\
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\272\ 17 CFR 23.105(d)(2).
\273\ 17 CFR 23.105(e)(4).
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A nonbank SD that has obtained approval from the Commission or NFA
to use internal capital models also must submit certain model metrics,
such as aggregate VaR and counterparty credit risk information, each
month to the Commission and NFA.\274\ A nonbank SD also is required to
provide the Commission and NFA with a detailed list of financial
positions reported at fair market value as part of its monthly
unaudited financial statements.\275\ Each nonbank SD is also required
to provide information to the Commission and NFA regarding its
counterparty credit concentration for the 15 largest exposures in
derivatives, a summary of its derivatives exposures by internal credit
ratings, and the geographical distribution of derivatives exposures for
the 10 largest countries.\276\
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\274\ 17 CFR 23.105(k) and (l) and appendix B to subpart E of
part 23.
\275\ 17 CFR 23.105(l) and appendix B to subpart E of part 23.
\276\ 17 CFR 23.105(l) in Schedules 2, 3, and 4, respectively.
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CFTC Financial Reporting Rules also require a nonbank SD to attach
to each unaudited and audited financial report an oath or affirmation
that to the best knowledge and belief of the individual making the
affirmation the information contained in the financial report is true
and correct.\277\ The individual making the oath or affirmation must be
a duly authorized officer if the nonbank SD is a corporation, or one of
the persons specified in the regulation for business organizations that
are not corporations.\278\
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\277\ 17 CFR 23.105(f).
\278\ Id.
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The CFTC Financial Reporting Rules further require a nonbank SD to
make certain financial information publicly available by posting the
information on its public website.\279\ Specifically, a nonbank SD must
post on its website a statement of financial condition and a statement
detailing the amount of the nonbank SD's regulatory capital and the
minimum regulatory capital requirement based on its audited financial
statements and based on its unaudited financial statements that are as
of a date that is six months after the nonbank SD's audited financial
statements.\280\ Such public disclosure is required to be made within
10 business days of the filing of the audited financial statements with
the Commission, and within 30 calendar days of the filing of the
unaudited financial statements required with the Commission.\281\ A
nonbank SD also must obtain written approval from NFA to change the
date of its fiscal year-end for financial reporting.\282\
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\279\ 17 CFR 23.105(i).
\280\ Id.
\281\ Id.
\282\ 17 CFR 23.105(g).
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The CFTC Financial Reporting Rules also require a nonbank SD to
provide the Commission and NFA with information regarding the
custodianship of margin for uncleared swap transactions (``Margin
Report'').\283\ The Margin Report must contain: (i) the name and
address of each custodian holding initial margin or variation margin
that is required for uncleared swaps subject to the CFTC margin rules
(``uncleared margin rules''), on behalf of the nonbank SD or its swap
counterparties; (ii) the amount of initial and variation margin
required by the uncleared margin rules held by each custodian on behalf
of the nonbank SD and on behalf its swap counterparties; and (iii) the
aggregate amount of initial margin that the nonbank SD is required to
collect from, or post with, swap counterparties for uncleared swap
transactions subject to the uncleared margin rules.\284\ The Commission
requires this information in order to monitor the use of custodians by
nonbank SDs and their swap counterparties. Such information assists the
Commission in monitoring the safety and soundness of a nonbank SD by
verifying whether the firm is current with its swap counterparties with
respect to the posting and collecting of margin required by the
uncleared margin rules. By requiring the nonbank SD to report the
required amount of margin to be posted and collected, and the amount of
margin that is actually posted and collected, the Commission could
identify potential issues with the margin practices and compliance by
nonbank SDs that may hinder the ability of the firm to meet its
obligations to market participants. The Margin Report also allows the
Commission to identify custodians used by nonbank SDs and their
counterparties, which may permit the Commission to assess potential
market issues, including a concentration of custodial services by a
limited number of banks.
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\283\ 17 CFR 23.105(m).
\284\ Id.
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2. PRA-Designated UK Nonbank Swap Dealer Financial Reporting
Requirements
The UK PRA Financial Reporting Rules impose financial reporting
requirements on a PRA-designated UK nonbank SD that are designed to
provide the PRA with a comprehensive view of the financial information
and capital position of the firm.
Specifically, Article 430 of the Reporting (CRR) Part of the PRA
Rulebook requires a PRA-designated UK nonbank SD to report information
concerning its capital and financial condition, including information
on the firm's capital requirements, leverage ratio, large exposures,
and liquidity requirements.\285\ PRA-designated UK nonbank SDs must
follow the templates and instructions provided in the PRA Rulebook for
purposes of the prudential requirements reporting referred to
COREP.\286\ Under the COREP requirements, PRA-designated UK nonbank SDs
are required to provide, on a quarterly basis,\287\ calculations in
relation to the PRA-designated UK nonbank SD's capital and capital
requirements,\288\ capital ratios and capital levels,\289\ and market
risk,\290\ among other items.
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\285\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 4
Reporting (Part Seven A CRR), Rule 1.
\286\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 6
Templates and Instructions.
\287\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, 5 Reporting
Requirements, Chapter 3 Format and Frequency of Reporting on Own
Funds, Own Funds Requirements.
\288\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 6
Templates and Instructions, Annex I, Templates C 01.00 and C 02.00.
\289\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 6
Templates and Instructions, Annex I, Template C 03.00.
\290\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 6
Templates and Instructions, Annex I, Template C 02.00.
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In addition to the prudential requirements reporting, Article
430(3) of the Reporting (CRR) Part of the PRA Rulebook imposes
financial information reporting on PRA-designated UK nonbank SDs that
are subject to Section 403(1) of the Companies Act 2006 (i.e., entities
that are parent companies \291\ and report on a consolidated basis
using UK-adopted IFRS and that issue securities admitted to trading on
a UK-
[[Page 8049]]
regulated market).\292\ The relevant reporting templates and
instructions, referred to as FINREP, are included in Chapter 6 of the
Reporting (CRR) Part of the PRA Rulebook. Under the FINREP
requirements, PRA-designated UK nonbank SDs subject to the requirements
of Article 430(3) of the Reporting (CRR) Part of the PRA Rulebook are
required to provide the following documents to the PRA, among other
items: (i) on a quarterly basis, a balance sheet statement (or
statement of financial position) that reflects the PRA-designated UK
nonbank SD's financial condition; \293\ (ii) on a quarterly basis, a
statement of profit or loss; \294\ (iii) on a quarterly basis, a
breakdown of financial liabilities by product and by counterparty
sector; \295\ (iv) on a quarterly basis, a listing of subordinated
financial liabilities; \296\ and (v) on an annual basis, a statement of
changes in equity.\297\
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\291\ A parent company (i.e., ``parent undertaking'') is defined
in Companies Act 2006, Section 1162.
\292\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 4
Reporting (Part Seven A CRR), Article 430, Rule 3.
\293\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 6
Templates and Instructions, Templates 1.1., 1.2., and 1.3 at Annex
III (for reporting according to IFRS) and Templates 1.1., 1.2., and
1.3 at Annex IV (for reporting according to national accounting
frameworks).
\294\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 6
Templates and Instructions, Template 2 at Annex III (for reporting
according to IFRS) and Template 2 at Annex IV (for reporting
according to national accounting frameworks).
\295\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 6
Templates and Instructions, Template 8.1 at Annex III (for reporting
according to IFRS) and Template 8.1 at Annex IV (for reporting
according to national accounting frameworks).
\296\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 6
Templates and Instructions, Template 8.2 at Annex III (for reporting
according to IFRS) and Template 8.2. at Template 8.2 at Annex IV
(for reporting according to national accounting frameworks).
\297\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 6
Templates and Instructions, Template 46 at Annex III (for reporting
according to IFRS) and Template 46 at Annex IV (for reporting
according to national accounting frameworks).
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Under the FINREP requirements, a PRA-designated UK nonbank SD
subject to the requirements of Article 430(3) of the Reporting (CRR)
Part of the PRA Rulebook is also required to provide the PRA with
additional financial information, including a breakdown of its loans
and advances by product and type of counterparty,\298\ as well as
detailed information regarding its derivatives trading activities,\299\
collateral and guarantees.\300\
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\298\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 6
Templates and Instructions, Templates 5.1 and 6.1 at Annex III (for
reporting according to IFRS) and Templates 5.1 and 6.1 at Annex IV
(for reporting according to national accounting frameworks).
\299\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 6
Templates and Instructions, Template 10 at Annex III (for reporting
according to IFRS) and Template 10 at Annex IV (for reporting
according to national accounting frameworks).
\300\ PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 6
Templates and Instructions, Template 13 at Annex III (for reporting
according to IFRS) and Template 13 at Annex IV (for reporting
according to national accounting frameworks).
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For PRA-designated UK nonbank SD that are not subject to financial
information reporting under Article 430(3) of the Reporting (CRR) Part
of the PRA Rulebook, the Regulatory Reporting Part of the PRA Rulebook
dictates the applicable reporting requirements.\301\ Specifically, as
firms that fall into Regulated Activity Group 3 (``RAG 3''), PRA-
designated UK nonbank SDs are required to provide the following
documents to the PRA, among other items: (i) on a quarterly basis, a
balance sheet statement (or statement of financial position) that
reflects the PRA-designated UK nonbank SD's financial condition; \302\
(ii) on a quarterly basis, a statement of profit or loss; \303\ and
(iii) on an annual basis, an annual report and accounts.\304\ The
Applicants represented that the six UK PRA-designated nonbank SDs
currently registered with the Commission are designated as RAG 3 firms
and are required to provide the aforementioned documents.\305\
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\301\ As indicated by the Applicants, the Regulatory Reporting
Part of the PRA Rulebook applies to all PRA-designated UK nonbank
SDs. See Responses to Staff Questions dated October 5, 2023.
\302\ PRA Rulebook, CRR Firms, Regulatory Reporting Part,
Chapter 9 Regulated Activity Group 3, Rule 9.2 (referencing
Templates 1.1., 1.2., and 1.3 at Annex III and Templates 1.1., 1.2.,
and 1.3 at Annex IV of Chapter 6 of the Reporting (CRR) Part) and
Rule 9.3.
\303\ PRA Rulebook, CRR Firms, Regulatory Reporting Part,
Chapter 9 Regulated Activity Group 3, Rule 9.2 (referencing Template
2 at Annex III and Template 2 at Annex IV of Chapter 6 of the
Reporting (CRR) Part) and Rule 9.3.
\304\ PRA Rulebook, CRR Firms, Regulatory Reporting Part,
Chapter 9 Regulated Activity Group 3, Rule 9.2 and Rule 9.3.
\305\ See Response to Staff Questions of October 5, 2023. For
the avoidance of doubt, as represented by the Applicants, the six
PRA-designated UK nonbank SDs currently registered with the
Commission are subject to the RAG 3 requirements in the Regulatory
Reporting Part of the PRA Rulebook but are not subject the FINREP
requirements set forth in Article 430(3) of the Reporting (CRR) Part
of the PRA Rulebook. As such, the six PRA-designated UK nonbank SDs
currently registered with the Commission are required to submit to
the PRA only Templates 1 through 3 of FINREP.
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Furthermore, all PRA-designated UK nonbank SDs are required to
prepare annual audited accounts and a strategic report (together,
``annual audited financial report'') pursuant to Parts 15 and 16 of the
Companies Act 2006.\306\ The audit of the accounts and report is
required to be performed by one or more independent statutory auditors,
which have the required skill, resources, and experience to perform
their duties based on the complexity of the firm's business and the
regulatory requirements to which the firm is subject.\307\ PRA-
designated UK nonbank SDs must submit the annual audited financial
report to the PRA within 80 business days from the firm's accounting
reference date.\308\ In addition, under generally applicable company
law requirements, PRA-designated UK nonbank SDs are required to submit
the annual audited financial report to the UK Registrar of
Companies.\309\ The registrar makes the report available to the public
on its website, free of charge.\310\
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\306\ Companies Act 2006, Sections 393 to 414D and 475. Section
475 provides for an exemption from the audit requirement for certain
entities (i.e., ``small companies'', qualifying ``subsidiary
companies'' and ``dormant companies.'') None of the six PRA-
designated UK nonbank SD, however, falls into the exempt categories.
See Responses to Staff Questions dated October 5, 2023.
\307\ Companies Act 2006, Section 485 et seq.; see also PRA
Rulebook, CRR Firms, Auditors Part, Rule 3 Auditors' Qualifications,
and Rule 4 Auditors' Independence.
\308\ PRA Rulebook, CRR Firms, Regulatory Reporting Part,
Chapter 9 Regulatory Activity Group 3, Rules 9.1. and 9.4. The
``accounting reference date'' is determined in accordance with
Section 391 of the Companies Act 2006 and depending on the firm's
date of incorporation.
\309\ See Companies Act 2006, Section 441. The deadline for
filing the annual audited financial report with the UK Registrar of
Companies is nine months from the firm's accounting reference date
for private companies and six months from the firm's accounting
reference date for public companies. Id., Articles 442 (setting
forth the filing deadlines by category of firm) and 391 (defining
the terms ``accounting reference period'' and accounting reference
date'').
\310\ See Companies Act 2006, Sections 1080 and 1085.
Information filed with the UK Registrar of Companies is available
at: https://www.gov.uk/government/organisations/companies-house.
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The annual audited accounts must comprise, at a minimum, a balance
sheet, a profit and loss statement, and notes about the accounts.\311\
The auditor's audit report must include: (i) a description of the
annual accounts subject to the audit and the financial reporting
framework that was applied in their preparation; (ii) a description of
the scope of the audit, which must specify the auditing standards used
to conduct the audit; (iii) an audit opinion stating whether the annual
accounts give a true and fair view of the state of affairs and/or the
profit and loss of the firm, as applicable, and whether the annual
accounts have been prepared in accordance with the relevant financial
reporting framework; and (iv) a
[[Page 8050]]
reference to any matters emphasized by the auditor that did not qualify
the audit opinion.\312\
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\311\ Companies Act 2006, Section 396.
