2014-22962

Federal Register, Volume 79 Issue 192 (Friday, October 3, 2014)

[Federal Register Volume 79, Number 192 (Friday, October 3, 2014)]

[Proposed Rules]

[Pages 59897-59936]

From the Federal Register Online via the Government Printing Office [www.gpo.gov]

[FR Doc No: 2014-22962]

[[Page 59897]]

Vol. 79

Friday,

No. 192

October 3, 2014

Part II

Commodity Futures Trading Commission

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17 CFR Parts 23 and 140

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap

Participants; Proposed Rule

Federal Register / Vol. 79 , No. 192 / Friday, October 3, 2014 /

Proposed Rules

[[Page 59898]]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 23 and 140

RIN 3038-AC97

Margin Requirements for Uncleared Swaps for Swap Dealers and

Major Swap Participants

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rule; advance notice of proposed rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or

``CFTC'') is proposing regulations to implement section 4s(e) of the

Commodity Exchange Act (``CEA''), as added by section 731 of the Dodd-

Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank

Act''). This provision requires the Commission to adopt initial and

variation margin requirements for certain swap dealers (``SDs'') and

major swap participants (``MSPs''). The proposed rules would establish

initial and variation margin requirements for SDs and MSPs but would

not require SDs and MSPs to collect margin from non-financial end

users. In this release, the Commission is also issuing an Advance

Notice of Proposed Rulemaking requesting public comment on the cross-

border application of such margin requirements. The Commission is not

proposing rules on this topic at this time. It is seeking public

comment on several potential alternative approaches.

DATES: Comments must be received on or before December 2, 2014.

ADDRESSES: You may submit comments, identified by RIN 3038-AC97 and

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap

Participants, by any of the following methods:

Agency Web site, via its Comments Online process at http://comments.cftc.gov. Follow the instructions for submitting comments

through the Web site.

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: Same as Mail, above.

Federal eRulemaking Portal: http://www.regulations.gov.

Follow the instructions for submitting comments.

Please submit your comments using only one of these methods.

All comments must be submitted in English, or if not, accompanied

by an English translation. Comments will be posted as received to

http://www.cftc.gov. You should submit only information that you wish

to make available publicly. If you wish the Commission to consider

information that may be exempt from disclosure under the Freedom of

Information Act, a petition for confidential treatment of the exempt

information may be submitted according to the established procedures in

Sec. 145.9 of the Commission's regulations, 17 CFR 145.9.

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 www.cftc.gov that it may deem to be inappropriate for

publication, such as obscene language. All submissions that have been

redacted, or removed that contain comments on the merits of the

rulemaking will be retained in the public comment file and will be

considered as required under the Administrative Procedure Act and other

applicable laws, and may be accessible under the Freedom of Information

Act.

FOR FURTHER INFORMATION CONTACT: John C. Lawton, Deputy Director,

Division of Clearing and Risk, 202-418-5480, [email protected]; Thomas

J. Smith, Deputy Director, Division of Swap Dealer and Intermediary

Oversight, 202-418-5495, [email protected]; Rafael Martinez, Financial

Risk Analyst, Division of Swap Dealer and Intermediary Oversight, 202-

418-5462, [email protected]; Francis Kuo, Attorney, Division of Swap

Dealer and Intermediary Oversight, 202-418-5695, [email protected]; or

Stephen A. Kane, Research Economist, Office of Chief Economist, 202-

418-5911, [email protected]; Commodity Futures Trading Commission, 1155

21st Street NW., Washington DC 20581.

SUPPLEMENTARY INFORMATION:

I. Background

A. Statutory Authority

On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\

Title VII of the Dodd-Frank Act amended the CEA \2\ to establish a

comprehensive regulatory framework designed to reduce risk, to increase

transparency, and to promote market integrity within the financial

system by, among other things: (1) Providing for the registration and

regulation of SDs and MSPs; (2) imposing clearing and trade execution

requirements on standardized derivative products; (3) creating

recordkeeping and real-time reporting regimes; and (4) enhancing the

Commission's rulemaking and enforcement authorities with respect to all

registered entities and intermediaries subject to the Commission's

oversight.

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\1\ See Dodd-Frank Wall Street Reform and Consumer Protection

Act, Public Law 111-203, 124 Stat. 1376 (2010).

\2\ 7 U.S.C. 1 et seq.

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Section 731 of the Dodd-Frank Act added a new section 4s to the CEA

setting forth various requirements for SDs and MSPs. Section 4s(e)

mandates the adoption of rules establishing margin requirements for SDs

and MSPs.\3\ Each SD and MSP for which there is a Prudential Regulator,

as defined below, must meet margin requirements established by the

applicable Prudential Regulator, and each SD and MSP for which there is

no Prudential Regulator must comply with the Commission's regulations

governing margin.

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\3\ Section 4s(e) also directs the Commission to adopt capital

requirements for SDs and MSPs. The Commission proposed capital rules

in 2011. Capital Requirements for Swap Dealers and Major Swap

Participants, 76 FR 27802 (May 12, 2011). The Commission will

address capital requirements in a separate release.

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The term Prudential Regulator is defined in section 1a(39) of the

CEA, as amended by Section 721 of the Dodd-Frank Act. This definition

includes the Federal Reserve Board (``FRB''); the Office of the

Comptroller of the Currency (``OCC''); the Federal Deposit Insurance

Corporation (``FDIC''); the Farm Credit Administration; and the Federal

Housing Finance Agency.

The definition specifies the entities for which these agencies act

as Prudential Regulators. These consist generally of federally insured

deposit institutions, farm credit banks, federal home loan banks, the

Federal Home Loan Mortgage Corporation, and the Federal National

Mortgage Association. The FRB is the Prudential Regulator under section

4s not only for certain banks, but also for bank holding companies,

certain foreign banks treated as bank holding companies, and certain

subsidiaries of these bank holding companies and foreign banks. The FRB

is not, however, the Prudential Regulator for nonbank subsidiaries of

bank holding companies, some of which are required to be registered

with the Commission as SDs or MSPs. In general, therefore, the

Commission is required to establish margin requirements for all

registered SDs and MSPs that are not subject to a Prudential Regulator.

These include, among others, nonbank subsidiaries of bank holding

companies, as well as certain foreign SDs and MSPs.

Specifically, section 4s(e)(1)(B) of the CEA provides that each

registered SD

[[Page 59899]]

and MSP for which there is not a Prudential Regulator shall meet such

minimum capital requirements and minimum initial margin and variation

margin requirements as the Commission shall by rule or regulation

prescribe.

Section 4s(e)(2)(B) provides that the Commission shall adopt rules

for SDs and MSPs, with respect to their activities as an SD or an MSP,

for which there is not a Prudential Regulator imposing (i) capital

requirements and (ii) both initial and variation margin requirements on

all swaps that are not cleared by a registered derivatives clearing

organization (``DCO'').

Section 4s(e)(3)(A) provides that to offset the greater risk to the

SD or MSP and the financial system arising from the use of swaps that

are not cleared, the requirements imposed under section 4s(e)(2) shall

(i) help ensure the safety and soundness of the SD or MSP and (ii) be

appropriate for the risk associated with the non-cleared swaps.

Section 4s(e)(3)(C) provides, in pertinent part, that in

prescribing margin requirements the Prudential Regulator and the

Commission shall permit the use of noncash collateral the Prudential

Regulator or the Commission determines to be consistent with (i)

preserving the financial integrity of markets trading swaps and (ii)

preserving the stability of the United States financial system.

Section 4s(e)(3)(D)(i) provides that the Prudential Regulators, the

Commission, and the Securities and Exchange Commission (``SEC'') shall

periodically (but not less frequently than annually) consult on minimum

capital requirements and minimum initial and variation margin

requirements.

Section 4s(e)(3)(D)(ii) provides that the Prudential Regulators,

Commission and SEC shall, to the maximum extent practicable, establish

and maintain comparable minimum capital and minimum initial and

variation margin requirements, including the use of noncash collateral,

for SDs and MSPs.

B. Previous Proposal

Following extensive consultation and coordination with the

Prudential Regulators, the Commission published proposed rules for

public comment in 2011.\4\ The Prudential Regulators published

substantially similar rules two weeks later.\5\

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\4\ Margin Requirements for Uncleared Swaps for Swap Dealers and

Major Swap Participants, 76 FR 23732 (April 28, 2011).

\5\ Margin and Capital Requirements for Covered Swap Entities,

76 FR 27564 (May 11, 2011).

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The Commission received 102 comment letters. The Prudential

Regulators received a comparable number. The commenters included

financial services industry associations, agricultural industry

associations, energy industry associations, insurance industry

associations, banks, brokerage firms, investment managers, insurance

companies, pension funds, commercial end users, law firms, public

interest organizations, and other members of the public. The commenters

addressed numerous topics including applicability of the rules to

certain products, applicability to certain market participants, margin

calculation methodologies, two-way vs. one-way margin, margin

thresholds, permissible collateral, use of independent custodians,

rehypothecation of collateral, and harmonization with other regulators.

The Commission has taken the comments it received into

consideration in developing the further proposal contained herein. This

proposal differs in a number of material ways from the previous

proposal \6\ and the Commission has determined that it is appropriate

to issue a new request for comment. The Prudential Regulators have also

decided to issue a new request for comment. The public is invited to

comment on any aspect of the current proposal.

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\6\ These include, among others, the definition of financial end

user, the definition of material swaps exposure, the requirement for

two-way margin between SDs and financial end users, and the list of

eligible collateral for initial margin.

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C. International Standards

While the comments on the 2011 proposal were being reviewed,

regulatory authorities around the world determined that global

harmonization of margin standards was an important goal. The CFTC and

the Prudential Regulators decided to hold their rulemakings in abeyance

pending completion of the international efforts.

