June 29. 2015
The Commission’s proposal for the cross-border application of margin requirements for uncleared swaps is a highly complicated labyrinth. I look forward to the jolt to U.S. economic growth that will occur in the 3rd quarter of 2015 as a result of the thousands of billable hours that will be expended by lawyers and other professionals, who will have to read, interpret and respond to this tangled regulatory construct.
I have many concerns and questions regarding the proposal, including:
My concerns extend to the standards set forth for determining comparability. An appropriate framework for the cross-border application of margin requirements for uncleared swaps is essential if we are to preserve the global nature of the swaps market. Congress recognized this when it instructed the CFTC, the SEC and the prudential regulators to “coordinate with foreign regulatory authorities on the establishment of consistent international standards with respect to the regulation … of swaps.”2 Towards that end, representatives of more than 20 regulatory authorities, including the CFTC, participated in consultations with the Basel Committee on Banking Supervision (“BCBS”) and the Board of the International Organization of Securities Commissions (“IOSCO”), which resulted in the issuance of a final BCBS-IOSCO framework in September 2013 that establishes minimum margin standards for uncleared swaps (“BCBS-IOSCO framework”).3
Element seven of the BCBS-IOSCO framework discusses the cross-border application of margin requirements and stresses the importance of developing consistent requirements across jurisdictions to ensure that implementation at a national jurisdictional level is appropriately interactive:
that is, that each national jurisdiction’s rule is territorially complementary such that (i) regulatory arbitrage opportunities are limited, (ii) a level playing field is maintained, (iii) there is no application of duplicative or conflicting margin requirements to the same transaction or activity, and (iv) there is substantial certainty as to which national jurisdiction’s rules apply. When a transaction is subject to two sets of rules (duplicative requirements), the home and the host regulators should endeavor to (1) harmonize the rules to the extent possible or (2) apply only one set of rules, by recognizing the equivalence and comparability of their respective rules.4
Regulatory authorities in major financial centers continue to collaborate in the development of their rules and I commend CFTC staff for their continued dialogue with fellow domestic and foreign regulators. Nevertheless, there are bound to be differences across jurisdictions in the final rule sets that are ultimately adopted. Comparability determinations allowing for substituted compliance with the margin requirements of foreign jurisdictions will be essential to achieving a workable cross-border framework. I am concerned that the standards for making comparability determinations outlined in the Commission’s proposal may be too restrictive.
The Commission states that it will employ an outcome-based comparability standard focusing on whether the margin requirements in a foreign jurisdiction achieve the same regulatory objectives as the CFTC’s margin requirements and will not require specific rules identical to the Commission’s rules. The Commission states further, however, that it will make its outcome-based determinations on an element-by-element basis that will include, but not be limited to, analyzing: (i) the transactions subject to the foreign jurisdiction’s margin requirements; (ii) the entities subject to the foreign jurisdiction’s margin requirements; (iii) the methodologies for calculating the amounts of initial and variation margin; (iv) the process and standards for approving models for calculating initial and variation margin models; (v) the timing and manner in which initial and variation margin must be collected and/or paid; (vi) any threshold levels or amount; (vii) risk management controls for the calculation of initial and variation margin; (viii) eligible collateral for initial and variation margin; (ix) the requirements of custodial arrangements, including rehypothecation and segregation of margin; (x) documentation requirements relating to margin; and (xi) the cross-border application of the foreign jurisdiction’s margin regime.
As proposed, the Commission will not be assessing whether the foreign authority’s margin regime as a whole meets the broad regulatory objectives of requiring margin for uncleared swaps.5 Rather, in looking at each element (and any other factor not included in the foregoing list) the Commission may determine that a foreign regime is comparable as to some elements, but not others, in which case substituted compliance might be allowed, for example, with respect to the methodologies for calculating initial and variation margin, but not for the eligible collateral.
Depending on how it is put into practice, this element-by-element approach may be difficult to distinguish from the rule-by-rule analysis the Commission claims to eschew. We have seen this before when the Commission made its comparability determinations for certain foreign countries regarding certain transaction-level requirements for swap dealers and major swap participants.6 There, the Commission made its determinations on a “requirement-by-requirement” basis, rather than on the basis of the foreign regime as a whole.7 Former Commissioner Scott O’Malia observed in that instance that this was a “rule-by-rule” analysis, which was contrary to the recommendations of the OTC Derivatives Regulators Group and afforded only limited substituted compliance relief.8 Will our “element-by-element” analysis be any different than the “requirement-by-requirement” method the Commission employed then?