\312\ Id., Section 495.
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The strategic report is required to include a review of the
development and performance of the PRA-designated UK nonbank SD's
during the financial year and a description of the principal risks and
uncertainties that the firm faces.\313\ The auditors are required to
express an opinion on whether the strategic report is consistent with
the accounts for the same financial year, and whether the strategic
report has been prepared in accordance with applicable legal
requirements.\314\ The opinion also must state whether the auditor has
identified material misstatements in the strategic report and, if so,
describe the misstatement.\315\
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\313\ Id., Section 414C.
\314\ Id., Section 496.
\315\ Id.
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In addition, the SEC's UK Order granting substituted compliance for
financial reporting to UK nonbank SBSDs, as supplemented by the SEC
Order on Manner and Format of Filing Unaudited Financial and
Operational Information, require a UK nonbank SBSD to file an unaudited
SEC Form X-17A-5 Part II (``FOCUS Report'') with the SEC on a monthly
basis.\316\ The FOCUS Report is required to include, among other
statements and schedules: (i) a statement of financial condition; (ii)
a statement of the UK nonbank SBSD's capital computation in accordance
with home country Basel-Based requirements; (iii) a statement of
income/loss; and (iv) a statement of capital withdrawals.\317\ A UK
nonbank SBDS is required to file its FOCUS Report with the SEC within
35 calendar days of the month end.\318\
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\316\ See, UK Order. See also, SEC Order on Manner and Format of
Filing Unaudited Financial and Operational Information.
\317\ See, SEC Order on Manner and Format of Filing Unaudited
Financial and Operational Information.
\318\ Id.
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3. Commission Analysis
The Commission has reviewed the UK Application and the relevant UK
laws and regulations, and has preliminarily determined that, subject to
the proposed conditions described below, the financial reporting
requirements of the UK PRA Financial Reporting Rules are comparable to
CFTC Financial Reporting Rules in purpose and effect as they are
intended to provide the PRA and the Commission, respectively, with
financial information to monitor and assess the financial condition of
nonbank SDs and their ability to absorb decreases in firm assets and
increases in firm liabilities, and to cover losses from business
activities, including swap dealing activities, without the firm
becoming insolvent.
The UK PRA Financial Reporting Rules require PRA-designated UK
nonbank SDs to prepare and submit to the PRA on a quarterly basis
unaudited financial information that includes a statement of financial
condition and a statement of profit or loss. Under the FINREP reporting
requirements, a PRA-designated UK nonbank SD subject to the
requirements set forth in Article 430(3) of the Reporting (CRR) Part of
the PRA Rulebook is also required to provide the PRA with additional
financial information, including: (i) a schedule of the breakdown of
financial liabilities by product and by counterparty sector; (ii) a
breakdown of its loans and advances by product and type of
counterparty; and (iii) detailed information regarding its derivatives
trading activities, collateral, and guarantees. PRA-designated UK
nonbank SDs subject to the Regulatory Reporting Part of the PRA
Rulebook are not required to submit such additional financial
information. To the extent the Commission believes some of this
additional information is necessary to the exercise of its and NFA's
oversight function, the Commission is proposing, as noted below, to
require the submission of such information as a condition to the
Capital Comparability Determination Order.
In addition, under the COREP reporting requirement, all PRA-
designated UK nonbank SDs are required to provide the PRA on a
quarterly basis with calculations in relation to the PRA-designated UK
nonbank SD's capital requirements and capital ratios, among other
items. The UK PRA Financial Reporting Rules further require all PRA-
designated UK nonbank SDs to prepare and publish an annual audited
financial report. The annual audited financial report is required to
include a statement of financial condition and a statement of profit or
loss, and must also include relevant notes to the financial
statements.\319\
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\319\ Companies Act 2006, Section 396.
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The Commission preliminarily finds that the UK PRA Financial
Reporting Rules impose reporting requirements that are comparable with
respect to overall form and content to the CFTC Financial Reporting
Rules, which require each nonbank SD to file, among other items,
periodic unaudited financial reports with the Commission and NFA that
contain at a minimum: (i) a statement of financial condition; (ii) a
statement of profit or loss; and (iii) a statement demonstrating
compliance with the capital requirements. Accordingly, the Commission
has preliminarily determined that a PRA-designated UK nonbank SD may
comply with the financial reporting requirements contained in
Commission Regulation 23.105 by complying with the corresponding UK PRA
Financial Reporting Rules, subject to the conditions set forth
below.\320\
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\320\ A PRA-designated UK nonbank SD that qualifies and elects
to seek substituted compliance with the UK PRA Capital Rules must
also seek substituted compliance with the UK PRA Financial Reporting
Rules.
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The Commission is proposing to condition the Capital Comparability
Determination Order on a PRA-designated UK nonbank SD providing the
Commission and NFA with copies of the relevant templates of the FINREP
reports and COREP reports that correspond to the PRA-designated UK
nonbank SD's statement of financial condition, statement of income/
loss, and statement of regulatory capital, total risk exposure, and
capital ratios. These templates consist of FINREP templates 1.1
(Balance Sheet Statement: assets), 1.2 (Balance Sheet Statement:
liabilities), 1.3 (Balance Sheet Statement: equity), and 2 (Statement
of profit or loss), and COREP templates 1 (Own Funds), 2 (Own Funds
Requirements) and 3 (Capital Ratios).
The Commission also notes that PRA-designated UK nonbank SDs submit
COREP templates in addition to the ones listed above to the PRA. These
templates generally provide supporting detail to the core templates
that the Commission is proposing to require from each PRA-designated UK
nonbank SD. The Commission is not proposing to require a PRA-designated
UK nonbank SD to file these additional COREP templates as a condition
to the Capital Comparability Order, and alternatively would exercise
its authority under Commission Regulation 23.105(h) to direct PRA-
designated UK nonbank SDs to provide such additional information to the
Commission and NFA on an ad hoc basis as necessary to oversee the
financial condition of the firms.\321\
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\321\ Commission Regulation 23.105(h) provides that the
Commission or NFA may, by written notice, require any nonbank SD to
file financial or operational information as may be specified by the
Commission or NFA. 17 CFR 23.105(h).
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As noted in Section D.2. of this Determination, the UK PRA
Financial Reporting Rules require PRA-designated UK nonbank SDs to
submit the unaudited FINREP and COREP templates to PRA on a quarterly
basis.
[[Page 8051]]
The CFTC Financial Reporting Rules contain a more frequent reporting
requirement by requiring nonbank SDs that elect the Bank-Based Approach
to file unaudited financial information with the Commission and NFA, on
a monthly basis.\322\ The financial statement reporting requirements
are an integral part of the Commission's and NFA's oversight programs
to effectively and timely monitor nonbank SDs' compliance with capital
and other financial requirements, and for Commission and NFA staff to
assess the overall financial condition and business operations of
nonbank SDs. The Commission has extensive experience with monitoring
the financial condition of registrants through the receipt of financial
statements, including FCMs and, more recently, nonbank SDs. Both FCMs
and nonbank SDs that elect the Bank-Based Approach or NLA Approach file
financial statements with the Commission and NFA on a monthly basis.
The Commission preliminarily believes that receiving financial
information from PRA-designated UK nonbank SDs on a quarterly basis is
not comparable with the CFTC Financial Reporting Rules and would impede
the Commission's and NFA's ability to effectively and timely monitor
the financial condition of PRA-designated UK nonbank SDs for the
purposes of assessing their safety and soundness, as well as their
ability to meet obligations to creditors and counterparties without
becoming insolvent. Therefore, the Commission is preliminarily
proposing to include a condition in the Capital Comparability
Determination Order to require PRA-designated UK nonbank SDs to file
the applicable templates of the FINREP reports and COREP reports with
the Commission and NFA on a monthly basis. The Commission also is
proposing to condition the Capital Comparability Determination Order on
the PRA-designated UK nonbank SD filing the above-listed templates of
the FINREP reports and COREP reports with the Commission and NFA within
35 calendar days of the end of each month.\323\
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\322\ Commission Regulation 23.105(d) (17 CFR 23.105(d)).
\323\ The proposed condition for PRA-designated UK nonbank SDs
to file monthly unaudited financial information with the Commission
and NFA is consistent with proposed conditions contained in the
Commission's proposed Capital Comparability Determinations for
Japanese nonbank SDs, Mexican nonbank SDs, and EU nonbank SDs. See
Proposed Japan Order, Proposed Mexico Order, and Proposed EU Order.
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The Commission is further proposing that in lieu of filing such
FINREP and COREP reports, PRA-designated UK nonbank SDs that are
registered with the SEC as UK nonbank SBSDs could satisfy this
condition by filing with the CFTC and NFA, on a monthly basis, copies
of the unaudited FOCUS Reports that the PRA-designated UK nonbank SDs
are required to file with the SEC pursuant to the SEC UK Order, as
supplemented by the SEC Order on Manner and Format of Filing Unaudited
Financial and Operational Information. The FOCUS Report is required to
include, among other statements and schedules: (i) a statement of
financial condition; (ii) a statement of the UK nonbank SBSD's capital
computation in accordance with home country Basel-Based requirements;
(iii) a statement of income/loss; and (iv) a statement of capital
withdrawals.\324\
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\324\ See, SEC Order on Manner and Format of Filing Unaudited
Financial and Operational Information.
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The filing of a FOCUS Report would be at the election of the PRA-
designated UK nonbank SD as an alternative to the filing of unaudited
FINREP and COREP templates that such firms would otherwise be required
to file with the Commission and NFA pursuant to the proposed Order. All
six of the PRA-designated UK nonbank SDs are currently registered with
the SEC as UK nonbank SBSDs and would be eligible to file copies of
their monthly FOCUS Report with the Commission and NFA in lieu of the
FINREP and COREP templates and Schedule 1. A PRA-designated UK nonbank
SD electing to file copies of its monthly FOCUS Report would be
required to submit the reports to the Commission and NFA within 35
calendar days of the end of each month.\325\
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\325\ Commission Regulation 23.105(d)(3) currently provides that
a nonbank SD or nonbank MSP that is also registered with the SEC as
a broker or dealer, an SBSD, or a major security-based swap
participant may elect to file a FOCUS Report in lieu of the
financial reports required by the Commission. In a separate
rulemaking, the Commission has proposed to amend Regulation
23.105(d)(3) to mandate the filing of a FOCUS Report by such dually-
registered entities, including dually-registered non-U.S. nonbank
SDs, in lieu of the Commission's financial reports. See CFTC Press
Release 8836-23 issued on December 15, 2023, available at cftc.gov.
If the Commission adopts such a requirement, the Commission would
also require PRA-designated UK nonbank SDs that are registered with
the SEC as UK nonbank SBSDs to file FOCUS Reports with the
Commission.
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In addition, the Commission is proposing to condition the Capital
Comparability Determination Order on a PRA-designated UK nonbank SD
submitting to the Commission and NFA copies of the PRA-designated UK
nonbank SD's annual audited financial report that is required to be
prepared pursuant to the Companies Act 2006.\326\ PRA-designated UK
nonbank SDs would be required to file the annual audited financial
report with the Commission and NFA on the earlier of the date the
report is filed with the PRA or the date the report is required to be
filed with the PRA.\327\
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\326\ Companies Act 2006, Parts 15 and 16.
\327\ PRA-designated UK nonbank SDs are required to submit the
annual audited financial report to the PRA within 80 business days
of the firm's accounting reference date. See PRA Rulebook,
Regulatory Reporting Part, Rule 9.1.
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The Commission is also proposing to condition the Capital
Comparability Determination Order on the PRA-designated UK nonbank SD
providing the reports and statements with balances converted to U.S.
dollars.\328\ The Commission, however, recognizes that the requirement
to convert accounts denominated in British pound to U.S. dollars on the
annual audited financial report may impact the opinion provided by the
independent auditor. The Commission is therefore proposing to accept
the annual audited financial report denominated in British pound.
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\328\ The conversion of account balances from British pound to
U.S. dollars is not required to be subject to the audit of the
independent auditor. A PRA-designated UK nonbank SD must report the
exchange rate that it used to convert balances from British pound to
U.S. dollars to the Commission and NFA as part of the financial
reporting.
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The Commission is proposing to impose these conditions as they are
necessary to ensuring that the CFTC Financial Reporting Rules and UK
PRA Financial Reporting Rules, supplemented by the proposed conditions,
are comparable and provide the Commission and NFA with appropriate
financial information to effectively monitor the financial condition of
PRA-designated UK nonbank SDs. Frequent financial reporting is a
central component of the Commission's and NFA's programs for monitoring
and assessing the safety and soundness of nonbank SDs as required under
section 4s(e) of the CEA. Although, as further discussed in Section
F.2. below, the Commission preliminarily believes that the PRA has the
necessary powers to supervise and enforce compliance by PRA-designated
UK nonbank SDs with applicable capital and financial reporting
requirements, the Commission is proposing the conditions to facilitate
the timely access to information allowing the Commission and NFA to
effectively monitor and assess the ongoing financial condition of all
nonbank SDs, including PRA-designated UK nonbank SDs, to help ensure
their safety and soundness and their ability to meet their financial
obligations to customers, counterparties, and creditors.
The Commission preliminarily considers that its approach of
requiring
[[Page 8052]]
PRA-designated UK nonbank SDs to provide the Commission and NFA with
the selected FINREP and COREP templates and the annual audited
financial report that the firms currently file with the PRA strikes an
appropriate balance of ensuring that the Commission receives the
financial reporting necessary for the effective monitoring of the
financial condition of the nonbank SDs, while also recognizing the
existing regulatory structure of the UK PRA Financial Reporting Rules.