In October 2011, the Basel Committee on Banking Supervision

(``BCBS'') and the International Organization of Securities Commissions

(``IOSCO''), in consultation with the Committee on Payment and

Settlement Systems (``CPSS'') and the Committee on Global Financial

Systems (``CGFS''), formed a working group to develop international

standards for margin requirements for uncleared swaps. Representatives

of more than 20 regulatory authorities participated. From the United

States, the CFTC, the FDIC, the FRB, the OCC, the Federal Reserve Bank

of New York, and the SEC were represented.

In July 2012, the working group published a proposal for public

comment.\7\ In addition, the group conducted a Quantitative Impact

Study (``QIS'') to assess the potential liquidity and other

quantitative impacts associated with margin requirements.\8\

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\7\ BCBS/IOSCO, Consultative Document, Margin requirements for

non-centrally cleared derivatives (July 2012).

\8\ BCBS/IOSCO, Quantitative Impact Study, Margin requirements

for non-centrally cleared derivatives (November 2012).

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After consideration of the comments on the proposal and the results

of the QIS, the group published a near-final proposal in February 2013

and requested comment on several specific issues.\9\ The group

considered the additional comments in finalizing the recommendations

set out in the report.

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\9\ BCBS/IOSCO, Consultative Document, Margin requirements for

non-centrally cleared derivatives (February 2013).

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The final report was issued in September 2013.\10\ This report (the

``2013 international framework'') articulates eight key principles for

non-cleared derivatives margin rules, which are described below. These

principles represent the minimum standards approved by BCBS and IOSCO

and recommended to the regulatory authorities in member jurisdictions

of these organizations.

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\10\ BCBS/IOSCO, Margin requirements for non-centrally cleared

derivatives (September 2013) (``BCBS/IOSCO Report'').

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1. Appropriate Margining Practices Should be in Place With Respect to

all Non-Cleared Derivative Transactions

The 2013 international framework recommends that appropriate

margining practices be in place with respect to all derivative

transactions that are not cleared by central counterparties (``CCPs'').

The 2013 international framework does not include a margin requirement

for physically settled foreign exchange (``FX'') forwards and swaps.

The framework also would not apply initial margin requirements to the

fixed physically-settled FX component of cross-currency swaps.

2. Financial Firms and Systemically Important Nonfinancial Entities

(Covered Entities) Must Exchange Initial and Variation Margin

The 2013 international framework recommends bilateral exchange of

initial and variation margin for non-cleared derivatives between

covered entities. The precise definition of ``covered entities'' is to

be determined by each national regulator, but in general should include

financial firms and systemically important non-financial entities.

Sovereigns, central banks, certain multilateral development banks, the

Bank for International

[[Page 59900]]

Settlements (BIS), and non-systemic, non-financial firms are not

included as covered entities.

Under the 2013 international framework, all covered entities that

engage in non-cleared derivatives should exchange, on a bilateral

basis, the full amount of variation margin with a zero threshold on a

regular basis (e.g., daily). All covered entities are also expected to

exchange, on a bilateral basis, initial margin with a threshold not to

exceed [euro]50 million. The threshold applies on a consolidated group,

rather than legal entity, basis. In addition, and in light of the

permitted initial margin threshold, the 2013 international framework

recommends that entities with a level of non-cleared derivative

activity of [euro]8 billion notional or more would be subject to

initial margin requirements.

3. The Methodologies for Calculating Initial and Variation Margin

Should (i) Be Consistent Across Covered Entities, and (ii) Ensure That

All Counterparty Risk Exposures Are Covered With a High Degree of

Confidence

The 2013 international framework states that the potential future

exposure of a non-cleared derivative should reflect an estimate of an

increase in the value of the instrument that is consistent with a one-

tailed 99% confidence level over a 10-day horizon (or longer, if

variation margin is not collected on a daily basis), based on

historical data that incorporates a period of significant financial

stress.

The 2013 international framework permits the amount of initial

margin to be calculated by reference to internal models approved by the

relevant national regulator or a standardized margin schedule, but

covered entities should not ``cherry pick'' between the two calculation

methods. Models may allow for conceptually sound and empirically

demonstrable portfolio risk offsets where there is an enforceable

netting agreement in effect. However, portfolio risk offsets may only

be recognized within, and not across, certain well-defined asset

classes: credit, equity, interest rates and foreign exchange, and

commodities. A covered entity using the standardized margin schedule

may adjust the gross initial margin amount (notional exposure

multiplied by the relevant percentage in the table) by a ``net-to-gross

ratio,'' which is also used in the bank counterparty credit risk

capital rules to reflect a degree of netting of derivative positions

that are subject to an enforceable netting agreement.

4. To Ensure That Assets Collected as Collateral Can Be Liquidated in a

Reasonable Amount of Time To Generate Proceeds That Could Sufficiently

Protect Covered Entities From Losses in the Event of a Counterparty

Default, These Assets Should Be Highly Liquid and Should, After

Accounting for an Appropriate Haircut, be Able To Hold Their Value in a

Time of Financial Stress

The 2013 international framework recommends that national

supervisors develop a definitive list of eligible collateral assets.

The 2013 international framework includes examples of permissible

collateral types, provides a schedule of standardized haircuts, and

indicates that model-based haircuts may be appropriate. In the event

that a dispute arises over the value of eligible collateral, the 2013

international framework provides that both parties should make all

necessary and appropriate efforts, including timely initiation of

dispute resolution protocols, to resolve the dispute and exchange any

required margin in a timely fashion.

5. Initial Margin Should be Exchanged on a Gross Basis and Held in Such

a Way as to Ensure That (i) the Margin Collected Is Immediately

Available to the Collecting Party in the Event of the Counterparty's

Default, and (ii) the Collected Margin Is Subject to Arrangements That

Fully Protect the Posting Party

The 2013 international framework provides that collateral collected

as initial margin from a ``customer'' (defined as a ``buy-side

financial firm'') should be segregated from the initial margin

collector's proprietary assets. The initial margin collector also

should give the customer the option to individually segregate its

initial margin from other customers' margin. In very specific

circumstances, the initial margin collector may use margin provided by

the customer to hedge the risks associated with the customer's

positions with a third party. To the extent that the customer consents

to rehypothecation, it should be permitted only where applicable

insolvency law gives the customer protection from risk of loss of

initial margin in instances where either or both of the initial margin

collector and the third party become insolvent. Where a customer has

consented to rehypothecation and adequate legal safeguards are in

place, the margin collector and the third party to which customer

collateral is rehypothecated should comply with additional restrictions

detailed in the 2013 international framework, including a prohibition

on any further rehypothecation of the customer's collateral by the

third party.

6. Requirements for Transactions Between Affiliates Are Left to the

National Supervisors

The 2013 international framework recommends that national

supervisors establish margin requirements for transactions between

affiliates as appropriate in a manner consistent with each

jurisdiction's legal and regulatory framework.

7. Requirements for Margining Non-Cleared Derivatives Should Be

Consistent and Non-Duplicative Across Jurisdictions

Under the 2013 international framework, home-country supervisors

may allow a covered entity to comply with a host-country's margin

regime if the host-country margin regime is consistent with the 2013

international framework. A branch may be subject to the margin

requirements of either the headquarters' jurisdiction or the host

country.

8. Margin Requirements Should Be Phased in Over an Appropriate Period

of Time

The 2013 international framework phases in margin requirements

between December 2015 and December 2019. Covered entities should begin

exchanging variation margin by December 1, 2015. The date on which a

covered entity should begin to exchange initial margin with a

counterparty depends on the notional amount of non-cleared derivatives

(including physically settled FX forwards and swaps) entered into both

by its consolidated corporate group and by the counterparty's

consolidated corporate group.

Currency denomination. The 2013 international framework recommends

specific quantitative levels for several requirements such as the level

of notional derivative exposure that results in an entity being subject

to the margin requirements ([euro]8 billion), permitted initial margin

thresholds ([euro]50 million), and minimum transfer amounts

([euro]500,000). In the 2013 international framework, all such amounts

are denominated in Euros. In this proposal all such amounts are

denominated in U.S. dollars. The Commission is aware that, over time,

amounts that are denominated in different currencies in different

jurisdictions may fluctuate relative to one another due to changes in

exchange rates.

[[Page 59901]]

The Commission seeks comment on whether and how fluctuations

resulting from exchange rate movements should be addressed. In

particular, should these amounts be expressed in terms of a single

currency in all jurisdictions to prevent such fluctuations? Should the

amounts be adjusted over time if and when exchange rate movements

necessitate realignment? Are there other approaches to deal with

fluctuations resulting from significant exchange rate movements? Are

there other issues that should be considered in connection to the

effects of fluctuating exchange rates?

II. Proposed Margin Regulations

A. Introduction

During the financial crisis of 2008-2009, DCOs met all their

obligations without any financial support from the government. By

contrast, significant sums were expended by governmental entities as

the result of losses incurred in connection with uncleared swaps. For

example, a unit of American International Group (``AIG'') entered into

many credit default swaps and did not post initial margin or regularly

pay variation margin on these positions.\11\ AIG was unable to meet its

obligations and the Federal Reserve and the Department of the Treasury

expended large sums of money to meet these obligations.\12\

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\11\ See The Financial Crisis Inquiry Commission, The Financial

Crisis Inquiry Report: Final Report of the National Commission on

the Causes of the Financial and Economic Crisis in the United States

(Official Government Edition) at 265-268 (2011), available at http://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_full.pdf.

\12\ Id. at 344-352, 350. See also United States Department of

the Treasury, Office of Financial Stability, Troubled Asset Relief

Program, Four Year Retrospective: An Update on the Wind Down of

TARP, pp. 3, 18-19. Treasury and the Federal Reserve committed $182

billion to stabilize AIG. Ultimately all of this was recovered plus

a return of $22.7 billion.

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A key reason for this difference in the performance of cleared and

uncleared swaps is that DCOs use variation margin and initial margin as

the centerpiece of their risk management programs while these tools

often were not universally used in connection with uncleared swaps.

Consequently, in designing the proposed margin rules for uncleared

swaps, the Commission has built upon the sound practices for risk

management employed by central counterparties for decades.