I fear that the proposed element-by-element approach will be outcome-based in name only. In a perfect world all G-20 countries will adopt comparable margin requirements, but we cannot let the perfect be the enemy of the good. For substituted compliance to work, we must focus on broad objectives, not specific requirements.
I am also troubled by the provision of the proposed rule that would not permit swaps executed “through or by” a U.S. branch of a non-U.S. CSE to qualify for the Exclusion for non-U.S. CSEs who qualify as Foreign Consolidated Subsidiaries. Under the proposal, uncleared swaps entered into by a non-U.S. CSE with a non-U.S. person counterparty (purely foreign-to-foreign swaps), where neither counterparty is a Foreign Consolidated Subsidiary or guaranteed by a U.S. person, would be excluded from the Commission’s margin rules. The Exclusion is not available, however, if the swap is executed “through or by” the U.S. branch of a non-U.S. CSE.9 The request for comment following this discussion asks how the Commission should determine whether a swap is executed “through or by” a U.S. branch and suggests using the same analysis used in the Commission’s Volcker Rule, which required that personnel that “arrange, negotiate, or execute” a purchase or sale conducted under the exemption for trading activity of a foreign banking entity must be located outside the U.S.10
Prior to its appearance in the Commission’s final Volcker Rule this concept appeared in a hastily issued, November 2013 Staff Advisory 13-69 (sometimes referred to in the industry as the “elevator rule”) that imposed swaps transaction rules on trades between non-U.S. persons whenever anyone on U.S. soil “arranged, negotiated, or executed” the trade.11 The effective date of this Staff Advisory has been delayed four times.12 As I have stated before, the elevator rule is causing many overseas trading firms to consider cutting off all activity with U.S.-based trade support personnel to avoid subjecting themselves to the CFTC’s flawed swaps trading rules. The Staff Advisory, if it goes into effect, will jeopardize the role of bank sales personnel in U.S. financial centers like Boston, Charlotte, Chicago, New Jersey and New York. It will likely have a ripple effect on technology staff supporting U.S. electronic trading systems, along with the thousands of jobs tied to the vendors who provide food services, office support, custodial services and transportation for the U.S. financial series industry. With this proposal, rather than recognizing the myriad of problematic issues arising from the Staff Advisory, the Commission is proposing to expand its scope from trading rules to margin rules.
Despite my many questions and concerns, I support issuing the proposed rule only so that the public may provide thorough analysis and thoughtful comment. My vote to issue the proposal for public comment should not signal, however, my agreement with it. I look forward to reviewing public comment.
1 Interpretive Guidance and Policy Statement Regarding Compliance With Certain Swap Regulations, 78 FR 45292 (Jul. 26, 2013).
2 15 U.S.C. 8325(a) (added by section 752 of the Dodd-Frank Act).
4 Id. at 23.
5 The regulatory objectives of requiring margin for uncleared swaps, as stated in the Dodd-Frank Act, are to help insure the safety and soundness of the swap dealer or major swap participant, the financial integrity of the markets and the stability of the U.S. financial system. Section 4s(e)(3)(A), (C), 7 U.S.C. 6s(e)(3)(A), (C).
6 See, e.g., Comparablility Determination for the European Union: Certain Transaction-Level Requirements, 78 FR 78878 (Dec. 27, 2013).
7 Id. at 78881.
8 Id. at 78889.
9 I note that the “through or by” language appears in the preamble to the rule, not the rule text.
10 See Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, 79 FR 5808, 5927 & n.1526 (Jan. 31, 2014).
11 CFTC Staff Advisory No. 13-69 (Nov. 14, 2013), available at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-69.pdf.
12 CFTC Letter No. 14-140, Extension of No-Action Relief: Transaction-Level Requirements for Non-U.S. Swap Dealers (Nov. 14, 2014), available at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-140.pdf.
Last Updated: June 29, 2015