Under the proposed conditions, with limited exceptions, the PRA-
designated UK nonbank SD would not be required to prepare different
financial reports and statements for filing with the Commission, but
would be required to prepare selected reports and statements in the
content and format used for submissions to the PRA and convert the
balances to U.S. dollars so that Commission staff may efficiently
analyze the financial information. Although the Commission is proposing
to require submission of certain reports (i.e., selected FINREP and
COREP templates) on a more frequent basis (monthly instead of quarterly
as required by the UK PRA Financial Reporting Rules), the proposed
conditions provide the PRA-designated UK nonbank SDs with 35 calendar
days from the end of each month to convert balances to U.S. dollars. In
addition, PRA-designated UK nonbank SDs that are registered as SBSDs
with the SEC would have the option of filing a copy of the FOCUS Report
they submit to the SEC in lieu of the FINREP and COREP templates. The
Commission preliminarily believes that by requiring that PRA-designated
UK nonbank SDs file unaudited financial reports on a monthly basis
instead of quarterly, the Commission would help ensure that the CFTC
Financial Reporting Rules and the UK PRA Financial Reporting Rules
achieve a comparable outcome.
The Commission is also proposing to condition the Capital
Comparability Determination Order on PRA-designated UK nonbank SDs
filing with the Commission and NFA, on a monthly basis, the aggregate
securities, commodities, and swap positions information set forth in
Schedule 1 of appendix B to subpart E of part 23.\329\ The Commission
is proposing to require that Schedule 1 be filed with the Commission
and NFA as part of the PRA-designated UK nonbank SD's monthly
submission of selected FINREP and COREP templates or FOCUS Report, as
applicable. Schedule 1 provides the Commission and NFA with detailed
information regarding the financial positions that a nonbank SD holds
as of the end of each month, including the firm's swap positions, which
will allow the Commission and NFA to monitor the types of investments
and other activities that the firm engages in and will enhance the
Commission's and NFA's ability to monitor the safety and soundness of
the firm.
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\329\ Schedule 1 of appendix B to subpart E of part 23 includes
a nonbank SD's holding of U.S Treasury securities, U.S. government
agency debt securities, foreign debt and equity securities, money
market instruments, corporate obligations, spot commodities, cleared
and uncleared swaps, cleared and non-cleared security-based swaps,
and cleared and uncleared mixed swaps in addition to other position
information.
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The Commission is also proposing to condition the Capital
Comparability Determination Order on a PRA-designated UK nonbank SD
submitting with each set of selected FINREP and COREP templates, annual
audited financial report, and the applicable Schedule 1, a statement by
an authorized representative or representatives of the PRA-designated
UK nonbank SD that to the best knowledge and belief of the person(s)
the information contained in the respective reports and statements is
true and correct, including the conversion of balances in the
statements to U.S. dollars, as applicable. The statement by the
authorized representative or representatives of the PRA-designated UK
nonbank SD is in lieu of the oath or affirmation required of nonbank
SDs under Commission Regulation 23.105(f), and is intended to ensure
that reports and statements filed with the Commission and NFA are
prepared and submitted by firm personnel with knowledge of the
financial reporting of the firm who can attest to the accuracy of the
reporting and translation.
The Commission is further proposing to condition the Capital
Comparability Determination Order on a PRA-designated UK nonbank SD
filing the Margin Report specified in Commission Regulation 23.105(m)
with the Commission and NFA. The Margin Report contains: (i) the name
and address of each custodian holding initial margin or variation
margin on behalf of the nonbank SD or its swap counterparties; (ii) the
amount of initial and variation margin held by each custodian on behalf
of the nonbank SD and on behalf its swap counterparties; and (iii) the
aggregate amount of initial margin that the nonbank SD is required to
collect from, or post with, swap counterparties for uncleared swap
transactions.\330\
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\330\ 17 CFR 23.105(m).
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The Commission preliminarily believes that receiving this margin
information from PRA-designated UK nonbank SDs will assist in the
Commission's assessment of the safety and soundness of the PRA-
designated UK nonbank SDs. Specifically, the Margin Report would
provide the Commission with information regarding a PRA-designated UK
nonbank SD's swap book, the extent to which it has uncollateralized
exposures to counterparties or has not met its financial obligations to
counterparties. This information, along with the list of custodians
holding both the firms' and counterparties' collateral for swap
transactions, is expected to assist the Commission in assessing and
monitoring potential financial impacts to the nonbank SD resulting from
defaults on its swap transactions. The Commission is further proposing
to require a PRA-designated UK nonbank SD to file the Margin Report
with the Commission and NFA within 35 calendar days of the end of each
month, which corresponds with the proposed timeframe for the PRA-
designated UK nonbank SD to file the selected FINREP and COREP
templates or FOCUS Report, as applicable, and proposing to require the
Margin Report to be provided with balances reported in U.S. dollars.
The Commission notes that the proposed conditions in the UK PRA
Capital Comparability Determination Order are consistent with the
proposed conditions set forth in the proposed Capital Comparability
Determination Orders for Japan, Mexico, and the EU,\331\ and reflects
the Commission's approach of preliminarily determining that non-U.S.
nonbank SDs could meet their financial statement reporting obligations
to the Commission by filing financial reports currently prepared for
home country regulators, albeit in the case of certain financial
reports under a more frequent submission schedule, and, in certain
circumstances, with balances expressed in U.S. dollars. The
Commission's proposed conditions also include certain financial
information and notices that the Commission believes are necessary for
effective monitoring of PRA-designated UK nonbank SDs that are not
currently part of the PRA's supervision regimes.
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\331\ See Proposed Japan Order, Proposed Mexico Order, and
Proposed EU Order.
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The Commission is not proposing to require that a PRA-designated UK
nonbank SD that has been approved by the PRA to use capital models
files with the Commission or NFA the monthly model metric information
contained in
[[Page 8053]]
Commission Regulation 23.105(k) \332\ or that a PRA-designated UK
nonbank SD files with the Commission or NFA the monthly counterparty
credit exposure information specified in Commission Regulation
23.105(l) and Schedules 2, 3, and 4 of appendix B to subpart E of part
23.\333\
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\332\ Commission Regulation 23.105(k) requires a nonbank SD that
has obtained approval from the Commission or NFA to use internal
capital models to submit to the Commission and NFA each month
information regarding its risk exposures, including VaR and credit
risk exposure information when applicable. The model metrics are
intended to provide the Commission and NFA with information that
would assist with the ongoing oversight and assessment of internal
market risk and credit risk models that have been approved for use
by a nonbank SD. 17 CFR 23.105(k).
\333\ Commission Regulation 23.105(l) requires each nonbank SD
to provide information to the Commission and NFA regarding its
counterparty credit concentration for the 15 largest exposures in
derivatives, a summary of its derivatives exposures by internal
credit ratings, and the geographic distribution of derivatives
exposures for the 10 largest countries in Schedules 2, 3, and 4,
respectively. 17 CFR 23.105(l).
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The Commission, in making the preliminary determination to not
require a PRA-designated UK nonbank SD to file the model metrics and
counterparty exposures required by Commission Regulations 23.105(k) and
(l), respectively, recognizes that NFA's current risk monitoring
program requires each bank SD and each nonbank SD, including each PRA-
designated UK nonbank SD, to file risk metrics addressing market risk
and credit risk with NFA on a monthly basis. NFA's monthly risk metric
information includes: (i) VaR for interest rates, credit, foreign
exchange, equities, commodities, and total VaR; (ii) total stressed
VaR; (iii) interest rate, credit spread, foreign exchange market, and
commodity sensitivities; (iv) total swaps current exposure both before
and after offsetting against collateral held by the firm; and (v) a
list of the 15 largest swaps counterparty current exposures before
collateral and net of collateral.\334\
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\334\ See NFA Financial Requirements, Section 17--Swap Dealer
and Major Swap Participant Reporting Requirements, and Notice to
Members--Monthly Risk Data Reporting for Swap Dealers (May 30,
2017).
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Although there are differences in the information required under
Commission Regulations 23.105(k) and (l), the NFA risk metrics provide
a level of information that allows NFA to identify SDs that may pose
heightened risk and to allocate appropriate NFA regulatory oversight
resources. The Commission preliminarily believes that the proposed
financial statement reporting set forth in the proposed Capital
Comparability Determination Order, and the risk metric and counterparty
exposure information currently reported by nonbank SDs (including PRA-
designated UK nonbank SDs) under NFA rules, provide the appropriate
balance of recognizing the comparability of the UK PRA Financial
Reporting Rules to the CFTC Financial Reporting Rules while also
ensuring that the Commission and NFA receive sufficient data to monitor
and assess the overall financial condition of PRA-designated UK nonbank
SDs. The Commission has access to the monthly risk metric filings
collected by NFA. In addition, the Commission retains authority to
request PRA-designated UK nonbank SDs to provide information regarding
their model metrics and counterparty exposures on an ad hoc basis.
Furthermore, the Commission notes that although the UK PRA
Financial Reporting Rules do not contain an analogue to the CFTC's
requirements for nonbank SDs to file monthly model metric information
and counterparty exposures information, the PRA has access to
comparable information. More specifically, under the UK PRA Financial
Reporting Rules, the PRA has broad powers to request any information
necessary for the exercise of its functions.\335\ As such, the PRA has
access to information allowing it to assess the ongoing performance of
risk models and to monitor the PRA-designated UK nonbank SD's credit
exposures, which may be comprised of credit exposures to primarily
other UK and EU counterparties. In addition, the COREP reports, which
PRA-designated UK nonbank SDs are required to file with the PRA on a
quarterly basis, include information regarding the PRA-designated UK
nonbank SD's risk exposure amounts, including risk-weighted exposure
amounts for credit risk.\336\
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\335\ See FSMA, Part XI (indicating that the PRA has broad
information gathering powers).
\336\ See PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter
6 Templates and Instructions, Annex I.
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The Commission invites public comment on its analysis above,
including comment on the UK Application and relevant UK PRA Financial
Reporting Rules. The Commission also invites comment on the proposed
conditions listed above and on the Commission's proposal to exclude
PRA-designated UK nonbank SDs from certain reporting requirements
outlined above. Specifically, the Commission requests comment on its
preliminary determination to not require PRA-designated UK nonbank SDs
to submit the information set forth in Commission Regulations 23.105(k)
and (l). Are there specific elements of the data required under
Commission Regulations 23.105(k) and (l) that the Commission should
require of PRA-designated UK nonbank SDs for purposes of monitoring
model performance?
The Commission requests comment on the proposed filing dates for
the reports and information specified above. Specifically, do the
proposed filing dates provide sufficient time for PRA-designated UK
nonbank SDs to prepare the reports, and, where required, convert
balances into U.S. dollars? If not, what period of time should the
Commission consider imposing on one or more of the reports?
The Commission also requests specific comment regarding the setting
of compliance dates for any new reporting obligations that the proposed
Capital Comparability Determination Order would impose on PRA-
designated UK nonbank SDs. In this connection, if the Commission were
to require PRA-designated UK nonbank SDs to file the Margin Report
discussed above and included in the proposed Order below, how much time
would PRA-designated UK nonbank SDs need to develop new systems or
processes to capture information that is required? Would PRA-designated
UK nonbank SDs need a period of time to develop any systems or
processes to meet any other reporting obligations in the proposed
Capital Comparability Determination Order? If so, what would be an
appropriate amount of time for a PRA-designated UK nonbank SD to
develop and implement such systems or processes?
E. Notice Requirements
1. CFTC Nonbank SD Notice Reporting Requirements
The CFTC Financial Reporting Rules require nonbank SDs to provide
the Commission and NFA with written notice of certain defined
events.\337\ The notice provisions are intended to provide the
Commission and NFA with an opportunity to assess whether the
information contained in the notices indicates the existence of actual
or potential financial and/or operational issues at a nonbank SD, and,
when necessary, allows the Commission and NFA to engage the nonbank SD
in an effort to minimize potential adverse impacts on swap
counterparties and the larger swaps market. The notice provisions are
part of the Commission's overall program for helping to ensure the
safety and soundness of nonbank SDs and the swaps markets in general.
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\337\ 17 CFR 23.105(c).
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[[Page 8054]]
The CFTC Financial Reporting Rules require a nonbank SD to provide
written notice within specified timeframes if the firm is: (i)
undercapitalized; (ii) fails to maintain capital at a level that is in
excess of 120 percent of its minimum capital requirement; or (iii)
fails to maintain current books and records.\338\ A nonbank SD is also
required to provide written notice if the firm experiences a 30 percent
or more decrease in excess regulatory capital from its most recent
financial report filed with the Commission.\339\ A nonbank SD also is
required to provide notice if the firm fails to post or collect initial
margin for uncleared swap and non-cleared security-based swap
transactions or exchange variation margin for uncleared swap and non-
cleared security-based swap transactions as required by the
Commission's uncleared swaps margin rules or the SEC's non-cleared
security-based swaps margin rules, respectively, if the aggregate is
equal to or greater than: (i) 25 percent of the nonbank SD's required
capital under Commission Regulation 23.101 calculated for a single
counterparty or group of counterparties that are under common ownership
or control; or (ii) 50 percent of the nonbank SD's required capital
under Commission Regulation 23.101 calculated for all of the firm's
counterparties.\340\
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\338\ 17 CFR 23.105(c)(1), (2), and (3).
\339\ 17 CFR 23.105(c)(4).
\340\ 17 CFR 23.105(c)(7).