Variation margin serves as a mechanism for periodically recognizing

changes in the value of open positions and reducing unrealized losses

to zero. Open positions are marked to their current market value each

day and funds are transferred between the parties to reflect any change

in value since the previous time the positions were marked. This

process prevents losses from accumulating over time and thereby reduces

both the chance of default and the size of any default should one

occur.

Initial margin serves as a performance bond against potential

future losses. If a party fails to meet its obligation to pay variation

margin, resulting in a default, the other party may use initial margin

to cover some or all of any loss. Because the payment of variation

margin prevents losses from compounding over an extended period of

time, initial margin only needs to cover any additional losses that

might accrue between the previous time that variation margin was paid

and the time that the position is liquidated.

Well-designed margin systems protect both parties to a trade as

well as the overall financial system. They serve both as a check on

risk-taking that might exceed a party's financial capacity and as a

resource that can limit losses when there is a failure by a party to

meet its obligations.

The statutory provisions cited above reflect Congressional

recognition that (i) margin is an essential risk-management tool and

(ii) uncleared swaps pose greater risks than cleared swaps. As

discussed further below, many commenters expressed concern that the

imposition of margin requirements on uncleared swaps will be very

costly for SDs and MSPs.\13\ However, margin has been, and will

continue to be, required for all cleared products. Given the

Congressional reference to the ``greater risk'' of uncleared swaps and

the requirement that margin for such swaps ``be appropriate for the

risk,'' the Commission believes that establishing margin requirements

for uncleared swaps that are at least as stringent as those for cleared

swaps is necessary to fulfill the statutory mandate. Within these

statutory bounds the Commission has endeavored to limit costs

appropriately, as detailed further below.

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\13\ For purposes of this proposal, the term ``SD'' means any

swap dealer registered with the Commission. Similarly, the term

``MSP'' means any major swap participant registered with the

Commission.

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The discussion below addresses: (i) The products covered by the

proposed rules; (ii) the market participants covered by the proposed

rules; (iii); the nature and timing of the margin obligations; (iv) the

methods of calculating initial margin; (v) the methods of calculating

variation margin; (vi) permissible forms of margin; (vii) custodial

arrangements; (viii) documentation requirements; (ix) the

implementation schedule; and (x) advance notice of proposed rulemaking

on the cross-border application of the rules.

In developing the proposed rules, the Commission staff worked

closely with the staff of the Prudential Regulators.\14\ In most

respects, the proposed rules would establish a similar framework for

margin requirements as the Prudential Regulators' proposal. Key

differences are noted in the discussion below.

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\14\ As required by section 4s of the CEA, the Commission staff

also has consulted with the SEC staff.

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The proposed rules are consistent with the 2013 international

framework. In some instances, as contemplated in the framework, the

proposed rules provide more detail than the framework. In a few other

instances, the proposed rules are stricter than the framework. Any such

variations from the framework are noted in the discussion below.

B. Products

As noted above, section 4s(e)(2)(B)(ii) of the CEA directs the

Commission to establish both initial and variation margin requirements

for SDs and MSPs ``on all swaps that are not cleared.'' The scope

provision of the proposed rules \15\ states that the proposal would

cover swaps that are uncleared swaps \16\ and that are executed after

the applicable compliance date.\17\

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\15\ Proposed Regulation Sec. 23.150.

\16\ The term uncleared swap is defined in proposed Regulation

Sec. 23.151.

\17\ A schedule of compliance dates is set forth in proposed

Regulation Sec. 23.160.

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The term ``cleared swap'' is defined in section 1a(7) of the CEA to

include any swap that is cleared by a DCO registered with the

Commission. The Commission notes, however, that SDs and MSPs also clear

swaps through foreign clearing organizations that are not registered

with the Commission. The Commission believes that a clearing

organization that is not a registered DCO must meet certain basic

standards in order to avoid creating a mechanism for evasion of the

uncleared margin requirements. Accordingly, the Commission is proposing

to include in the definition of cleared swaps certain swaps that have

been accepted for clearing by an entity that has received a no-action

letter from the Commission staff or exemptive relief from the

Commission permitting it to clear such swaps for U.S. persons without

being registered as a DCO.\18\

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\18\ See CFTC Ltr. No. 14-107 (August 18, 2014) (granting no-

action relief to Clearing Corporation of India Ltd.); CFTC Ltr. No.

14-87 (June 26, 2014) (granting no-action relief to Korea Exchange,

Inc.); CFTC Ltr. No. 14-68 (May 7, 2014) (granting no-action relief

to OTC Clearing Hong Kong Limited and certain of its clearing

members); CFTC Ltr. No. 14-27 (Mar. 20, 2014) (extending previous

grant of no-action relief to Eurex Clearing AG and certain of its

clearing members); CFTC Ltr. No. 14-07 (Feb. 6, 2014) (granting no-

action relief to ASX Clear (Futures) Pty Limited); and CFTC Ltr. No.

13-73 (Dec. 19, 2013) (extending previous grant of no-action relief

to Japan Securities Clearing Corporation and certain of its clearing

members).

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[[Page 59902]]

The Commission requests comment on whether it is appropriate to

exclude swaps that are cleared by an entity that is not a registered

DCO. If so, the Commission further requests comment on whether the

proposed rule captures the proper clearing organizations. For example,

should the Commission require that the clearing organizations be

qualifying central counterparties (``QCCPs'') \19\ or be subject to

regulation and supervision that is consistent with the CPSS-IOSCO

Principles for Financial Market Infrastructures (``PFMIs'')?

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\19\ A QCCP is a clearing organization that meets the standards

to be designated as such set forth by the Basel Committee for

Banking Supervision in the report ``Capital requirements for bank

exposures to central counterparties'' (April 2014).

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Because the pricing of swaps reflects the credit arrangements under

which they were executed, it could be unfair to the parties and

disruptive to the markets to require that the rules apply to positions

executed before the applicable compliance dates. The rules, however,

would permit SDs and MSPs voluntarily to include swaps executed before

the applicable compliance date in portfolios margined pursuant to the

proposed rules.\20\ Many market participants might do so to take

advantage of netting effects across transactions.

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\20\ See proposed Regulation Sec. 23.154(b)(2) for initial

margin and proposed Regulation Sec. 23.153(c) for variation margin.

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As a result of the determination by the Secretary of the Treasury

to exempt foreign exchange swaps and foreign exchange forwards from the

definition of swap,\21\ the following transactions would not be subject

to the requirements: (i) Foreign exchange swaps; (ii) foreign exchange

forwards; and (iii) the fixed, physically settled foreign exchange

transactions associated with the exchange of principal in cross-

currency swaps.

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\21\ Determination of Foreign Exchange Swaps and Foreign

Exchange Forwards Under the Commodity Exchange Act, 77 FR 69694

(Nov. 20, 2012).

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In a cross-currency swap, the parties exchange principal and

interest rate payments in one currency for principal and interest rate

payments in another currency. The exchange of principal occurs upon the

inception of the swap, with a reversal of the exchange of principal at

a later date that is agreed upon at the inception of the swap. The

foreign exchange transactions associated with the fixed exchange of

principal in a cross-currency swap are closely related to the exchange

of principal that occurs in the context of a foreign exchange forward

or swap. Accordingly, the Commission is proposing to treat that portion

of a cross-currency swap that is a fixed exchange of principal in a

manner that is consistent with the treatment of foreign exchange

forwards and swaps. This treatment of cross-currency swaps is limited

to cross-currency swaps and does not extend to any other swaps such as

non-deliverable currency forwards.

The Commission requests comment on the proposed treatment of

products. In particular, commenters are invited to discuss the costs

and benefits of the proposed approach. Commenters are urged to quantify

the costs and benefits, if practicable. Commenters also may suggest

alternatives to the proposed approach where the commenters believe that

the alternatives would be appropriate under the CEA.

C. Market Participants

1. SDs and MSPs

As noted above, section 4s(e)(2)(B) of the CEA directs the

Commission to impose margin requirements on SDs and MSPs for which

there is no Prudential Regulator (``covered swap entities'' or

``CSEs'').\22\ This provision further states that the requirement shall

apply to ``all swaps that are not cleared.'' Section 4s(e)(3)(A)(2)

states that the requirements must be ``appropriate to the risks

associated with'' the swaps.

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\22\ This term is defined in proposed Regulation Sec. 23.151.

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Because different types of counterparties can pose different levels

of risk, the Commission's proposed requirements would differ depending

on the category of counterparty. The proposed rules would establish

three categories of counterparty: (i) SDs and MSPs, (ii) financial end

users,\23\ and (iii) non-financial end users.\24\ As discussed below,

the nature of an SD/MSP's obligations under the rules would differ

depending on whether the counterparty was a covered counterparty or a

non-financial end user.

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\23\ This term is defined in proposed Regulation Sec. 23.151.

\24\ This term is defined in proposed Regulation Sec. 23.151 to

include entities that are not SDs, MSPs, or financial entities.

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2. Financial End Users

a. Definition

Financial end users would include any entity that (i) is specified

in the definition, and (ii) is not an SD or MSP. The definition lists

numerous entities whose business is financial in nature. The proposed

rule also would permit the Commission to designate additional entities

as financial end users if it identified additional entities whose

activities and risk profile would warrant inclusion. As contemplated by

the 2013 international framework, the CFTC proposal, which is the same

as the Prudential Regulator's proposal, contains greater detail in

defining financial end users than the international standards.\25\

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\25\ ``The precise definition of financial firms, non-financial

firms, and systemically important non-financial firms will be

determined by appropriate national regulation.'' See BCBS/IOSCO

Report at 9.

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In developing the definition, the Commission and the Prudential

Regulators sought to provide clarity about whether particular

counterparties would be subject to the margin requirements of the

proposed rule. The definition is an attempt to strike a balance between

the need to capture all financial counterparties that pose significant

risk to the financial system and the danger of being overly inclusive.

The Commission believes that financial firms generally present a

higher level of risk than other types of counterparties because the

profitability and viability of financial firms is more tightly linked

to the health of the financial system than other types of

counterparties. Because financial counterparties are more likely to

default during a period of financial stress, they pose greater systemic

risk and risk to the safety and soundness of the CSE.