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The CFTC Financial Reporting Rules further require a nonbank SD to
provide notice two business days prior to a withdrawal of capital by an
equity holder that would exceed 30 percent of the firm's excess
regulatory capital.\341\ Finally, a nonbank SD that is dually-
registered with the SEC as an SBSD or major security based swap
participant (``MSBSP'') must file a copy of any notice with the
Commission and NFA that the SBSD or MSBSP is required to file with the
SEC under SEC Rule 18a-8 (17 CFR 240.18a-8).\342\ SEC Rule 18a-8
requires SBSDs and MSBSPs to provide written notice to the SEC for
comparable reporting events as in the CFTC Capital Rule in Commission
Regulation 23.105(c), including if a SBSD or MSBSP is undercapitalized
or fails to maintain current books and records.
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\341\ 17 CFR 23.105(c)(5).
\342\ 17 CFR 23.105(c)(6).
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2. PRA-Designated UK Nonbank Swap Dealer Notice Requirements
The UK capital and resolution frameworks require PRA-designated UK
nonbank SDs to provide certain notices to the PRA concerning the firm's
compliance with relevant laws and regulations. Specifically, the UK PRA
Financial Reporting Rules require a PRA-designated UK nonbank SD to
provide notice to the PRA within five business days if the firm fails
to meet its combined buffer requirement, which at a minimum consists of
a capital conservation buffer of 2.5 percent of the PRA-designated UK
nonbank SD's total risk exposure amount.\343\ As noted earlier, to meet
its capital buffer requirements, a PRA-designated UK nonbank SDs must
hold common equity tier 1 capital in addition to the minimum common
equity tier 1 ratio requirement of 4.5 percent of the firm's core
capital requirement of 8 percent of the firm's total risk exposure
amount. The notice to the PRA must be accompanied by a capital
conservation plan that sets out how the PRA-designated UK nonbank SD
will restore its capital levels.\344\ The capital conservation plan is
required to include: (i) the ``maximum distributable amount''
calculated in accordance with the PRA rules; (ii) estimates of income
and expenditures and a forecast balance sheet; (iii) measures to
increase the capital ratios of the PRA-designated UK nonbank SD; and
(iv) a plan and timeframe for the increase in the capital of the PRA-
designated UK nonbank SD with the objective of meeting fully the
combined buffer requirement.\345\
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\343\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 4
Capital Conservation Measures, Rule 4.4. The combined capital buffer
requirement is the total common equity tier 1 capital required to
meet the sum of the capital conservation buffer and the institution-
specific countercyclical capital buffer. PRA Rulebook, Capital
Buffers Part, Chapter 1 Application and Definitions, Rule 1.2.
\344\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 4
Capital Conservation Measures, Rules 4.4 and 4.5.
\345\ PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter 4
Capital Conservation Measures, Rule 4.5.
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The PRA assesses the capital conservation plan and will approve the
plan only if it considers that the plan would be reasonably likely to
conserve or raise sufficient capital to enable the PRA-designated UK
nonbank SD to meet its combined capital buffer requirement within a
timeframe that the PRA considers to be appropriate.\346\ A PRA-
designated UK nonbank SD is required to notify the PRA as early as
possible where it has identified a material risk to its ability to meet
the combined buffer according to the capital conservation plan and
timeframe approved by the PRA.\347\
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\346\ Supervisory Statement SS6/14 Implementing Capital Buffers,
Prudential Regulation Authority, January 2021 (``SS6/14''),
available here: https://www.bankofengland.co.uk/prudential-regulation/publication/2014/implementing-crdiv-capital-buffers-ss.
\347\ See id.
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In addition, a PRA-designated UK nonbank SD must notify the PRA if
the firm's management considers that the firm is failing or will in the
near future fail to satisfy one or more of the ``threshold
conditions,'' which are the minimum requirements that a PRA-designated
UK nonbank SD must meet in order to be permitted to carry the regulated
activities in which it engages.\348\ In broad terms, the PRA's
threshold conditions include, among other things, requirements that the
firm has appropriate financial resources and capacity to measure,
monitor and manage risks.\349\
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\348\ PRA Rulebook, CRR Firms, Notifications Part, Chapter 8
Specific Notifications, Rule 8.3.
\349\ FSMA, Part 4A and Schedule 6.
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3. Commission Analysis
The Commission has reviewed the UK Application and the relevant UK
laws and regulations, and has preliminarily determined that the UK PRA
Financial Reporting Rules related to notice provisions, subject to the
conditions specified below, are comparable to the notice provisions of
the CFTC Financial Reporting Rules. The Commission is therefore
proposing to issue a Capital Comparability Determination Order
providing that a PRA-designated UK nonbank SD may comply with the
notice provisions required under UK laws and regulations in lieu of
certain notice provisions required of nonbank SDs under Commission
Regulation 23.105(c),\350\ subject to the conditions set forth below.
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\350\ 17 CFR 23.105(c).
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The notice provisions contained in Commission Regulation 23.105(c)
are intended to provide the Commission and NFA with information in a
prompt manner regarding actual or potential financial or operational
issues that may adversely impact the safety and soundness of a nonbank
SD by impairing the firm's ability to meet its obligations to
counterparties, creditors, and the general swaps market. Upon the
receipt of a notice from a nonbank SD under Commission Regulation
23.105(c), the Commission and NFA initiate reviews of the facts and
circumstances that resulted in the notice being filed including, as
appropriate, communicating with personnel of the nonbank SD. The review
of the facts and the interaction with the personnel of the nonbank SD
provide the Commission and NFA with information to develop an
assessment of whether it is necessary for the nonbank SD to take
remedial
[[Page 8055]]
action to address potential financial or operational issues, and
whether the remedial actions instituted by the nonbank SD properly
address the issues that are the root cause of the operational or
financial issues. Such actions may include the infusion of additional
capital into the firm, or the development and implementation of
additional internal controls to address operational issues. The notice
filings further allow the Commission and NFA to monitor the firm's
performance after the implementation of remedial actions to assess the
effectiveness of such actions.
The UK PRA Financial Reporting Rules require a PRA-designated UK
nonbank SD to provide notice to the PRA if the firm fails to maintain a
minimum capital ratio of common equity tier 1 capital to risk-weighted
assets equal or greater than 7 percent (4.5 percent of the core capital
requirement plus the 2.5 percent capital conservation buffer
requirement, assuming no other capital buffer requirements apply). The
PRA-designated UK nonbank SD is also required to file a capital
conservation plan with its notice to the PRA. The capital conservation
plan is required to contain information regarding actions that the PRA-
designated UK nonbank SD will take to ensure proper capital adequacy.
The Commission has preliminarily determined that the requirement
for a PRA-designated UK nonbank SD to provide notice of a breach of its
capital buffer requirements to the PRA is not sufficiently comparable
in purpose and effect to the CFTC notice provisions contained in
Commission Regulation 23.105(c)(1) and (2),\351\ which require a
nonbank SD to provide notice to the Commission and to NFA if the firm
fails to meet its minimum capital requirement or if the firm's
regulatory capital falls below 120 percent of its minimum capital
requirement (``Early Warning Level''). The requirement for a PRA-
designated UK nonbank SD to provide notice of a breach of its capital
buffer requirements does not achieve a comparable outcome to the CFTC's
Early Warning Level requirement due to the difference in the thresholds
triggering a notice requirement in the respective rule sets.
---------------------------------------------------------------------------
\351\ 17 CFR 23.105(c)(1) and (2).
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The requirement for a nonbank SD to file notice with the Commission
and NFA if the firm becomes undercapitalized or if the firm experiences
a decrease of excess regulatory capital below defined levels is a
central component of the Commission's and NFA's oversight program for
nonbank SDs.\352\ Therefore, the Commission preliminarily believes that
it is necessary for the Commission and NFA to receive copies of notices
filed under the Capital Buffers Part of the PRA Rulebook by PRA-
designated UK nonbank SDs alerting the PRA of a breach of the PRA-
designated UK nonbank SD's combined capital buffer. The notice must be
filed by the PRA-designated UK nonbank SD within 24 hours of the filing
of the notice with the PRA, and the Commission expects that, upon the
receipt of a notice, Commission staff and NFA staff will engage with
staff of the PRA-designated UK nonbank SD to obtain an understanding of
the facts that led to the filing of the notice and will discuss with
the PRA-designated UK nonbank SD the firm's capital conservation plan.
The proposed condition would not require the PRA-designated UK nonbank
SD to file copies of its capital conservation plan with the Commission
or NFA. To the extent Commission staff needs further information from
the PRA-designated UK nonbank SD, the Commission expects to request
such information as part of its assessment of the notice and its
communications with the PRA-designated UK nonbank SD.
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\352\ See Commission Regulation 23.105(c)(4), which requires a
nonbank SD to file notice with the Commission and NFA if it
experiences decrease in excess capital of 30 percent or more from
the excess capital reported in its last financial filing with the
Commission. 17 CFR 23.105(c)(4).
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In addition, due to the lack of a sufficiently comparable analogue
to the CFTC Financial Reporting Rules' Early Warning Level requirement,
the Commission is proposing to condition the Capital Comparability
Determination Order to require a PRA-designated UK nonbank SD to file a
notice with the Commission and NFA if the firm's capital ratio does not
equal or exceed 12.6 percent.\353\ The proposed condition would further
require the PRA-designated UK nonbank SD to file the notice with the
Commission and NFA within 24 hours of when the firm knows or should
have known that its regulatory capital was below 120 percent of its
minimum capital requirement. The timing requirement for the filing of
the proposed notice with the Commission and NFA is consistent with the
Commission's requirements for an FCM or a nonbank SD, which are both
required to file an Early Warning Level notice with the Commission and
NFA when the firm knows or should have known that its regulatory
capital is below specified reporting levels.\354\ The requirement for a
firm to file a notice with the Commission when it knows or should have
known that its capital is below the reporting level is designed to
prevent a situation where a firm's deficient recordkeeping leads to an
inadequate monitoring of the Early Warning Level threshold. More
generally, the ``should have known'' part of the timing standard for
the filing of the proposed notice is intended to cover facts and
circumstances that should reasonably lead the firm to believe that its
regulatory capital is below 120 percent of the minimum
requirement.\355\ In practice, even if the PRA-designated UK nonbank
SD's books and records do not reflect a decrease of regulatory capital
below 120 percent of the minimum requirement or if the computations
that may reveal a decrease of regulatory capital below 120 percent have
not been made yet, the firm would be expected to provide notice if it
became aware of deficiencies in its recordkeeping processes that could
result in inaccurate recording of the firm's capital levels or if it
had other reasons to believe its regulatory capital is below the Early
Warning Level threshold.\356\
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\353\ The Commission's proposed reporting level of 12.6 percent
reflects the aggregate of the PRA-designated UK nonbank SD's core
capital requirement of 8 percent and capital conservation buffer
requirement of 2.5 percent, multiplied by a factor of 1.20. For
purposes of the calculation, the Commission proposes that the 20
percent capital increase must be comprised of common equity tier 1
capital (i.e., common equity tier 1 capital must comprise a minimum
of 8.4 percent, which reflects the aggregate of the 4.5 percent core
common equity tier 1 capital requirement and the 2.5 percent capital
conservation buffer requirement, multiplied by a factor of 1.20).
\354\ 17 CFR 1.12(b) and 17 CFR 23.105(c)(ii)(2).
\355\ This interpretation is consistent with the Commission's
discussion of the timing standard in the preamble to the 1998 final
rule adopting amendments to Commission Regulation 1.12, where the
Commission noted that the part of the standard requiring an FCM to
report when it ``should know'' of a problem may be defined as the
point at which a party, in the exercise of reasonable diligence,
should become aware of an event. See 63 FR 45711 at 45713.
\356\ To that point, in discussing the standard applicable to
the timing requirement for the filing of a notice by an FCM to
report an undersegregated or undersecured condition (i.e., situation
where the FCM has insufficient funds in accounts segregated for the
benefit of customers trading on U.S. contract markets or has
insufficient funds set aside for customers trading on non-U.S.
markets to meet the FCM's obligations to its customers), the
Commission noted that an obligation to file a notice could arise
even before the required computations that would reveal deficiencies
must be made. See id.
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As noted above, a purpose of the proposed Early Warning Level
notice provision is to allow the Commission and NFA to initiate
conversations and fact finding with a registrant that may be
experiencing operational or financial issues that may adversely impact
the firm's ability to meet its obligations to
[[Page 8056]]
market participants, including customers or swap counterparties. The
notice filing is a central component of the Commission's and NFA's
oversight program, and the Commission believes that a firm that is
experiencing operational challenges that prevent the firm from
definitively computing its capital level during a period when it
recognizes from the facts and circumstances that the firm's capital
level may be below the reporting threshold should file the notice with
the Commission and NFA. Therefore, the Commission preliminarily deems
it appropriate to include a similar early warning notice condition in
the Capital Comparability Determination Order.
The UK PRA Financial Reporting Rules also do not contain an
explicit requirement for a PRA-designated UK nonbank SD to notify the
PRA if the firm fails to maintain current books and records,
experiences a decrease in regulatory capital over levels previously
reported, or fails to collect or post initial margin with uncleared
swap counterparties that exceed certain threshold levels.\357\ The UK
PRA Financial Reporting Rules also do not require a PRA-designated UK
nonbank SD to provide the PRA with advance notice of equity withdrawals
initiated by equity holders that exceed defined amounts or percentages
of the firm's excess regulatory capital.\358\
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\357\ 17 CFR 23.105(c)(3), (4), and (7).
\358\ Commission Regulation 23.105(c)(5) requires a nonbank SD
to provide written notice to the Commission and NFA two business
days prior to the withdrawal of capital by action of the equity
holders if the amount of the withdrawal exceeds 30 percent of the
nonbank SD's excess regulatory capital. 17 CFR 23.105(c)(5).
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To ensure that the Commission and NFA receive prompt information
concerning potential operational or financial issues that may adversely
impact the safety and soundness of a PRA-designated UK nonbank SD, the
Commission is proposing to condition the Capital Comparability
Determination Order to require PRA-designated UK nonbank SDs to file
certain notices required under the CFTC Financial Reporting Rules with
the Commission and NFA. In this connection, the Commission is proposing
to condition the Capital Comparability Determination Order on a PRA-
designated UK nonbank SD providing the Commission and NFA with notice
if the firm fails to maintain current books and records with respect to
its financial condition and financial reporting requirements. For
avoidance of doubt, in this context the Commission believes that books
and records would include current ledgers or other similar records
which show or summarize, with appropriate references to supporting
documents, each transaction affecting the PRA-designated UK nonbank
SD's asset, liability, income, expense, and capital accounts in
accordance with the accounting principles accepted by the relevant
authorities.\359\ The Commission preliminarily believes that the
maintenance of current books and records is a fundamental and essential
component of operating as a registered nonbank SD and that the failure
to comply with such a requirement may indicate an inability of the firm
to promptly and accurately record transactions and to ensure compliance
with regulatory requirements, including regulatory capital
requirements. Therefore, the proposed Order would require a PRA-
designated UK nonbank SD to provide the Commission and NFA with a
written notice within 24 hours if the firm fails to maintain books and
records on a current basis.
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\359\ For comparison, see Commission Regulation 23.105(b), which
similarly defines the term ``current books and records'' as used in
the context of the Commission's requirements. 17 CFR 23.105(b).
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The proposed Capital Comparability Determination Order would also
require a PRA-designated UK nonbank SD to file notice with the
Commission and NFA if: (i) a single counterparty, or group of
counterparties under common ownership or control, fails to post
required initial margin or pay required variation margin on uncleared
swap and security-based swap positions that, in the aggregate, exceeds
25 percent of the PRA-designated UK nonbank SD's minimum capital
requirement; (ii) counterparties fail to post required initial margin
or pay required variation margin to the PRA-designated UK nonbank SD
for uncleared swap and security-based swap positions that, in the
aggregate, exceeds 50 percent of the PRA-designated UK nonbank SD's
minimum capital requirement; (iii) a PRA-designated UK nonbank SD fails
to post required initial margin or pay required variation margin for
uncleared swap and security-based swap positions to a single
counterparty or group of counterparties under common ownership and
control that, in the aggregate, exceeds 25 percent of the PRA-
designated UK nonbank SD's minimum capital requirement; and (iv) a PRA-
designated UK nonbank SD fails to post required initial margin or pay
required variation margin to counterparties for uncleared swap and
security-based swap positions that, in the aggregate, exceeds 50
percent of the PRA-designated UK nonbank SD's minimum capital
requirement. The Commission is proposing to require this notice so that
it and the NFA may commence communication with the PRA-designated UK
nonbank SD and the PRA in order to obtain an understanding of the facts
that have led to the failure to exchange material amounts of initial
margin and variation margin in accordance with the applicable margin
rules, and to assess whether there is a concern regarding the financial
condition of the firm that may impair its ability to meet its financial
obligations to customers, counterparties, creditors, and general market
participants, or otherwise adversely impact the firm's safety and
soundness.
The proposed Capital Determination Order would not require a PRA-
designated UK nonbank SD to file notices with the Commission and NFA
concerning withdrawals of capital or changes in capital levels as such
information will be reflected in the financial statement reporting
filed with the Commission and NFA as conditions of the Order, and
because the PRA-designated UK nonbank SD's capital levels are monitored
by the PRA, which the Commission preliminarily believes renders the
separate reporting to the Commission superfluous.
The proposed Capital Comparability Determination Order would
require a PRA-designated UK nonbank SD to file any notices required
under the Order with the Commission and NFA reflecting any balances,
where applicable, in U.S. dollars. Each notice required by the proposed
Capital Comparability Determination Order must be filed in accordance
with instructions issued by the Commission or NFA.\360\
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\360\ The proposed conditions for PRA-designated UK nonbank SDs
to file a notice with the Commission and NFA if the firm fails to
maintain current books and records or fails to collect or post
margin with uncleared swap counterparties that exceed the above-
referenced threshold levels are consistent with the proposed
conditions in the proposed Capital Comparability Determination
Orders for Japan, Mexico, and the EU. See Proposed Japan Order,
Proposed Mexico Order, and Proposed EU Order.
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The Commission invites public comment on its analysis above,
including comment on the UK Application and relevant UK Financial
Reporting Rules. The Commission also invites comment on the proposed
conditions to the Capital Comparability Determination Order that are
listed above.
The Commission requests comment on the timeframes set forth in the
proposed conditions for PRA-designated UK nonbank SDs to file notices
with the Commission and NFA. In this regard,
[[Page 8057]]
the proposed conditions would require PRA-designated UK nonbank SDs to
file certain written notices with the Commission within 24 hours of the
occurrence of a reportable event or of being alerted to a reportable
event by the PRA. The Commission requests comment on the issues PRA-
designated UK nonbank SDs may face meeting the filing requirements
given time-zone difference or governance issues. The Commission also
requests specific comment regarding the setting of compliance dates for
the notice reporting conditions that the proposed Capital Comparability
Determination Order would impose on PRA-designated UK nonbank SDs.
F. Supervision and Enforcement
1. Commission and NFA Supervision and Enforcement of Nonbank SDs
The Commission and NFA conduct ongoing supervision of nonbank SDs
to assess their compliance with the CEA, Commission regulations, and
NFA rules by reviewing financial reports, notices, risk exposure
reports, and other filings that nonbank SDs are required to file with
the Commission and NFA. The Commission and/or NFA also conduct periodic
examinations as part of the supervision of nonbank SDs, including
routine onsite examinations of nonbank SDs' books, records, and
operations to ensure compliance with CFTC and NFA requirements.\361\
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\361\ Section 17(p)(2) of the CEA requires NFA as a registered
futures association to establish minimum capital and financial
requirements for non-bank SDs and to implement a program to audit
and enforce compliance with such requirements. 7 U.S.C. 21(p)(2).
Section 17(p)(2) further provides that NFA's capital and financial
requirements may not be less stringent than the capital and
financial requirements imposed by the Commission.
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As noted in Section D.1. above, financial reports filed by a
nonbank SD provide the Commission and NFA with information necessary to
ensure the firm's compliance with minimum capital requirements and to
assess the firm's overall safety and soundness and its ability to meet
its financial obligations to customers, counterparties, and creditors.
A nonbank SD is also required to provide written notice to the
Commission and NFA if certain defined events occur, including that the
firm is undercapitalized or maintains a level of capital that is less
than 120 percent of the firm's minimum capital requirements.\362\ The
notice provisions, as stated in Section E.1. above, are intended to
provide the Commission and NFA with information of potential issues at
a nonbank SD that may impact the firm's ability to maintain compliance
with the CEA and Commission regulations. The Commission and NFA also
have the authority to require a nonbank SD to provide any additional
financial and/or operational information on a daily basis or at such
other times as the Commission or NFA may specify to monitor the safety
and soundness of the firm.\363\
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\362\ See 17 CFR 23.105(c).
\363\ See 17 CFR 23.105(h).
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The Commission also has authority to take disciplinary actions
against a nonbank SD for failing to comply with the CEA and Commission
regulations. Section 4b-1(a) of the CEA \364\ provides the Commission
with exclusive authority to enforce the capital requirements imposed on
nonbank SDs adopted under section 4s(e) of the CEA.\365\
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\364\ 7 U.S.C. 6b-1(a).
\365\ 7 U.S.C. 6s(e).
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2. PRA's Supervision and Enforcement of PRA-Designated UK Nonbank SDs
The PRA has supervision, audit, and investigation powers with
respect to PRA-designated UK nonbank SDs, which include the powers to
obtain specified information reasonably required in connection with the
exercise of the PRA's functions, the power to conduct or order
investigations, and the power to impose sanctions on PRA-designated UK
nonbank SDs that breach their regulatory obligations, including those
deriving from the UK PRA Capital Rules and the UK PRA Financial
Reporting Rules.\366\
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\366\ FSMA, Parts 4A, XI, and XIV.
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The PRA also monitors the capital adequacy of PRA-designated UK
nonbank SDs through supervisory measures on an ongoing basis. The
monitoring includes assessing the notices and the capital conservation
plan discussed in Section E.2. above. In addition, the PRA is empowered
with a variety of measures to address a PRA-designated UK nonbank SD's
financial deterioration.\367\ Under its general supervisory powers, the
PRA may impose new requirements to a PRA-designated UK nonbank SD if
the firm is failing, or likely to fail, to satisfy the threshold
conditions for which the PRA is responsible.\368\ More specifically, a
breach in a PRA-designated UK nonbank SD's capital buffers
automatically triggers restrictions on the firm's ability to make
certain distributions (e.g., pay certain dividends or employee
bonuses).\369\ In addition, the PRA may impose administrative penalties
or other administrative measures, including prudential charges, if a
PRA-designated nonbank SD's liquidity position falls below the
liquidity and stable funding requirements.\370\
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\367\ See PRA, The Prudential Regulation Authority's approach to
banking supervision, July 2023, available at: https://www.bankofengland.co.uk/prudential-regulation/publication/pras-approach-to-supervision-of-the-banking-and-insurance-sectors.
\368\ FSMA, Part 4A, Section 55M.
\369\ See PRA Rulebook, CRR Firms, Capital Buffers Part, Chapter
4 Capital Conservation Measures, Rule 4.3.
\370\ See Capital Requirements Regulations 2013, Regulation 35B
and FSMA, Part XIV Disciplinary Measures (setting forth the PRA's
disciplinary power with respect to all rules adopted under FSMA).
The Applicants represented that ``CRR rules'' (i.e., general PRA
rules applying to CRR firms, including PRA-designated UK nonbank
SDs) are adopted pursuant to FSMA, Part 9D, and as such the PRA has
power to impose disciplinary measures in connection with these
rules. See Response to Staff Questions dated October 5, 2023.
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In case of non-compliance with the capital and liquidity
thresholds, the PRA may also order PRA-designated UK nonbank SDs to
comply with additional requirements, including: (i) maintaining
additional capital in excess of the minimum requirements, if certain
conditions are met; (ii) requiring that the PRA-designated UK nonbank
SD submit a plan to restore compliance with applicable capital or
liquidity thresholds; (iii) imposing restrictions on the business or
operations of the PRA-designated UK nonbank SD; (iv) imposing
restrictions or prohibitions on distributions or interest payments to
shareholders or holders of additional tier 1 capital instruments; (v)
requiring additional or more frequent reporting requirements; and (vi)
imposing additional specific liquidity requirements.\371\ The PRA may
also sanction the PRA-designated UK nonbank SD if the firm's capital or
liquidity fall below the applicable thresholds or the PRA has evidence
that the firm will breach such thresholds in the next 12 months.\372\
The PRA may also withdraw a PRA-designated UK nonbank SD's
authorization if the firm no longer meets its minimum capital
requirements.\373\
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\371\ FSMA, Parts 4A, Sections 55M and 55P, and Capital
Requirements Regulation 2013, Regulation 35B.
\372\ FSMA, Parts 4A and XIV.
\373\ FSMA, Part 4A, Sections 55J-55K.
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In addition, if the capital and liquidity requirements are
breached, the PRA may take early measures to intervene, such as
requiring management to take certain actions, order members of
management to be removed or replaced, or require changes to the firm's
business strategy or legal or
[[Page 8058]]
operational structure, among other measures.\374\
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\374\ Bank Recovery and Resolution (No. 2) Order 2014, Article 2
(defining ``conditions for early intervention'' in case of breach of
UK CRR requirements or requirements derived from CRD) and Part 8
(laying down the procedure to be followed by the PRA to determine
whether early intervention measures should be taken under FSMA). If
additional requirements are met, it is also possible that the Bank
of England, as the resolution authority, may assess the PRA-
designated UK nonbank SD as ``failing or likely to fail,''
triggering a resolution action, which could occur even before the
firm actually breached its minimum capital requirements. Banking Act
2009, Sections 4 to 83.
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Although the PRA generally has broad discretion as to what powers
it may exercise, the UK PRA Capital Rules and the UK PRA Financial
Reporting Rules specifically mandate that the PRA require PRA-
designated UK nonbank SDs to hold increased capital when: (i) risks or
elements of risks are not covered by the capital requirements imposed
by the UK PRA Capital Rules; (ii) the PRA-designated UK nonbank SD
lacks robust governance arrangements, appropriate resolution and
recovery plans, processes to manage large exposures or effective
processes to maintain on an ongoing basis the amounts, types, and
distribution of capital needed to cover the nature and level of risks
to which they might be exposed; or (iii) the sole application of other
administrative measures would be unlikely to timely and sufficiently
improve the firm's arrangements and processes.\375\
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\375\ Capital Requirements Regulation 2013, Section 34.
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3. Commission Analysis
Based on the above, the Commission preliminarily finds that the PRA
has the necessary powers to supervise, investigate, and discipline PRA-
designated UK nonbank SDs for compliance with the applicable capital,
financial and reporting requirements, and to detect and deter
violations of, and ensure compliance with, the applicable capital and
financial reporting requirements in the UK.
The Commission would expect to communicate and consult, to the
fullest extent permissible under applicable law, with the PRA regarding
the supervision of the financial and operational condition of the PRA-
designated UK nonbank SDs. An appropriate MOU or similar arrangement
with the PRA would facilitate cooperation and information sharing in
the context of supervising the PRA-designated UK nonbank SDs. Such an
arrangement would enhance communication with respect to entities within
the arrangement's scope (``Covered Firms''), as appropriate, regarding:
(i) general supervisory issues, including regulatory, oversight, or
other related developments; (ii) issues relevant to the operations,
activities, and regulation of Covered Firms; and (iii) any other areas
of mutual supervisory interest, and would anticipate periodic meetings
to discuss relevant functions and regulatory oversight programs. The
arrangement would provide for the Commission and the PRA to inform each
other of certain events, including any material events that could
adversely impact the financial or operational stability of a Covered
Firm, and would provide a procedure for any on-site examinations of
Covered Firms.