The list of financial entities is based to a significant extent on

Federal statutes that impose registration or chartering requirements on

entities that engage in specified financial activities. Such activities

include deposit taking and lending, securities and swaps dealing,

investment advisory activities, and asset management.

Because Federal law largely looks to the States for the regulation

of the business of insurance, the proposed definition broadly includes

entities organized as insurance companies or supervised as such by a

State insurance regulator. This element of the proposed definition

would extend to reinsurance and monoline insurance firms, as well as

insurance firms supervised by a foreign insurance regulator.

The proposal also would cover a broad variety and number of nonbank

lending and retail payment firms that operate in the market. To this

end, the proposal would include State-licensed or registered credit or

lending entities

[[Page 59903]]

and money services businesses, under proposed regulatory language

incorporating an inclusive list of the types of firms subject to State

law.\26\ However, the Commission recognizes that the licensing of

nonbank lenders in some states extends to commercial firms that provide

credit to the firm's customers in the ordinary course of business.

Accordingly, the Commission is proposing to exclude an entity

registered or licensed solely because it finances the entity's direct

sales of goods or services to customers. The Commission requests

comment on whether this aspect of the proposed rule adequately

maintains a distinction between financial end users and commercial end

users.

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\26\ The Commission expects that financial cooperatives that

provide financial services to their members, such as lending to

their members and entering into swaps in connection with those

loans, would be treated as financial end users, pursuant to this

aspect of the proposed rule's coverage of credit or lending

entities.

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In addition, real estate investment companies would be financial

end users, as they are entities that would be investment companies

under section 3 of the Investment Company Act but for section

3(c)(5)(C). Furthermore, other securitization vehicles would be

financial end users in cases where those vehicles are entities that are

deemed not to be investment companies under section 3 of the Investment

Company Act pursuant to Rule 3a-7. The Commission also notes that the

category of investment companies registered with the SEC under the

Investment Company Act would include registered investment companies as

well as business development companies.

Under the proposed rule, those cooperatives that are financial

institutions, such as credit unions, Farm Credit System banks and

associations, and the National Rural Utilities Cooperative Finance

Corporation would be financial end users because their sole business is

lending and providing other financial services to their members,

including engaging in swaps in connection with such loans.\27\

Cooperatives that are financial end users may qualify for an exemption

from clearing,\28\ and therefore, they may enter into non-cleared swaps

with covered swap entities that are subject to the proposed rule.

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\27\ Under the proposed rule, the financing subsidiaries or

affiliates of producer or consumer cooperatives would be non-

financial end users.

\28\ Section 2(h)(7)(c)(ii) of the CEA and section 3C(g)(4) of

the Securities Exchange Act of 1934 authorize the CFTC and the SEC,

respectively, to exempt small depository institutions, small Farm

Credit System institutions, and small credit unions with total

assets of $10 billion or less from the mandatory clearing

requirements for swaps and security-based swaps. Additionally, the

CFTC, pursuant to its authority under section 2(h)(1)(A) of the CEA,

enacted 17 CFR 50.51, which allows cooperative financial entities,

including those with total assets in excess of $10 billion, to elect

an exemption from mandatory clearing of swaps that: (1) They enter

into in connection with originating loans for their members; or (2)

hedge or mitigate commercial risk related to loans or swaps with

their members.

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The Commission remains concerned, however, that one or more types

of financial entities might escape classification under the specific

Federal or State regulatory regimes included in the proposed definition

of a financial end user. Accordingly, the definition includes two

additional prongs. First, the definition would cover an entity that is,

or holds itself out as being, an entity or arrangement that raises

money from investors primarily for the purpose of investing in loans,

securities, swaps, funds or other assets for resale or other

disposition or otherwise trading in loans, securities, swaps, funds or

other assets. The Commission requests comment on the extent to which

there are (or may be in the future) pooled investment vehicles that are

not captured by the other prongs of the definition (such as the

provisions covering private funds under the Investment Advisers Act or

commodity pools under the CEA). The Commission also requests comment on

whether this aspect of the definition of financial end user provides

sufficiently clear guidance to covered swap entities and market

participants as to its intended scope, and whether it adequately

maintains a distinction between financial end users and commercial end

users.

Second, the proposal would allow the Commission to require a swap

dealer and major swap participant (``covered swap entity'') to treat an

entity as a financial end user for margin purposes, even if the person

is not specifically listed within the definition of ``financial end

user'' or if the entity is excluded from the definition of financial

end user as described below. This provision was included out of an

abundance of caution to act as a safety mechanism in the event that an

entity didn't fall squarely within one of the listed categories but was

effectively acting as a financial end user.

To address the classification of foreign entities as financial end

users, the proposal would require the covered swap entity to determine

whether a foreign counterparty would fall within another prong of the

financial end user definition if the foreign entity was organized under

the laws of the United States or any State. The Commission recognizes

that this approach would impose upon covered swap entities the

difficulties associated with analyzing a foreign counterparty's

business activities in light of a broad array of U.S. regulatory

requirements. The alternative, however, would require covered swap

entities to gather a foreign counterparty's financial reporting data

and determine the relative amount of enumerated financial activities in

which the counterparty is engaged over a rolling period.\29\ The

Commission requests comment on whether some other method or approach

would adequately assure that the rule's objectives with respect to

dealer safety and soundness and reductions of systemic risk can be

achieved, in a fashion that can be more readily operationalized by

covered swap entities. For example, would it be appropriate to have

foreign counterparties certify to CSEs whether they are financial end

users or not? This could be operationally simpler for the CSEs and

would avoid the circumstance where one CSE, in good faith, deemed a

foreign counterparty to be a financial end user and another CSE, in

good faith, did not.

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\29\ See e.g., Definitions of ``Predominantly Engaged In

Financial Activities'' and ``Significant Nonbank Financial Company

and Bank Holding Company'', 68 FR 20756 (April 5, 2013).

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The definition of financial entities \30\ would exclude the

government of any country, central banks, multilateral development

banks, the Bank for International Settlements, captive finance

companies,\31\ and agent affiliates.\32\ The exclusion for sovereign

entities, multilateral development banks and the Bank for International

Settlements is consistent with the 2013 international framework and the

proposal of the Prudential Regulators.

[[Page 59904]]

Captive finance companies and agent affiliates were excluded by the

Dodd-Frank Act from the definition of financial entity subject to

mandatory clearing.

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\30\ Proposed Regulation Sec. 23.151.

\31\ A captive finance company is an entity that is excluded

from the definition of financial entity under section

2(h)(7)(c)(iii) of the CEA for purposes of the requirement to submit

certain swaps for clearing. That section describes it as ``an entity

whose primary business is providing financing, and uses derivatives

for the purpose of hedging underlying commercial risks related to

interest rate and foreign currency exposures, 90 percent or more of

which arise from financing that facilitates the purchase or lease of

products, 90 percent or more of which are manufactured by the parent

company or another subsidiary of the parent company.''

\32\ An agent affiliate is an entity that is an affiliate of a

person that qualifies for an exception from the requirement to

submit certain trades for clearing. Under section 2(h)(7)(D) of the

CEA, ``an affiliate of a person that qualifies for an exception

under subparagraph (A) (including affiliate entities predominantly

engaged in providing financing for the purchase of the merchandise

or manufactured goods of the person) may qualify for the exception

only if the affiliate, acting on behalf of the person and as an

agent, uses the swap to hedge or mitigate the commercial risk of the

person or other affiliate of the person that is not a financial

entity.''

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The Commission notes that States would not be excluded from the

definition of financial end user, as the term ``sovereign entity''

includes only central governments. The categorization of a State or

particular part of a State as a financial end user depends on whether

that part of the State is otherwise captured by the definition of

financial end user. For example, a State entity that is a

``governmental plan'' under ERISA would meet the definition of

financial end user.

For a foreign entity that was not a central government, a foreign

regulator could request a determination whether the entity was a

financial end user. Such a determination could extend to other

similarly situated entities in that jurisdiction.

The Commission seeks comment on all aspects of the financial end

user definition, including whether the definition has succeeded in

capturing all entities that should be included. The Commission requests

comment on whether there are additional entities that should be

included as financial end users and, if so, how those entities should

be defined. Further, the Commission also requests comment on whether

there are additional entities that should be excluded from the

definition of financial end user and why those particular entities

should be excluded. The Commission also requests comment on whether

another approach to defining financial end user (e.g., basing the

financial end user definition on the financial entity definition as in

the 2011 proposal) would provide more appropriate coverage and clarity,

and whether covered swap entities could operationalize such an approach

as part of their regular procedures for taking on new counterparties.

The Commission requests comment on the costs and benefits of the

proposed definition of financial end user. Commenters are urged to

quantify the costs and benefits, if practicable. Commenters also may

suggest alternatives to the proposed approach where the commenters

believe that the alternatives would be appropriate under the CEA.

b. Small Banks

As noted above, banks would be financial end users under the

proposal. They would be subject to initial margin requirements if they

entered into uncleared swaps with CSEs and, as discussed below, had

material swaps exposure. Staff of the Prudential Regulators have

indicated that they expect that the proposed rule likely will have

minimal impact on small banks.

Staff of the Prudential Regulators believe that the vast majority

of small banks do not engage in swaps at or near that level of activity

that would meet the material swaps exposure threshold. If, however, a

small bank did exceed the threshold level, the Prudential Regulators

believe it would be appropriate for the protection of both the CSE and

the small bank for two-way initial margin to be posted. The Commission

notes that, as discussed in more detail below, initial margin would

only need to be posted to the extent it exceeded $65 million.

The proposed rule would require a CSE to exchange daily variation

margin with a small bank, regardless of whether the institution had

material swap exposure. However, the covered swap entity would only be

required to collect variation margin from a small bank when the amount

of both initial margin and variation margin required to be collected

exceeded $650,000. The Prudential Regulators have indicated that they

expect that the vast majority of small banks will have a daily margin

requirement that is below this amount.