In the absence of an MOU or similar information sharing
arrangement, the Commission is proposing to condition the Capital
Comparability Determination Order on a PRA-designated UK nonbank SD
providing notice to the Commission and NFA if the PRA has required the
PRA-designated UK nonbank SD to: (i) maintain additional capital in
excess of the minimum requirements; (ii) require that the PRA-
designated UK nonbank SD submit a plan to restore compliance with
applicable capital or liquidity thresholds; (iii) impose restrictions
on the business or operations of the PRA-designated UK nonbank SD; (iv)
impose restrictions or prohibitions on distributions or interest
payments to shareholders or holders of additional tier 1 capital
instruments; (v) require additional or more frequent reporting
requirements; or (vi) impose additional specific liquidity
requirements.\376\ Upon receipt of such notice, the Commission and NFA
would communicate with the PRA-designated UK nonbank SD to obtain
further information regarding the underlying issues that prompted the
PRA to direct the PRA-designated UK nonbank SD to take such actions and
would obtain information regarding how the PRA-designated UK nonbank SD
would address the underlying issues.
---------------------------------------------------------------------------
\376\ PRA's authority to impose such conditions or requirements
is set forth in FSMA, Part 4A, Sections 55M and 55P, and Capital
Requirements Regulation 2013, Regulation 35B.
---------------------------------------------------------------------------
The Commission invites public comment on the UK Application, the UK
laws and regulations, and the Commission's analysis above regarding its
preliminary determination that the PRA and the CFTC have supervision
programs and enforcement authority that are comparable in that the
purpose of the relevant programs and authority is to ensure that
nonbank SDs maintain compliance with applicable capital and financial
reporting requirements.
IV. Proposed Capital Comparability Determination Order
A. Commission's Proposed Comparability Determination
The Commission's preliminary view, based on the UK Application and
the Commission's review of applicable UK laws and regulations, is that
the UK PRA Capital Rules and the UK PRA Financial Reporting Rules,
subject to the conditions set forth in the proposed Capital
Comparability Determination Order below, achieve comparable outcomes
and are comparable in purpose and effect to the CFTC Capital Rules and
CFTC Financial Reporting Rules. In reaching this preliminary
conclusion, the Commission recognizes that there are certain
differences between the UK PRA Capital Rules and CFTC Capital Rules and
certain differences between the UK PRA Financial Reporting Rules and
the CFTC Financial Reporting Rules. The proposed Capital Comparability
Determination Order is subject to proposed conditions that are
preliminarily deemed necessary to promote consistency in regulatory
outcomes, or to reflect the scope of substituted compliance that would
be available notwithstanding certain differences. In the Commission's
preliminary view, the differences between the two rules sets would not
be inconsistent with providing a substituted compliance framework for
PRA-designated UK nonbank SDs subject to the conditions specified in
the proposed Order below.
Furthermore, the proposed Capital Comparability Determination Order
is limited to the comparison of the UK PRA Capital Rules to the Bank-
Based Approach contained within the CFTC Capital Rules. As noted
previously, the Applicants have not requested, and the Commission has
not performed, a comparison of the UK PRA Capital Rules to the
Commission's NAL Approach or TNW Approach. In addition, as discussed in
Section I.C. above, due to the differences between the capital and
financial reporting regimes applicable to PRA-designated UK nonbank SD
and FCA-regulated UK nonbank SDs, the Commission anticipates assessing
the comparability of the rules applicable to FCA-regulated UK nonbank
SDs through a separate capital comparability determination.
[[Page 8059]]
B. Proposed Capital Comparability Determination Order
The Commission invites comments on all aspects of the UK
Application, relevant UK laws and regulations, the Commission's
preliminary views expressed above, the question of whether requirements
under the UK PRA Capital Rules are comparable in purpose and effect to
the Commission's requirement for a nonbank SD to hold regulatory
capital equal to or greater than 8 percent of its uncleared swap margin
amount, and the Commission's proposed Capital Comparability
Determination Order, including the proposed conditions included in the
proposed Order, set forth below.
C. Proposed Order Providing Conditional Capital Comparability
Determination for PRA-Designated UK Nonbank Swap Dealers
It is hereby determined and ordered, pursuant to Commodity Futures
Trading Commission (``CFTC'' or ``Commission'') Regulation 23.106 (17
CFR 23.106) under the Commodity Exchange Act (``CEA'') (7 U.S.C. 1 et
seq.) that a swap dealer (``SD'') subject to the Commission's capital
and financial reporting requirements under sections 4s(e) and (f) of
the CEA (7 U.S.C. 6s(e) and (f)), that is organized and domiciled in
the United Kingdom (``UK'') and designated for prudential supervision
by the UK Prudential Regulation Authority (``PRA''), may satisfy the
capital requirements under section 4s(e) of the CEA and Commission
Regulation 23.101(a)(1)(i) (17 CFR 23.101(a)(1)(i)) (``CFTC Capital
Rules''), and the financial reporting rules under section 4s(f) of the
CEA and Commission Regulation 23.105 (17 CFR 23.105) (``CFTC Financial
Reporting Rules''), by complying with certain specified requirements of
the UK laws and regulations cited below and otherwise complying with
the following conditions, as amended or superseded from time to time:
(1) The SD is not subject to regulation by a prudential regulator
defined in section 1a(39) of the CEA (7 U.S.C. 1a(39));
(2) The SD is organized under the laws of the UK and is domiciled
in the UK;
(3) The SD is licensed as an investment firm in the UK and is
designated for prudential supervision by the PRA (``PRA-designated UK
nonbank SD'');
(4) The PRA-designated UK nonbank SD is subject to and complies
with: Regulation (EU) No 575/2013 of the European Parliament and of the
Council of 26 June 2013 on prudential requirements for credit
institutions and amending Regulation (EU) No 648/2012 as restated and
applicable in the UK (``UK CRR''), the provisions implementing the
Directive 2013/36/EU of the European Parliament and of the Council of
26 June 2013 on access to the activity of credit institutions and the
prudential supervision of credit institutions, amending Directive 2002/
87/EC and repealing Directives 2006/48/EC and 2006/49/EC (``CRD''),
including Capital Requirements Regulations 2013 and Capital
Requirements (Capital Buffers and Macro-prudential Measures)
Regulations 2014, Commission Delegated Regulation (EU) 2015/61 of 10
October 2014 to supplement Regulation (EU) No 575/2013 of the European
Parliament and the Council with regard to liquidity coverage
requirement for Credit Institutions (``Liquidity Coverage Delegated
Regulation''), the Banking Act 2009 and its secondary legislation, and
the rules of the PRA as reflected in the PRA Rulebook (collectively the
``UK PRA Capital Rules'');
(5) The PRA-designated UK nonbank SD satisfies at all times
applicable capital ratio and leverage ratio requirements set forth in
Article 92 of UK CRR and the rules in PRA Rulebook, CRR Firms, Leverage
Ratio--Capital Requirements and Buffers Part, Chapter 3 Minimum
Leverage Ratio, the capital conservation buffer requirements set forth
in PRA Rulebook, CRR Firms, Capital Buffers Part, and applicable
liquidity requirements set forth in PRA Rulebook, CRR Firms, Liquidity
Coverage Requirement--UK Designated Investment Firms Part and PRA
Rulebook, CRR Firms, Liquidity (CRR) Part, and otherwise complies with
the requirements to maintain a liquidity risk management program as
required under PRA Rulebook, CRR Firms, Internal Liquidity Adequacy
Assessment Part;
(6) The PRA-designated UK nonbank SD is subject to and complies
with: Reporting (CRR) and Regulatory Reporting parts of the PRA
Rulebook and the Companies Act 2006, Parts 15 and 16 (collectively and
together with UK CRR, the ``UK PRA Financial Reporting Rules'');
(7) The PRA-designated UK nonbank SD maintains at all times an
amount of regulatory capital in the form of common equity tier 1
capital as defined in Article 26 of UK CRR, equal to or in excess of
the equivalent of $20 million in United States dollars (``U.S.
dollars''). The PRA-designated UK nonbank SD shall use a commercially
reasonable and observable British pound/U.S. dollar exchange rate to
convert the value of the pound-denominated common equity tier 1 capital
to U.S. dollars;
(8) The PRA-designated UK nonbank SD has filed with the Commission
a notice stating its intention to comply with the UK PRA Capital Rules
and the UK PRA Financial Reporting Rules in lieu of the CFTC Capital
Rules and the CFTC Financial Reporting Rules. The notice of intent must
include the PRA-designated UK nonbank SD's representation that the firm
is organized and domiciled in the UK, is a licensed investment firm
designated for prudential supervision by the PRA, and is subject to,
and complies with, the UK PRA Capital Rules and UK PRA Financial
Reporting Rules. A PRA-designated UK nonbank SD may not rely on this
Capital Comparability Determination Order until it receives
confirmation from Commission staff, acting pursuant to authority
delegated by the Commission, that the PRA-designated UK nonbank SD may
comply with the applicable UK PRA Capital Rules and UK PRA Financial
Reporting Rules in lieu of the CFTC Capital Rules and CFTC Reporting
Rules. Each notice filed pursuant to this condition must be submitted
to the Commission via email to the following address:
cftc.gov">[email protected];
(9) The PRA-designated UK nonbank SD prepares and keeps current
ledgers and other similar records in accordance with the PRA Rulebook,
General Organisational Requirements Part, Rule 2.2 and Record Keeping
Part, Rule 2.1 and 2.2, and conforming with the applicable accounting
principles;
(10) The PRA-designated UK nonbank SD files with the Commission and
with the National Futures Association (``NFA'') a copy of templates 1.1
(Balance Sheet Statement: assets), 1.2 (Balance Sheet Statement:
liabilities), 1.3 (Balance Sheet Statement: equity), and 2 (Statement
of profit or loss) of the financial reports (``FINREP'') that PRA-
designated UK nonbank SDs are required to submit pursuant to PRA
Rulebook, CRR Firms, Regulatory Reporting Part, Chapter 9 Regulatory
Activity Group 3, Rule 9.2, and templates 1 (Own Funds), 2 (Own Funds
Requirements) and 3 (Capital Ratios) of the common reports (``COREP'')
that PRA-designated UK nonbank SDs are required to submit pursuant to
PRA Rulebook, CRR Firms, Reporting (CRR) Part, Chapter 4 Reporting
(Part Seven A CRR), Article 430 Reporting on Prudential Requirements
and Financial Information, Rule 1. The FINREP and COREP templates must
be provided with balances converted to U.S. dollars and must be filed
with the Commission
[[Page 8060]]
and NFA within 35 calendar days of the end of each month. PRA-
designated UK nonbank SDs that are registered as security-based swap
dealers (``SBSDs'') with the U.S. Securities and Exchange Commission
(``SEC'') may comply with this condition by filing with the Commission
and NFA a copy of Form X-17A-5 (``FOCUS Report'') that the PRA-
designated UK nonbank SD is required to file with the SEC or its
designee pursuant to an order granting conditional substituted
compliance with respect to Securities Exchange Act of 1934 Rule 18a-7.
The copy of the FOCUS Report must be filed with the Commission and NFA
within 35 calendar days after the end of each month in the manner,
format and conditions specified by the SEC in Order Specifying the
Manner and Format of Filing Unaudited Financial and Operational
Information by Security-Based Swap Dealers and Major Security-Based
Swap Participants that are not U.S. Persons and are Relying on
Substituted Compliance with Respect to Rule 18a-7, 86 FR 59208 (Oct.
26, 2021);
(11) The PRA-designated UK nonbank SD files with the Commission and
with NFA a copy of its annual audited accounts and strategic report
(together, ``annual audited financial report'') that are required to be
prepared and published pursuant to Parts 15 and 16 of Companies Act
2006. The annual audited financial report may be reported in British
pound. The annual audited financial report must be filed with the
Commission and NFA on the earlier of the date the report is filed with
the PRA or the date the report is required to be filed with the PRA
pursuant to the UK PRA Financial Reporting Rules;
(12) The PRA-designated UK nonbank SD files Schedule 1 of appendix
B to subpart E of part 23 of the CFTC's regulations (17 CFR 23 subpart
E--appendix B) with the Commission and NFA on a monthly basis. Schedule
1 must be prepared with balances reported in U.S. dollars and must be
filed with the Commission and NFA within 35 calendar days of the end of
each month;
(13) The PRA-designated UK nonbank SD submits with each set of
FINREP and COREP templates, annual audited financial report, and
Schedule 1 of appendix B to subpart E of part 23 of the CFTC's
regulations, a statement by an authorized representative or
representatives of the PRA-designated UK nonbank SD that to the best
knowledge and belief of the representative or representatives, the
information contained in the reports, including the conversion of
balances in the reports to U.S. dollars, is true and correct;
(14) The PRA-designated UK nonbank SD files a margin report
containing the information specified in Commission Regulation 23.105(m)
(17 CFR 23.105(m)) with the Commission and with NFA within 35 calendar
days of the end of each month. The margin report balances must be
reported in U.S. dollars;
(15) The PRA-designated UK nonbank SD files a notice with the
Commission and NFA within 24 hours of being informed by the PRA that
the firm is not in compliance with any component of the UK PRA Capital
Rules or the UK PRA Financial Reporting Rules;
(16) The PRA-designated UK nonbank SD files a notice within 24
hours with the Commission and NFA if it fails to maintain regulatory
capital in the form of common equity tier 1 capital as defined in
Article 26 of UK CRR, equal to or in excess of the U.S. dollar
equivalent of $20 million using a commercially reasonable and
observable British pound/U.S. dollar exchange rate;
(17) The PRA-designated UK nonbank SD provides the Commission and
NFA with notice within 24 hours of filing a capital conservation plan
with the PRA pursuant to PRA Rulebook, CRR Firms, Capital Buffers Part,
Chapter 4 Capital Conservation Measures, Rule 4.4, indicating that the
firm has breached its combined capital buffer requirement;
(18) The PRA-designated UK nonbank SD provides the Commission and
NFA with notice within 24 hours if it is required by the PRA to
maintain additional capital or additional liquidity requirements, or to
restrict its business operations, or to comply with other requirements
pursuant to Financial Services and Markets Act 2000, Part 4A or the
Capital Requirements Regulation 2013, Regulation 35B;
(19) The PRA-designated UK nonbank SD files a notice with the
Commission and NFA within 24 hours if it fails to maintain its minimum
requirement for own funds and eligible liabilities (``MREL''), if the
PRA-designated UK nonbank SD is subject to such requirement as set
forth by the Bank of England pursuant to the Banking Act 2009, Section
3A and the Bank Recovery and Resolution (No. 2) Order 2014, Part 9;
(20) The PRA-designated UK nonbank SD files a notice with the
Commission and NFA within 24 hours of when the firm knew or should have
known that its regulatory capital fell below 120 percent of its minimum
capital requirement, comprised of the firm's core capital requirements
and any applicable capital buffer requirements. For purposes of the
calculation, the 20 percent excess capital must be in the form of
common equity tier 1 capital;
(21) The PRA-designated UK nonbank SD files a notice with the
Commission and NFA within 24 hours if it fails to make or keep current
the financial books and records;
(22) The PRA-designated UK nonbank SD files a notice with the
Commission and NFA within 24 hours of the occurrence of any of the
following:
(i) A single counterparty, or group of counterparties under common
ownership or control, fails to post required initial margin or pay
required variation margin on uncleared swap and non-cleared security-
based swap positions that, in the aggregate, exceeds 25 percent of the
PRA-designated UK nonbank SD's minimum capital requirement;
(ii) Counterparties fail to post required initial margin or pay
required variation margin to the PRA-designated UK nonbank SD for
uncleared swap and non-cleared security-based swap positions that, in
the aggregate, exceeds 50 percent of the PRA-designated UK nonbank SD's
minimum capital requirement;
(iii) The PRA-designated UK nonbank SD fails to post required
initial margin or pay required variation margin for uncleared swap and
non-cleared security-based swap positions to a single counterparty or
group of counterparties under common ownership and control that, in the
aggregate, exceeds 25 percent of the PRA-designated UK nonbank SD's
minimum capital requirement; or
(iv) The PRA-designated UK nonbank SD fails to post required
initial margin or pay required variation margin to counterparties for
uncleared swap and non-cleared security-based swap positions that, in
the aggregate, exceeds 50 percent of the PRA-designated UK nonbank SD's
minimum capital requirement;
(23) The PRA-designated UK nonbank SD files a notice with the
Commission and NFA of a change in its fiscal year-end approved or
permitted to go into effect by the PRA. The notice required by this
paragraph will satisfy the requirement for a nonbank SD to obtain the
approval of NFA for a change in fiscal year-end under Commission
Regulation 23.105(g) (17 CFR 23.105(g)). The notice of change in fiscal
year-end must be filed with the Commission and NFA at least 15 business
days prior to the effective date of the PRA-designated UK nonbank SD's
change in fiscal year-end;
(24) The PRA-designated UK nonbank SD or an entity acting on its
behalf
[[Page 8061]]
notifies the Commission of any material changes to the information
submitted in the application for capital comparability determination,
including, but not limited to, material changes to the UK PRA Capital
Rules or UK PRA Financial Reporting Rules imposed on PRA-designated UK
nonbank SDs, the PRA's supervisory authority or supervisory regime over
PRA-designated UK nonbank SDs, and proposed or final material changes
to the UK PRA Capital Rules or UK PRA Financial Reporting Rules as they
apply to PRA-designated UK nonbank SDs; and
(25) Unless otherwise noted in the conditions above, the reports,
notices, and other statements required to be filed by the PRA-
designated UK nonbank SD with the Commission and NFA pursuant to the
conditions of this Capital Comparability Determination Order must be
submitted electronically to the Commission and NFA in accordance with
instructions provided by the Commission or NFA.
Issued in Washington, DC, on January 29, 2024, by the
Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Notice of Proposed Order and Request for Comment on an
Application for a Capital Comparability Determination Submitted on
Behalf of Nonbank Swap Dealers Subject to Capital and Financial
Reporting Requirements of the United Kingdom and Regulated by the
United Kingdom Prudential Regulation Authority--Commission Voting
Summary, Chairman's Statement, and Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Behnam and Commissioners Johnson,
Goldsmith Romero, Mersinger, and Pham voted in the affirmative. No
Commissioner voted in the negative.
Appendix 2--Statement of Support of Chairman Rostin Behnam
I support the Commission's proposed order and request for
comment on an application for a preliminary capital comparability
determination on behalf of six nonbank swap dealers that are
domiciled in the United Kingdom (UK) and registered with the CFTC.
All six of these UK nonbank SDs are subject to, and comply with, the
UK capital and financial reporting rules as implemented by the UK
Prudential Regulation Authority, which the Commission has
preliminarily determined are comparable to certain capital and
financial reporting requirements under the Commodity Exchange Act
and the Commission's regulations, subject to certain conditions.
This preliminary capital comparability determination for these UK
nonbank SDs is the fourth proposed order and request for comment to
come before the Commission since it adopted its substituted
compliance framework for non-U.S. domiciled nonbank swap dealers in
July 2020.
I greatly appreciate the work of staff in the Market Participant
Division, the Office of the General Counsel, and the Office of
International Affairs on this matter.
I look forward to reviewing the public's comments on the
proposed rule. The 60-day comment period will begin upon the
Commission's publication of the proposed rule on its website.
Appendix 3--Statement of Support of Commissioner Kristin N. Johnson
I support the Commodity Futures Trading Commission's (Commission
or CFTC) issuance of the proposed conditional capital comparability
determination order for comment (Proposed Comparability
Determination) pursuant to Commission Regulation 23.106.\1\ The
Proposed Comparability Determination, if approved, will allow
registered nonbank swap dealers (SDs) organized and domiciled in the
United Kingdom (UK) and designated for prudential supervision by the
UK Prudential Regulation Authority (PRA-designated non-bank SDs) to
satisfy certain capital and financial reporting requirements under
the Commodity Exchange Act (CEA) by complying with comparable
capital and financial reporting requirements under UK laws and
regulations.
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\1\ The application here is by three trade associations (the
Institute of International Bankers, the International Swaps and
Derivatives Association, and the Securities Industry and Financial
Markets Association). There are currently six PRA-designated non-
bank SDs eligible to take advantage of a comparability
determination, if the Commission approves the Proposed Comparability
Determination. These six PRA-designated non-bank SDs include
Citigroup Global Markets Limited, Goldman Sachs International,
Merrill Lynch International, Morgan Stanley & Co. International Plc,
MUFG Securities EMEA Plc, and Nomura International Plc.
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It is imperative that we carefully review the capital and
financial reporting requirements for PRA-designated non-bank SDs in
a manner consistent with the Commission's mandate under the Dodd-
Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank
Act) to ensure that foreign swap activities that have a ``direct and
significant'' effect on U.S. markets are subject to regulatory
requirements as sufficiently robust as our own.\2\
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\2\ 7 U.S.C. 2(i). Section 2(i)(1) of the CEA applies the swaps
provisions of both the Dodd-Frank Act and Commission regulations
promulgated under those provisions to activities outside the United
States that have a direct and significant connection with activities
in, or effect on, commerce of the United States.
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In 2010, the Dodd-Frank Act amended the CEA to create a new
regulatory framework for swaps, including adding Section 2(i) to
address the cross-border application of the CEA's swap provisions.
In recognition of the value of global regulatory coordination in the
swaps markets and international comity, the Commission in 2020 set
out a framework for substituted compliance and comparability
determinations for a given foreign jurisdiction that afforded ``due
consideration [to] international comity principles'' while being
``consistent with . . . the Commission's interest in focusing its
authority on potential significant risks to the U.S. financial
system.'' \3\
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\3\ Cross-Border Application of the Registration Thresholds and
Certain Requirements Applicable to Swap Dealers and Major Swap
Participants, 85 FR 56924, 56924 (Sept. 14, 2020); see Capital
Requirements of Swap Dealers and Major Swap Participants, 85 FR
57462 (Sept. 15, 2020).
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Sections 4s(e) and 4s(f) of the CEA instruct the Commission to
impose capital requirements on non-bank SDs and financial condition
reporting obligations on all registered SDs, which have been
codified by the Commission.\4\ These requirements aim to ensure the
integrity of domestic and foreign entities operating in our markets,
to facilitate the rapid identification and remediation of liquidity
crises, and to mitigate the threat of systemic risks that may
threaten the stability of domestic and global financial markets. As
I previously stated:
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\4\ 7 U.S.C. 6s(e), (f); 17 CFR part 23, subpart E.
The Commission's capital and financial reporting requirements
adopted pursuant to these sections of the CEA are critical to
ensuring the safety and soundness of our markets by addressing and
managing risks that arise from a firm's operation as an SD. Ensuring
necessary levels of capital, as well as accurate and timely
reporting about financial conditions, helps to protect [SDs] and the
broader financial markets ecosystem from shocks, thereby ensuring
solvency and resiliency. This, in turn, protects the financial
system as a whole, reducing the risk of contagion that could arise
from uncleared swaps. Financial reporting requirements work with the
capital requirements by allowing the Commission to monitor and
assess an SD's financial condition, including compliance with
minimum capital requirements. The Commission uses the information it
receives pursuant to these requirements to detect potential risks
before they materialize. Capital adequacy and financial reporting
are pillars of risk management oversight for any business, and, for
firms operating in our markets, it is of the utmost importance that
rules governing these risk management tools are effectively
calibrated, continuously assessed, and fit for purpose.\5\
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\5\ Kristin N. Johnson, Commissioner, CFTC, Statement in Support
of Notice and Order on EU Capital Comparability Determination (June
7, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement060723c.
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[[Page 8062]]
Systemic risks transcend national borders. Successful mitigation
of systemic risks, therefore, requires careful, engaged
collaboration.
I support acknowledging market participants' compliance with the
laws and regulations of their UK regulator when the requirements
lead to an outcome that is comparable to the outcome of complying
with the CFTC's corresponding requirements. Mutual understanding and
respect for partner regulators in other countries advances the
Commission's goal of setting a global standard for sound derivatives
regulation that both enhances market stability and is also deeply
rigorous, reflecting the Commission's commitment to safe swaps
markets.
As global standard setting authorities and federal prudential
regulators refine and reinforce the regulatory framework for capital
requirements globally, it will be important to ensure continued
alignment among jurisdictions, as with the ongoing implementation of
the Basel III capital framework (Basel III).
While prudential regulators continue to debate the
implementation of a final set of regulations under Basel III, the
Commission's capital comparability determinations closes a gap in
our regulatory framework. Today's successful adoption of the
Proposed Comparability Determination enables the Commission to
deploy an enforceable regime immediately in the context of our UK-
based registrants and is reflective of a desire to engage and
harmonize regulation globally.
I commend the work of the staff of the Market Participants
Division--Amanda Olear, Tom Smith, Rafael Martinez, Liliya
Bozhanova, Joo Hong, and Justin McPhee, as well as the members of
the Office of International Affairs--for their careful consideration
of this application.
The Commission's efforts in considering the Proposed
Comparability Determination reflect thoughtful evaluation of the
comparability of relevant standards and an attempt to coordinate our
efforts to bring transparency to the swaps market and reduce its
risks to the public. I look forward to reviewing the comments that
the Commission will receive in response to the Proposed
Comparability Determination.
Appendix 4--Statement of Commissioner Christy Goldsmith Romero
Today [January 23, 2024], the Commission considers a proposal
intended to safeguard the resilience of six swap dealers in the
United Kingdom (``UK'') supervised by the Prudential Regulation
Authority (``PRA'').\1\ The proposal is part of the Commission's
``substituted compliance'' framework.
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\1\ The six swap dealers are Citigroup Global Markets Limited,
Goldman Sachs International, Merrill Lynch International, Morgan
Stanley & Co. International Plc, MUFG Securities EMEA Plc, and
Nomura International Plc. The determination does not cover other UK
nonbank swap dealers supervised by the Financial Conduct Authority.
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Substituted compliance must leave U.S. markets at no greater
risk than full compliance with our rules. It is a framework that
promotes global harmonization with like-minded foreign regulators
that have rules, supervision, and enforcement that are comparable in
purpose and effect to the CFTC. Our capital rules are a critical
pillar of the Dodd-Frank Act reforms, ones that continue to evolve
with the risks that our financial system faces. We must ensure that
our comparability assessments are sound and do not increase risk to
U.S. markets.
The CFTC's capital framework for swap dealers heeds the lessons
of the 2008 financial crisis.
The 2008 financial crisis precipitated the failure or near-
failure of almost every major investment bank and a number of
systemically important banks. It demonstrated all too clearly the
financial stability risks presented by undercapitalized financial
institutions, including a sprawling network of globally
interconnected derivatives dealers. That is why Congress mandated
that the Commission establish capital requirements for non-bank swap
dealers. The Dodd-Frank Act provided that swap dealer capital
requirements should ``offset the greater risk to the swap dealer. .