The Commission requests comment on all aspects of the proposed

treatment of small banks. In particular, the Commission requests

comment on the interaction of this proposal with clearing exemptions

that have been granted.\33\

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\33\ See Commission Regulations Sec. Sec. 50.50(d)(small

banks), 50.51 (cooperatives), 50.52 (inter-affiliate trades), and

CFTC Ltr. No. 13-22 (June 4, 2013) (treasury affiliates).

---------------------------------------------------------------------------

c. Affiliates of CSEs

The proposal generally would cover swaps between CSEs and their

affiliates that are financial end users. The Commission notes that

other applicable laws require transactions between banks and their

affiliates to be on an arm's length basis. For example, section 23B of

the Federal Reserve Act provides that many transactions between a bank

and its affiliates must be on terms and under circumstances, including

credit standards, that are substantially the same or at least as

favorable to the bank as those prevailing at the time for comparable

transactions with or involving nonaffiliated companies.\34\ Consistent

with that treatment, the Prudential Regulators and the Commission are

proposing to apply the margin requirements to swaps between CSEs and

their affiliates.

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\34\ 12 U.S.C. 371c-1(a).

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The Commission requests comment on all aspects of the proposed

treatment of transactions with affiliates. In particular, the

Commission requests comment on the interaction of this proposal with

clearing exemptions that have been granted.

d. Multilateral Development Banks

The proposed definition of the term ``multilateral development

bank,'' includes a provision encompassing ``[a]ny other entity that

provides financing for national or regional development in which the

U.S. government is a shareholder or contributing member or which the

Commission determines poses comparable credit risk.'' The Commission

seeks comment regarding this definition. In particular, is the

criterion of comparability of credit risk appropriate for this

definition? Should the Commission look to other characteristics of the

entity in determining whether it should be within the definition of

``multilateral development bank''?

e. Material Swaps Exposure

A CSE would not be required to exchange initial margin with a

financial end user if the financial end user did not have ``material

swaps exposure.'' \35\ Material swaps exposure would be computed using

the average daily aggregate notional amount of uncleared swaps,

security-based swaps, foreign exchange forwards, and foreign exchange

swaps\36\ with all counterparties for June, July, and August of the

previous calendar year. Essentially, a financial end user would have

material swaps exposure if it held an aggregate gross notional amount

of these products of more than $3 billion.\37\

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\35\ Proposed Regulation Sec. 23.152 applies to ``covered

counterparties.'' Proposed Regulation Sec. 23.151 defines that term

to include financial entities with material swaps exposure.

\36\ The 2013 international framework states that all uncleared

derivatives, ``including physically settled FX forwards and swaps''

should be included in determining whether a covered entity should be

subject to margin requirements. BCBS/IOSCO Report Paragraph 8.8.

Although these products would not themselves be subject to margin

requirements, they are uncleared derivatives that pose risks. It was

the judgment of BCBS/IOSCO that they should be included in

identifying significant market participants in the uncleared space.

Consistent with international standards and with the Prudential

Regulators' proposal, the Commission is proposing to include them

for purposes of this calculation.

\37\ Proposed Regulation Sec. 23.151.

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This provision recognizes that a financial end user that has

relatively smaller positions does not pose the same risks as a

financial end user with

[[Page 59905]]

larger positions. By reducing the number of market participants subject

to certain margin requirements, it also addresses the concerns that

have been expressed about the availability of sufficient collateral to

meet these requirements.

While adoption of a material swaps exposure threshold is consistent

with the 2013 international framework,\38\ the Commission and the

Prudential Regulators, are proposing to set the materiality standard

lower than the international standard. However, the lower standard was

chosen in order to be consistent with the intent of the international

standards, which was to require collection of margin only when the

amount exceeds $65 million, as explained below.

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\38\ BCBS/IOSCO Report at 9.

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The 2013 international framework defines smaller financial end

users as those counterparties that have a gross aggregate amount of

covered swaps below [euro]8 billion, which, at current exchange rates,

is approximately equal to $11 billion. The preliminary view of the

Commission and the Prudential Regulators is that defining material

swaps exposure as a gross notional exposure of $3 billion, rather than

$11 billion, is appropriate because it reduces systemic risk without

imposing undue burdens on covered swap entities, and therefore, is

consistent with the objectives of the Dodd-Frank Act. This view is

based on data and analyses that have been conducted since the

publication of the 2013 international framework.

Specifically, the Commission and the Prudential Regulators have

reviewed actual initial margin requirements for a sample of cleared

swaps. These analyses indicate that there are a significant number of

cases in which a financial end user would have a material swaps

exposure level below $11 billion but would have a swap portfolio with

an initial margin collection amount that significantly exceeds the

proposed permitted initial margin threshold amount of $65 million. The

intent of both the Commission and the 2013 international framework is

that the initial margin threshold provide smaller counterparties with

relief from the operational burden of measuring and tracking initial

margin collection amounts that are expected to be below $65 million.

Setting the material swaps exposure threshold at $11 billion appears to

be inconsistent with this intent, based on the recent analyses.

The table below summarizes actual initial margin requirements for

4,686 counterparties engaged in cleared interest rate swaps. Each

counterparty represents a particular portfolio of cleared interest rate

swaps. Each counterparty had a swap portfolio with a total gross

notional amount less than $11 billion and each is a customer of a CCP's

clearing member. Column (1) displays the initial margin amount as a

percentage of the gross notional amount. Column (2) reports the initial

margin, in millions of dollars that would be required on a portfolio

with a gross notional amount of $11 billion.

Initial Margin Amounts on 4,686 Cleared Interest Rate Swap Portfolios

----------------------------------------------------------------------------------------------------------------

Column (1) initial Column (2) initial

margin amount as margin amount on an $11

percentage of gross billion gross notional

notional amount (%) portfolio ($MM)

----------------------------------------------------------------------------------------------------------------

Average....................................................... 2.1 231

25th Percentile............................................... 0.6 66

50th Percentile............................................... 1.4 154

75th Percentile............................................... 2.7 297

----------------------------------------------------------------------------------------------------------------

As shown in the table above, the average initial margin rate across

all 4,686 counterparties, reported in Column (1), is 2.1 percent, which

would equate to an initial margin collection amount, reported in Column

(2), of $231 million on an interest rate swap portfolio with a gross

notional amount of $11 billion. This average initial margin collection

amount significantly exceeds the proposed permitted threshold amount of

$65 million. Seventy-five percent of the 4,686 cleared interest rate

swap portfolios exhibit an initial margin rate in excess of 0.6

percent, which equates to an initial margin amount on a cleared

interest rate swap portfolio of $66 million (approximately equal to the

proposed permitted threshold amount).

The data above represent actual margin requirements on a sample of

interest rate swap portfolios that are cleared by a single CCP. Some

CCPs also provide information on the initial margin requirements on

specific and representative swaps that they clear. The Chicago

Mercantile Exchange (``CME''), for example, provides information on the

initial margin requirements for cleared interest rate swaps and credit

default swaps that it clears. This information does not represent

actual margin requirements on actual swap portfolios that are cleared

by the CME but does represent the initial margin that would be required

on specific swaps if they were cleared at the CME. The table below

presents the initial margin requirements for two swaps that are cleared

by the CME.

Initial Margin Amounts on CME Cleared Interest Rate and Credit Default Swaps

----------------------------------------------------------------------------------------------------------------

Column (1) initial Column (2) initial

margin amount as margin amount on an $11

percentage of gross billion gross notional

notional amount (%) portfolio ($MM)

----------------------------------------------------------------------------------------------------------------

5 year, receive fixed and pay floating rate interest rate swap 2.0 216

5 year, sold CDS protection on the CDX IG Series 20 Version 22 1.9 213

Index........................................................

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[[Page 59906]]

According to the CME, the initial margin requirement on the

interest rate swap and the credit default swap are both roughly two

percent of the gross notional amount. This initial margin rate

translates to an initial margin amount of roughly $216 million on a

swap portfolio with a gross notional amount of $11 billion.

Accordingly, this data also indicates that the initial margin

collection amount on a swap portfolio with a gross notional size of $11

billion could be significantly larger than the proposed permitted

initial margin threshold of $65 million.

In addition to the information provided in the tables above, the

Commission's preliminary view is that additional considerations suggest

that the initial margin collection amounts associated with uncleared

swaps could be even greater than those reported in the tables above.

The tables above represent initial margin requirements on cleared

interest rate and credit default index swaps. Uncleared swaps in other

asset classes, such as single name equity or single name credit default

swaps, are likely to be riskier and hence would require even more

initial margin. In addition, uncleared swaps often contain complex

features, such as nonlinearities, that make them even riskier and would

hence require more initial margin. Finally, uncleared swaps are

generally expected to be less liquid than cleared swaps and must be

margined, under the proposed rule, according to a ten-day close-out

period rather than the five-day period required for cleared swaps. The

data presented above pertains to cleared swaps that are margined

according to a five-day and not a ten-day close-out period. The

requirement to use a ten-day close-out period would further increase

the initial margin requirements of uncleared versus cleared swaps.

In light of the data and considerations noted above, the

Commission's preliminary view is that it is appropriate and consistent

with the intent of the 2013 international framework to identify a

material swaps exposure with a gross notional amount of $3 billion

rather than $11 billion ([euro]8 billion) as is suggested by the 2013

international framework. Identifying a material swaps exposure with a

gross notional amount of $3 billion is more likely to result in an

outcome in which entities with a gross notional exposure below the

material swaps exposure amount would be likely to have an initial

margin collection amount below the proposed permitted initial margin

threshold of $65 million. The Commission does recognize, however, that

even at the lower amount of $3 billion, there are likely to be some

cases in which the initial margin collection amount of a portfolio that

is below the material swaps exposure amount will exceed the proposed

permitted initial margin threshold amount of $65 million. The

Commission's preliminary view is that such instances should be

relatively rare and that the operational benefits of using a simple and

transparent gross notional measure to define the material swaps

exposure amount are substantial.