. and the financial system arising from the use of swaps that are
not cleared'' \2\ and ``help ensure the safety and soundness of the
swap dealer.'' \3\ The Commission's capital requirements, adopted in
2020,\4\ are intended to do exactly that.
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\2\ 7 U.S.C. 6s(e)(3)(A).
\3\ 7 U.S.C. 6s(e)(3)(A)(i). The capital requirements also must
``be appropriate to the risk associated with non-cleared swaps.'' 7
U.S.C. 6s(e)(3)(A)(ii).
\4\ See Commodity Futures Trading Commission, Capital
Requirements of Swap Dealers and Major Swap Participants, 85 FR
57462 (Sept. 15, 2020).
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Our capital requirements promote the resilience of swap dealers
and protect the U.S. financial system. They ensure that swap dealers
can weather economic downturns, and remain resilient during periods
of stress to continue their critical market functions. Our capital
requirements also help prevent contagion of losses spreading to
other financial institutions.
The CFTC must ensure that capital requirements eligible for
substituted compliance are comparable in outcomes, supervision, and
enforcement.
The Commission has to proceed cautiously in making a substituted
compliance determination given the importance of capital to
financial stability and the complexity of capital frameworks. The
Commission also has to consider the interconnected nature of global
derivatives markets, and the speed of contagion in the global
financial system.
Four of the swap dealers who would be able to avail themselves
of our determination today are affiliated with the largest Troubled
Asset Relief Program recipients. That fact alone is a good reminder
of what is at stake in terms of risk. It is not just danger to
financial institutions, but also American families and businesses.
Under this proposal in addition to the Commission's three prior
capital comparability proposals,\5\ 16 of 106 registered swap
dealers would be eligible to rely on substituted compliance.\6\ We
have a responsibility to ensure that our substituted compliance
framework recognizes only those frameworks that are legitimately a
substitute for the capital protections provided by U.S. law.
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\5\ See Commodity Futures Trading Commission, Notice of Proposed
Order and Request for Comment on an Application for a Capital
Comparability Determination from the Financial Services Agency of
Japan, 87 FR 48092 (Aug. 8, 2022); see also Commodity Futures
Trading Commission, Notice of Proposed Order and Request for Comment
on an Application for a Capital Comparability Determination
Submitted on behalf of Nonbank Swap dealers subject to Regulation by
the Mexican Comision Nacional Bancaria y de Valores, 87 FR 76374
(Dec. 13, 2022); see also Notice of Proposed Order and Request for
Comment on an Application for a Capital Comparability Determination
Submitted on Behalf of Nonbank Swap Dealers Domiciled in the French
Republic and Federal Republic of Germany and Subject to Capital and
Financial Reporting Requirements of the European Union, 88 FR 41774
(June 27, 2023).
\6\ 55 of the 107 swap dealers are subject to U.S. prudential
regulatory capital requirements.
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The fact that a foreign regulator may have comparable capital
rules will not be enough on its own. We have to look beyond the four
corners of rules. Substituted compliance requires a like-minded
foreign regulator with comparable supervision and enforcement to the
CFTC. The CFTC and the Prudential Regulation Authority (PRA) are
already cooperating on supervision and oversight of
clearinghouses.\7\ The PRA also has a long history of regulatory and
supervisory coordination with the U.S. banking regulators. I am
cognizant that the PRA recently received a secondary mandate to
promote the UK economy's international competitiveness and growth.
The PRA issued a statement that it will only advance this mandate
when it does not conflict with safety and soundness of regulated
entities.\8\ I expect our staff will continue to work closely with
the PRA to understand how it will implement this mandate, and work
with the PRA to safeguard the safety and soundness of non-bank swap
dealers and the stability of our global financial system.
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\7\ See CFTC, CFTC and BoE Sign New MOU for Supervision of
Cross-Border Clearing Organizations, https://www.cftc.gov/PressRoom/PressReleases/8289-20 (Oct. 20, 2020).
\8\ Prudential Regulation Authority, The Prudential Regulation
Authority's Approach to Policy, DP4/22, https://www.bankofengland.co.uk/prudential-regulation/publication/2022/september/pra-approach-to-policy (Sept. 2022).
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Our substituted compliance decisions should not allow for
regulatory arbitrage for swap dealers to escape strong U.S. capital
rules--a situation that could erode Dodd-Frank Act post-crisis
reforms. Today's determination is grounded in the PRA's capital
rules being comparable to the CFTC's ``Bank-Based Capital Approach''
to swap dealer capital requirements, which reflects requirements the
Federal Reserve imposes for bank holding companies.
The Federal Reserve and other U.S. prudential banking regulators
have proposed updates to the U.S. capital rules to implement
international standards known as ``Basel Endgame'' or Basel 3.1.\9\
The U.S.
[[Page 8063]]
updates are also informed by the failure of several banks in early
2023.\10\ The current proposal includes proposed changes that could
affect capital requirements for swap dealers subject to prudential
regulation. I would expect the Commission to monitor these changes
and update its own capital rules for swap dealers to remain
harmonized with the U.S. prudential regulators. The PRA is also
updating its capital requirements to implement the Basel
standards.\11\ As updates are finalized in the U.S. and globally,
the Commission should review whether capital requirements imposed by
jurisdictions with comparability determinations remain aligned with
capital requirements imposed by other U.S. financial regulators and
with the changes that the Commission makes to align its own capital
requirements.
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\9\ Federal Reserve System, Federal Deposit Insurance
Corporation, and Comptroller of the Currency, Regulatory Capital
Rule: Large Banking Organizations and Banking Organizations with
Significant Trading Activity, 88 FR 64028 (Sept. 18, 2023).
\10\ See Statement by Vice Chair for Supervision Michael S.
Barr, https://www.federalreserve.gov/newsevents/pressreleases/barr-statement-20230727.htm (July 27, 2023) (``Additionally, following
the banking turmoil in March 2023, the proposal seeks to further
strengthen the banking system by applying a broader set of capital
requirements to more large banks.'').
\11\ Prudential Regulation Authority, PS17/23--Implementation of
the Basel 3.1 standards near-final part 1, https://www.bankofengland.co.uk/prudential-regulation/publication/2023/december/implementation-of-the-basel-3-1-standards-near-final-policy-statement-part-1 (Dec. 12, 2023).
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Strong capital requirements and areas where the Commission would
particularly benefit from public comment.
All six of the UK swap dealers are dual-registered with the U.S.
Securities and Exchange Commission (``SEC''). The SEC has issued
final comparability determination orders permitting them to satisfy
certain SEC capital requirements through substituted compliance with
applicable UK requirements.\12\
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\12\ See Order Granting Conditional Substituted Compliance in
Connection with Certain Requirements Applicable to Non-U.S.
Security-Based Swap Dealers and Major Security-Based Swap
Participants Subject to Regulation in the United Kingdom, 86 FR
43318 (July 30, 2021); Amended and Restated Order Granting
Conditional Substituted Compliance in Connection with Certain
Requirements Applicable to Non-U.S. Security-Based Swap Dealers and
Major Security-Based Swap Participants Subject to Regulation in the
Federal Republic of Germany; Amended Orders Addressing Non-U.S.
Security-Based Swap Entities Subject to Regulation in the French
Republic or the United Kingdom; and Order Extending the Time to Meet
Certain Conditions Relating to Capital and Margin, 86 FR 59797 (Oct.
28, 2021); and Order Specifying the Manner and Format of Filing
Unaudited Financial and Operational Information by Security-Based
Swap Dealers and Major Security-Based Swap Participants that are not
U.S. Persons and are Relying on Substituted Compliance with Respect
to Rule 18a-7, 86 FR 59208 (Oct. 26, 2021).
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In conducting the CFTC's own analysis, it is important to
remember that substituted compliance is not an all-or-nothing
proposition. The Commission retains examinations and enforcement
authority and it can, should, and will, impose any conditions and
take all actions appropriate to protect the safety and soundness of
swap dealers and the U.S. financial system. Today, the Commission
proposes 25 conditions, including conditions requiring capital
reporting and Commission notification that are essential to
monitoring the financial condition and capital adequacy of swap
dealers.
Just as with swap dealers in Japan, Mexico and the European
Union,\13\ one of the most important conditions is that the
Commission will continue to require compliance with the CFTC's
minimum capital requirement of $20 million in common equity tier 1
capital.\14\ This is one of the most critical components of the
CFTC's capital requirements. It helps to ensure that each nonbank
swap dealer, whether current or a future new entrant, maintains at
all times, $20 million of the highest quality capital to meet its
financial obligations without becoming insolvent.
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\13\ See CFTC Commissioner Christy Goldsmith Romero, Proposal
for Strong Capital Requirements and Financial Reporting for Swap
Dealers in Japan, https://www.cftc.gov/PressRoom/SpeechesTestimony/romerostatement072722b (July 27, 2022); See also CFTC Commissioner
Christy Goldsmith Romero, Promoting the Resilience of Swap Dealers
in Mexico Through Strong Capital Requirements and Financial
Reporting, https://www.cftc.gov/PressRoom/SpeechesTestimony/romerostatment111022b (Nov. 10, 2022); CFTC Commissioner Christy
Goldsmith Romero, Promoting the Resilience of Swap Dealers in Europe
Through Strong Capital Requirements and Financial Reporting, https://www.cftc.gov/PressRoom/SpeechesTestimony/romerostatement060723e
(June 7, 2023).
\14\ This CFTC capital rule substantially exceeds the EUR 5
million minimum capital required under EU capital rules.
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Today, the Commission preliminarily finds that UK capital rules
requiring 8 percent of risk-weighted assets and an additional 2.5
percent buffer, for a total of 10.5 percent, are higher than the
CFTC's requirement of 8 percent of risk-weighted assets. This
capital requirement helps ensure that the swap dealer has sufficient
capital levels to cover for example, unexpected losses from business
activities.
There are proposed deviations from the Commission's bank-based
capital requirements that should be closely scrutinized. Some of
these deviations are similar to those raised by commenters to other
proposed determinations.\15\ For example, the Commission proposes to
permit compliance with UK capital rules that are not necessarily
anchored by a threshold percentage of uncleared swap margin as the
CFTC requires. The proposed determination discusses that UK capital
rules address liquidity, operational risks, as well as other risks
arising from derivatives exposures, through other mechanisms. I look
forward to public comment on the comparability of the approaches and
expect the Commission to publish additional analysis to address
concerns raised by commenters as part of any final determination.
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\15\ See Notice of Proposed Order and Request for Comment on an
Application for a Capital Comparability Determination Submitted on
Behalf of Nonbank Swap Dealers Domiciled in the French Republic and
Federal Republic of Germany and Subject to Capital and Financial
Reporting Requirements of the European Union, 88 FR 41774 (June 27,
2023) (Comment of Better Markets).
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In these areas, and others, public comments will be tremendously
beneficial. I approve.
Appendix 5--Statement of Support of Commissioner Caroline D. Pham
I support the Commission's proposed order and request for
comment on a comparability determination for nonbank swap dealers
subject to capital and financial reporting requirements of the
United Kingdom and regulated by the United Kingdom Prudential
Regulation Authority (PRA). I would like to thank Justin McPhee, Joo
Hong, Liliya Bozhanova, Rafael Martinez, Tom Smith, and Amanda Olear
in the Market Participants Division (MPD) for their hard work on
these technical and detailed requirements.
This proposal is the staff's fourth proposed capital adequacy
and financial reporting comparability determination.\1\ Each
involves significant engagement with the corresponding authority, in
this case the UK Prudential Regulation Authority, as well as CFTC
registrants. As I have previously said, the Commission, its staff,
and our regulatory counterparts around the world need to adhere to
the recommendations in IOSCO's 2020 report on Good Practices on
Processes for Deference, which was developed to provide solutions to
the challenges and drivers of market fragmentation.\2\ As set forth
in the IOSCO 2020 report, such processes for deference \3\ are
typically outcomes-based; risk sensitive; transparent; cooperative;
and sufficiently flexible.
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\1\ The prior three were for Japan, Mexico, and the EU. The
Commission maintains its list of comparability determinations for
substituted compliance purposes at https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm.
\2\ Statement of Commissioner Caroline D. Pham in Support of
Proposed Order and Request for Comment on Comparability
Determination for EU Nonbank Swap Dealer Capital and Financial
Reporting Requirements (June 9, 2023); IOSCO Report, ``Good
Practices on Processes for Deference'' (June 2020).
\3\ IOSCO uses ``deference'' as an ``overarching concept to
describe the reliance that authorities place on one another when
carrying out regulation or supervision of participants operating
cross-border.'' Id. at 1. The CFTC's use of substituted compliance
for swaps regulation is an example of regulatory deference
mechanisms.
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I continue to stress that this work by CFTC staff creates the
underpinnings of global markets that enable governments, central
banks and commercial banks, asset managers and investors, and
companies to manage the risks inherent in international flows of
capital that fuel economic growth and prosperity in both developed
and developing economies.\4\ I am pleased to continue to support
this work, and also encourage staff to finalize these proposals in
2024.
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\4\ Statement of Commissioner Caroline D. Pham in Support of
Proposed Order and Request for Comment on Comparability
Determination for EU Nonbank Swap Dealer Capital and Financial
Reporting Requirements (June 9, 2023); see also Concurring Statement
of Commissioner Caroline D. Pham Regarding Proposed Swap Dealer
Capital and Financial Reporting Comparability Determination (July
27, 2022); Concurring Statement of Commissioner Caroline D. Pham
Regarding Proposed Order and Request for Comment on an Application
for a Capital Comparability Determination (Nov. 10, 2022).
[FR Doc. 2024-02070 Filed 2-2-24; 8:45 am]
BILLING CODE 6351-01-P