The Commission notes that under the implementation schedule set out

below, this requirement would not take effect until January 1,

2019.\39\ Parties with gross notional exposures around this amount

would have several years notice before the requirements took effect.

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\39\ Proposed Regulation Sec. 23.160.

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The Commission requests comment on all aspects of the material

swaps exposure provision. In particular, the Commission requests

comment on the proposal to establish a level that is lower than the

level set forth in the 2013 international framework. Are there

alternative measurement methodologies that do not rely on gross

notional amounts that should be used? Does the proposed rule's use and

definition of the material swaps exposure raise any competitive equity

issues that should be considered? Are there any other aspects of the

material swaps exposure that should be considered by the Commission?

The Commission requests comment on the costs and benefits of the

proposed definition of material swaps exposure. Commenters are urged to

quantify the costs and benefits, if practicable. Commenters also may

suggest alternatives to the proposed approach where the commenters

believe that the alternatives would be appropriate under the CEA.

3. Non-Financial End Users

Non-financial end users would include any entity that was not an

SD, an MSP, or a financial end user. The proposal would not require

CSEs to exchange margin with non-financial end users. The Commission

believes that such entities, which generally are using swaps to hedge

commercial risk, pose less risk to CSEs than financial entities.

Therefore, under section 4s(e)(3)(A)(ii) of the CEA, applying a

different standard to trades by CSEs with non-financial entities than

to trades by CSEs with covered counterparties would be ``appropriate to

the risk.''

This approach is consistent with Congressional intent. Senior

Congressional leaders have stated that they do not believe that non-

financial end users should be required to post margin for uncleared

swaps.\40\ In addition, the Dodd-Frank Act generally exempted non-

financial end users from the requirement that they submit trades to

clearing.\41\ If the Commission required them to post margin for

uncleared trades, the clearing exemption could be weakened because the

costs of clearing are likely to be less than the costs of margining an

uncleared position. This approach is also consistent with international

standards.\42\

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\40\ Letter from Chairman Debbie Stabenow, Committee on

Agriculture, Nutrition and Forestry, U.S. Senate, Chairman Frank D.

Lucas, Committee on Agriculture, United States House of

Representatives, Chairman Tim Johnson, Committee on Banking,

Housing, and Urban Affairs, U.S. Senate, and Chairman Spencer

Bachus, Committee on Financial Services, United States House of

Representatives to Secretary Timothy Geithner, Department of

Treasury, Chairman Gary Gensler, U.S. Commodity Futures Trading

Commission, Chairman Ben Bernanke, Federal Reserve Board, and

Chairman Mary Shapiro, U.S. Securities and Exchange Commission

(April 6, 2011); Letter from Chairman Christopher Dodd, Committee on

Banking, Housing, and Urban Affairs, U.S. Senate, and Chairman

Blanche Lincoln, Committee on Agriculture, Nutrition, and Forestry,

U.S. Senate, to Chairman Barney Frank, Financial Services Committee,

United States House of Representatives, and Chairman Collin

Peterson, Committee on Agriculture, United States House of

Representatives (June 30, 2010); see also 156 Cong. Rec. S5904

(daily ed. July 15, 2010) (statement of Sen. Lincoln).

\41\ See section 2(h)(7) of the CEA.

\42\ BCBS/IOSCO Report at pp. 7-8.

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The Commission's proposal is generally consistent with the proposal

of the Prudential Regulators but differs in some particulars. The

Prudential Regulators' proposal contains the following provision:

A covered swap entity is not required to collect initial margin

with respect to any non-cleared swap or non-cleared security-based

swap with a counterparty that is neither a financial end user with

material swaps exposure nor a swap entity but shall collect initial

margin at such times and in such forms (if any) that the covered

swap entity determines appropriately address the credit risk posed

by the counterparty and the risks of such non-cleared swaps and non-

cleared security-based swaps.

The Commission's proposal does not contain this provision.

The Commission's proposal contains other provisions designed to

address the mandate under section 4s(e)(3)(A)(i) that Commission rules

``help ensure the safety and soundness'' of SDs and MSPs. First, as

discussed further below, the rules would require CSEs to enter into

certain documentation with all counterparties, including non-financial

entities, to provide clarity about the parties' respective rights and

obligations.\43\ CSEs and non-financial

[[Page 59907]]

entities would be free to set initial margin and variation margin

requirements, if any, in their discretion and any thresholds agreed

upon by the parties would be permitted.

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\43\ Proposed Regulation Sec. 23.158.

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Second, the proposal would require each CSE to calculate

hypothetical initial and variation margin amounts each day for

positions held by non-financial entities that have material swaps

exposure to the covered counterparty.\44\ That is, the CSE must

calculate what the margin amounts would be if the counterparty were

another SD or MSP and compare them to any actual margin requirements

for the positions.\45\ These calculations would serve as risk

management tools to assist the CSE in measuring its exposure and to

assist the Commission in conducting oversight of the CSE.

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\44\ Proposed Regulations Sec. Sec. 23.154(a)(6) and

23.155(a)(3).

\45\ This is consistent with the requirement set forth in

section 4s(h)(3)(B)(iii)(II) of the CEA that SDs and MSPs must

disclose to counterparties who are not SDs or MSPs a daily mark for

uncleared swaps.

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D. Nature and Timing of Margin Requirements

1. Initial Margin

Subject to thresholds discussed below, the proposal would require

each CSE to collect initial margin from, and to post initial margin

with, each covered counterparty on or before the business day after

execution \46\ for every swap with that counterparty.\47\ The proposal

would require the CSEs to continue to post and to collect initial

margin until the swap is terminated or expires.\48\

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\46\ Commission Regulation Sec. 23.200(e) defines execution to

mean, ``an agreement by the counterparties (whether orally, in

writing, electronically, or otherwise) to the terms of the swap

transaction that legally binds the counterparties to such terms

under applicable law.'' 17 CFR 23.200(e).

\47\ Proposed Regulation Sec. 23.152(a).

\48\ Proposed Regulation Sec. 23.152(b).

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Recognizing that SDs and MSPs pose greater risk to the markets and

the financial system than other swap market participants, Congress

established a comprehensive regulatory scheme for them including

registration, recordkeeping, reporting, margin, capital, and business

conduct requirements. Accordingly, under the mandate of section

4s(e)(3)(C) to preserve the financial integrity of markets trading

swaps and to preserve the stability of the United States financial

system, the Commission is proposing to require SDs and MSPs to collect

initial margin from, and to post initial margin with, one another.

Similarly, as discussed above, the Commission believes that

financial end users with material swaps exposure potentially pose

greater risk to CSEs and to the financial system than non-financial end

users or financial end users with smaller aggregate exposures.

Accordingly, under the mandate of section 4s(e)(3)(A) to help ensure

the safety and soundness of SDs and MSPs, the Commission is proposing

to require SDs and MSPs to collect initial margin from, and to post

initial margin with, financial end users.

Notably, the proposal would require both collecting and posting of

initial margin by CSEs (``two-way margin''). Two-way margin helps to

ensure the safety and soundness of CSEs. Daily collection of initial

margin increases the safety and soundness of the CSE by providing

collateral to cover potential future exposure from each counterparty.

That is, if a counterparty fails to meet an obligation, the CSE can

liquidate the initial margin that it holds to cover some or all of the

loss. But daily posting of initial margin also helps to ensure the

safety and soundness of a CSE by making it more difficult for the CSE

to build up exposures that it cannot fulfill. That is, the requirement

that a CSE post initial margin acts as a discipline on its risk taking.

The requirement also would make it more difficult for a rogue trader to

hide his positions.

In the wake of clearing mandates, uncleared swaps are likely to be

more customized and consequently trade in a less liquid market than

cleared swaps. As a result, uncleared swaps potentially might take a

longer time and require a greater price premium to be liquidated than

cleared swaps, particularly in distressed market conditions. Initial

margin is designed to address these risks.

The proposal contains a provision stating that a CSE would not be

deemed to have violated its obligation to collect initial margin if it

took certain steps.\49\ Specifically, if a counterparty failed to pay

the required initial margin to the CSE, the CSE would be required to

make the necessary efforts to attempt to collect the initial margin,

including the timely initiation and continued pursuit of formal dispute

resolution mechanisms,\50\ or otherwise demonstrate upon request to the

satisfaction of the Commission that it has made appropriate efforts to

collect the required initial margin or commenced termination of the

swap.

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\49\ Proposed Regulation Sec. 23.152(c).

\50\ See Commission Regulation Sec. 23.504(b)(4).

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The Commission requests comment on all aspects of the proposal

relating to the nature and timing of initial margin. In particular, the

Commission requests comment on two-way initial margin.

The Commission requests comment on the costs and benefits of the

proposed approach. Commenters are urged to quantify the costs and

benefits, if practicable. Commenters also may suggest alternatives to

the proposed approach where the commenters believe that the

alternatives would be appropriate under the CEA.

2. Variation Margin

Subject to a minimum transfer amount discussed below, the proposal

would require each CSE to collect variation margin from, and to pay

variation margin to, each counterparty that is a swap entity or a

financial end user, on or before the end of the business day after

execution for each swap with that counterparty.\51\ The proposed rule

would require the CSEs to continue to pay or collect variation margin

each business day until the swap is terminated or expires.\52\

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\51\ Proposed Regulation Sec. 23.153(a).

\52\ Proposed Regulation Sec. 23.153(b).

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Two-way variation margin would protect the safety and soundness of

CSEs for the same reasons discussed above in connection with initial

margin. Two-way variation margin has been a keystone of the ability of

DCOs to manage risk. Each day, starting on the day after execution,

current exposure is removed from the market through the payment and

collection of variation margin.

If two-way variation margin were not required for uncleared swaps

between CSEs and counterparties that are swap entities or financial end

users, current exposures might accumulate beyond the financial capacity

of a counterparty. In contrast to initial margin, which is designed to

cover potential future exposures, variation margin addresses actual

current exposures, that is, losses that have already occurred.

Unchecked accumulation of such exposures was one of the characteristics

of the financial crisis which, in turn, led to the enactment of the

Dodd-Frank Act.\53\ As with initial margin, the Commission believes

that requiring covered swap entities both to collect and pay margin

with these counterparties effectively reduces systemic risk by

protecting both the covered swap entity and its

[[Page 59908]]

counterparty from the effects of a default.

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\53\ See The Financial Crisis Inquiry Commission, The Financial

Crisis Inquiry Report: Final Report of the National Commission on

the Causes of the Financial and Economic Crisis in the United States

(Official Government Edition) at 265-268 (2011), available at http://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_full.pdf.

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In contrast to the initial margin requirement, which would only

apply to financial end users with material swaps exposure, the proposed

variation margin requirement would apply to all financial end users

regardless of whether the entity had material swaps exposure. This is

consistent with international standards.\54\ It reflects the

Commission's view that variation margin is an important risk mitigant

that (i) reduces the build-up of risk that may ultimately pose systemic

risk and (ii) imposes a lesser liquidity burden than does initial

margin. Moreover, this approach is consistent with current market

practice.

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\54\ BCBS/IOSCO Report at 9.

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The proposal would permit netting of variation margin across

swaps.\55\ Any netting would have to be done pursuant to an eligible

master netting agreement.\56\ The agreement would create a single legal

obligation for all individual transactions covered by the agreement

upon an event of default. It would specify the rights and obligations

of the parties under various circumstances.\57\

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\55\ Proposed Regulation Sec. 23.153(c).

\56\ Proposed Regulation Sec. 23.151, definition of ``eligible

master netting agreement.''

\57\ Id.

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As is the case for initial margin, the proposal contains a

provision stating that a CSE would not be deemed to have violated its

obligation to collect variation margin if it took certain steps.\58\

Specifically, if a counterparty failed to pay the required variation

margin to the CSE, the CSE would be required to make the necessary

efforts to attempt to collect the variation margin, including the

timely initiation and continued pursuit of formal dispute resolution

mechanisms, including pursuant to Commission Regulation 23.504(b)(4),

if applicable, or otherwise demonstrate upon request to the

satisfaction of the Commission that it has made appropriate efforts to

collect the required variation margin or commenced termination of the

swap.

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\58\ Proposed Regulation Sec. 23.153(d).

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The Commission requests comment on all aspects of the proposal

relating to the nature and timing of variation margin.

The Commission requests comment on the costs and benefits of the

proposed approach. Commenters are urged to quantify the costs and

benefits, if practicable. Commenters also may suggest alternatives to

the proposed approach where the commenters believe that the

alternatives would be appropriate under the CEA.

E. Calculation of Initial Margin

1. Overview

Under the proposed rules, a CSE could calculate initial margin

using either a model-based method or a standardized table-based

method.\59\ The required amount of initial margin would be the amount

computed pursuant to the model or the table minus a threshold amount of

$65 million.\60\ This amount could not be less than zero.\61\ The

initial margin specified under the rule would be a minimum requirement,

and the parties would be free to require more initial margin.

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\59\ Proposed Regulation Sec. 23.154.

\60\ Proposed Regulation Sec. 23.151, definition of ``initial

margin threshold amount.''

\61\ Proposed Regulation Sec. 23.154(a)(4).

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When a CSE entered into a swap with a counterparty that was either

another CSE or an SD/MSP subject to a Prudential Regulator, each party

would bear the responsibility for calculating the amount that it would

collect.\62\ Thus, for such trades, the amount a party posted could

differ from the amount it collected either because of differences in

their respective methodologies or because the product has asymmetric

risk. As a practical matter, the Commission understands that the

industry is working to develop common standards that would minimize

this for methodologies.

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\62\ Proposed Regulation Sec. 23.152(a).

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When, however, a CSE entered into a swap with a financial entity,

the CSE would have responsibility for calculating both the amount it

collected and the amount it posted.\63\ This is because the statute

does not directly impose margin requirements on financial entities.

They only come within the scope of section 4s when they trade with SDs

or MSPs.

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\63\ Proposed Regulation Sec. 23.154(b).

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As noted, the rules would permit CSEs and their covered

counterparties to establish margin thresholds of up to $65 million.

This means that the parties could agree not to post and/or to collect

any margin amount falling below this threshold level. For covered

entities that were part of a consolidated group, a single threshold

would be applied across the consolidated group, not individually to

each entity.\64\ This threshold is consistent with the 50 million Euro

threshold set forth in the international standards as is the

consolidated group requirement.\65\ The Prudential Regulators proposed

the same treatment in this regard.

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\64\ Proposed Regulation Sec. 23.151, definition of ``initial

margin threshold amount.''

\65\ BCBS/IOSCO Report at 9.

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Concern has been expressed by some in the industry about the

potential expense of two-way margin. The $65 million threshold is

designed to mitigate that expense while continuing to protect the

financial integrity of CSEs and the financial system. Smaller exposures

would be permitted to go uncollateralized, but a significant percentage

of all large exposures would be supported by collateral.

For example, if the initial margin calculated for a particular

trade were $55 million, the CSE would not be required to post or to

collect initial margin because the amount would be below the $65

million threshold. If the margin amount were $75 million, the CSE would

only be required to post and to collect $10 million, the amount the

margin calculation exceeded the $65 million threshold.

In order to reduce transaction costs, the proposal would establish

a ``minimum transfer amount'' of $650,000.\66\ Initial and variation

margin payments would not be required to be made if the payment were

below that amount. This amount is consistent with international

standards.\67\ It represents an amount sufficiently small that the

level of risk reduction might not be worth the transaction costs of

transferring the money. It would affect only the timing of collection;

it would not change the amount of margin that must be collected once

the $650,000 level was exceeded.

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\66\ Proposed Regulation Sec. 23.154(a)(3).

\67\ BCBS/IOSCO Report at 9.

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For example, if a party posted $80 million as initial margin on

Monday and the requirement increased to $80,400,000 on Tuesday, the

party would not be required to post additional funds on Tuesday because

the $400,000 increase would be less than the minimum transfer amount.

If, however, on Wednesday, the requirement increased by another

$400,000 to $80,800,000, the party would be required to post the entire

$800,000 additional amount.

The Commission requests comment on the $65 million threshold and

the $650,000 minimum transfer amount. The Commission requests comment

on the costs and benefits of the proposed approach. Commenters are

urged to quantify the costs and benefits, if practicable. Commenters

also may suggest alternatives to the proposed approach where the

commenters believe that the alternatives would be appropriate under the

CEA.

[[Page 59909]]

2. Models

a. Commission Approval

Consistent with international standards, the proposal would require

CSEs to obtain the written approval of the Commission before using a

model to calculate initial margin.\68\ Further, the CSE would have to

demonstrate that the model satisfied all of the requirements of this

section on an ongoing basis.\69\ In addition, a CSE would have to

notify the Commission in writing before extending the use of a model

that has been approved to an additional product type, making any change

to any initial margin model that has been approved that would result in

a material change in the CSE's assessment of initial margin

requirements; or making any material change to assumptions used in the

model.\70\ The Commission could rescind its approval of a model if the

Commission determined that the model no longer complied with this

section.\71\

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\68\ Proposed Regulation Sec. 23.154(b)(1). See BCBS/IOSCO

Report at 12: ``any quantitative model that is used for initial

margin purposes must be approved by the relevant supervisory

authority.''

\69\ Id.

\70\ Id.

\71\ Id.

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Given the central place of modeling in most margin systems and the

complexity of the process, the Commission believes that these oversight

provisions are necessary. The resources that would be needed, however,

to initially review and to periodically assess margin models present a

significant challenge to the Commission. To address this issue, the

Commission would seek to coordinate with both domestic and foreign

authorities in the review of models.

In many instances, CSEs whose margin models would be subject to

Commission review would be affiliates of entities whose margin models

would be subject to review by one of the Prudential Regulators. In such

situations, the Commission would coordinate with the Prudential

Regulators in order to avoid duplicative efforts and to provide

expedited approval of models that a Prudential Regulator had already

approved. For example, if a Prudential Regulator had approved the model

of a depository institution registered as an SD, Commission review of a

comparable model used by a non-bank affiliate of that SD would be

greatly facilitated. Similarly, the Commission would coordinate with

the SEC for CSEs that are dually registered and would coordinate with

foreign regulators that had approved margin models for foreign CSEs.

For CSEs that that wished to use models that were not reviewed by a

Prudential Regulator, the SEC, or a foreign regulator, the Commission

would coordinate, if possible, with the National Futures Association

(``NFA'') as each CSE would be required to be a member of the NFA.

The Commission requests comment on all aspects of the proposed

margin approval process. Specifically, the Commission requests comment

on the appropriateness and feasibility of coordinating with the

Prudential Regulators, the SEC, foreign regulators, and the NFA in this

regard.

The Commission is also considering whether it would be appropriate

to provide for provisional approval upon the filing of an application

pending review. The Commission requests comment on the appropriateness

of such an approach.

In order to expedite the review of models further, the Commission

is proposing to delegate authority to staff to perform the functions

described above. As is the case with existing delegations to staff, the

Commission would continue to reserve the right to perform these

functions itself at any time.

The Commission requests comment on whether additional procedural

detail is appropriate. For example, should time frames be specified for

completion of any of the functions?

b. Applicability to Multiple Swaps

To the extent that more than one uncleared swap is executed

pursuant to an eligible master netting agreement (``EMNA'') \72\

between a CSE and a covered counterparty, the CSE would be permitted to

calculate initial margin on an aggregate basis with respect to all

uncleared swaps governed by such agreement.\73\ As explained below,

however, only exposures in certain asset classes could be offset. If

the agreement covered uncleared swaps entered into before the

applicable compliance date, those swaps would have to be included in

the calculation.\74\

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\72\ This term is defined in Proposed Regulation Sec. 23.151.

\73\ Proposed Regulation Sec. 23.154(b)(2).

\74\ Id.

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The proposal defines EMNA as any written, legally enforceable

netting agreement that creates a single legal obligation for all

individual transactions covered by the agreement upon an event of

default (including receivership, insolvency, liquidation, or similar

proceeding) provided that certain conditions are met. These conditions

include requirements with respect to the covered swap entity's right to

terminate the contract and to liquidate collateral and certain

standards with respect to legal review of the agreement to ensure that

it meets the criteria in the definition.

The Commission requests comment on all aspects of the proposed

definition of EMNA. In particular, the Commission requests comment on

whether the proposal provides sufficient clarity regarding the laws of

foreign jurisdictions that provide for limited stays to facilitate the

orderly resolution of financial institutions. The Commission also seeks

comment regarding whether the provision for a contractual agreement

subject by its terms to limited stays under resolution regimes

adequately encompasses potential contractual agreements of this nature

or whether this provision needs to be broadened, limited, clarified, or

modified in some manner.

c. Elements of a Model

The proposal specifies a number of conditions that a model would

have to meet to receive Commission approval.\75\ They include, among

others, the following.

---------------------------------------------------------------------------

\75\ Proposed Regulation Sec. 23.154(b)(3).

---------------------------------------------------------------------------

(i) Ten-Day Close-Out Period

The model must calculate potential future exposure using a one-

tailed 99 percent confidence interval for an increase in the value of

the uncleared swap or netting set of uncleared swaps due to an

instantaneous price shock that is equivalent to a movement in all

material underlying risk factors, including prices, rates, and spreads,

over a holding period equal to the shorter of ten business days or the

maturity of the swap.

The required 10-day close-out period assumption is consistent with

counterparty credit risk capital requirements for banks. The

calculation must be performed directly over a 10-day period. In the

context of bank regulatory capital rules, a long horizon calculation

(such as 10 days), under certain circumstances, may be indirectly

computed by making a calculation over a shorter horizon (such as 1 day)

and then scaling the result of the shorter horizon calculation to be

consistent with the longer horizon. The proposed rule does not provide

this option to covered swap entities using an approved initial margin

model. The Commission's understanding is that the rationale for

allowing such indirect calculations that rely on scaling shorter

horizon calculations has largely been based on computational and cost

considerations that were material in the

[[Page 59910]]

past but are much less so in light of advances in computational speeds

and reduced computing costs. The Commission seeks comment on whether

the option to make use of such indirect calculations has a material

effect on the burden of complying with the proposed rule, and whether

such indirect methods are appropriate in light of current computing

methods and costs.

(ii) Portfolio Offsets

The model may reflect offsetting exposures, diversification, and

other hedging benefits for uncleared swaps that are governed by the

same EMNA by incorporating empirical correlations within the broad risk

categories, provided the covered swap entity validates and demonstrates

the reasonableness of its process for modeling and measuring hedging

benefits. The categories are agriculture, credit, energy, equity,

foreign exchange/interest rate, metals, and other. Empirical

correlations under an eligible master netting agreement may be

recognized by the model within each broad risk category, but not across

broad risk categories. The sum of the initial margins calculated for

each broad risk category must be used to determine the aggregate

initial margin due from the counterparty.

For example, if a CSE entered into two credit swaps and two energy

swaps with a single counterparty, the CSE could use an approved initial

margin model to perform two separate calculations: the initial margin

calculation for the credit swaps and the initial margin calculation for

the energy commodity swaps. Each calculation could recognize offsetting

and diversification within the credit swaps and within the energy

commodity swaps. The result of the two separate calculations would then

be summed together to arrive at the total initial margin amount for the

four swaps (two credit swaps and two energy commodity swaps).

The Commission believes that the correlations of exposures across

unrelated asset categories, such as credit and energy commodities, are

not stable enough over time, and, in particular, during periods of

financial stress, to be recognized in a regulatory margin model

requirement. The Commission further believes that a single commodity

asset class is too broad and that the relationship between disparate

commodity types, such as aluminum and corn, are not stable enough to

warrant hedging benefits within the initial margin model. The

Commission seeks comment on this specific treatment of asset classes

for initial margin purposes and whether fewer or more distinctions

should be made.

The Commission is aware that some swaps may be difficult to

classify into one and only one asset class because some swaps may have

characteristics that relate to more than one asset class. Under the

proposal, the Commission expects that the CSE would make a

determination as to which asset class best represents the swap based on

a holistic view of the underlying swap. As a specific example, many

swaps may have some sensitivity to interest rates even though most of

the swap's sensitivity relates to another asset class such as equity or

credit. The Commission seeks comment on whether or not this approach is

reasonable and whether or not instances in which the classification of

a swap into one of the broad asset classes described above is

problematic and material. If such instances are material, the

Commission seeks comment on alternative approaches to dealing with such

swaps.

(iii) Stress Calibration

The proposed rule requires the initial margin model to be

calibrated to a period of financial stress. In particular, the initial

margin model must employ a stress period calibration for each broad

asset class (agricultural commodity, energy commodity, metal commodity,

other commodity, credit, equity, and interest rate and foreign

exchange). The stress period calibration employed for each broad asset

class must be appropriate to the specific asset class in question.

While a common stress period calibration may be appropriate for some

asset classes, a common stress period calibration for all asset classes

would only be considered appropriate if it is appropriate for each

specific underlying asset class. Also, the time period used to inform

the stress period calibration must include at least one year, but no

more than five years, of equally-weighted historical data.

This proposed requirement is intended to balance the tradeoff

between shorter and longer data spans. Shorter data spans are sensitive

to evolving market conditions but may also overreact to short-term and

idiosyncratic spikes in volatility. Longer data spans are less

sensitive to short-term market developments but may also place too

little emphasis on periods of financial stress, resulting in

requirements that are too low. The requirement that the data be equally

weighted is intended to establish a degree of consistency in model

calibration while also ensuring that particular weighting schemes do

not result in excessive margin requirements during short-term bouts of

heightened volatility.

The model must use risk factors sufficient to measure all material

price risks inherent in the transactions for which initial margin is

being calculated. The risk categories must include, but should not be

limited to, foreign exchange or interest rate risk, credit risk, equity

risk, agricultural commodity risk, energy commodity risk, metal

commodity risk, and other commodity risk, as appropriate. For material

exposures in significant currencies and markets, modeling techniques

must capture spread and basis risk and incorporate a sufficient number

of segments of the yield curve to capture differences in volatility and

imperfect correlation of rates along the yield curve.

The initial margin model must include all material risks arising

from the nonlinear price characteristics of option positions or

positions with embedded optionality and the sensitivity of the market

value of the positions to changes in the volatility of the underlying

rates, prices, or other material risk factors.

(iv) Frequency of Margin Calculation

The proposed rule requires daily calculation of initial margin. The

use of an approved initial margin model may result in changes to the

initial margin amount on a daily basis for a number of reasons.

First, the characteristics of the swaps that have a material effect

on their risk may change over time. As an example, the credit quality

of a corporate reference entity upon which a credit default swap

contract is written may undergo a measurable decline.

Second, any change to the composition of the swap portfolio that

results in the addition or deletion of swaps from the portfolio would

result in a change in the initial margin amount.

Third, the underlying parameters and data that are used in the

model may change over time as underlying conditions change. For

example, a new period of financial stress may be encountered in one or

more asset classes. While the stress period calibration is intended to

reduce the extent to which small or moderate changes in the risk

environment influence the initial margin model's risk assessment, a

significant change in the risk environment that affects the required

stress period calibration could influence the margin model's overall

assessment of the risk of a swap.

Fourth, quantitative initial margin models are expected to be

maintained and refined on a continuous basis to

[[Page 59911]]

reflect the most accurate risk assessment possible with available best

practices and methods. As best practice risk management models and

methods change, so too may the risk assessments of initial margin

models.

(v) Benchmarking

The proposed rule requires that a model used for calculating

initial margin requirements be benchmarked periodically against

observable margin standards to ensure that the initial margin required

is not less than what a CCP would require for similar transactions.\76\

This benchmarking requirement is intended to ensure that any initial

margin amount produced by a model is subject to a readily observable

minimum. It will also have the effect of limiting the extent to which

the use of models might disadvantage the movement of certain types of

swaps to DCOs by setting lower initial margin amounts for uncleared

transactions than for similar cleared transactions.

---------------------------------------------------------------------------

\76\ Proposed Regulation Sec. 23.154(b)(5).

---------------------------------------------------------------------------

d. Control Mechanisms

The proposal would require CSEs to implement certain control

mechanisms.\77\ They include, among others, the following.

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\77\ Proposed Regulation Sec. 23.154(b)(5).

---------------------------------------------------------------------------

The CSE must maintain a risk management unit in accordance with

existing Commission Regulation 23.600(c)(4)(i) that reports directly to

senior management and is independent from the business trading

units.\78\ The unit must validate its model before implementation and

on an ongoing basis. The validation process must include an evaluation

of the conceptual soundness of the model, an ongoing monitoring process

to ensure that the initial margin is not less than what a DCO would

require for similar cleared products, and back testing.

---------------------------------------------------------------------------

\78\ Commission Regulation Sec. 23.600 requires each registered

SD/MSP to establish a risk management program that identifies the

risks implicated by the SD/MSP's activities along with the risk

tolerance limits set by the SD/MSP. The SD/MSP should take into

account a variety of risks, including market, credit, liquidity,

foreign currency, legal, operational, settlement, and other

applicable risks. The risks would also include risks posed by

affiliates. See 17 CFR 23.600.

---------------------------------------------------------------------------

If the validation process revealed any material problems with the

model, the CSE would be required to notify the Commission of the

problems, describe to the Commission any remedial actions being taken,

and adjust the model to insure an appropriate amount of initial margin

is being calculated.

The CSE must have an internal audit function independent of the

business trading unit that at least annually assesses the effectiveness

of the controls supporting the model. The internal audit function must

report its findings to the CSE's governing body, senior management, and

chief compliance officer at least annually.

Given the complexity of margin models and the incentives to

calculate lower margin amounts, the Commission believes that rigorous

internal oversight is necessary to ensure proper functioning.

The Commission seeks comment on all aspects of the proposed

standards for models and the proposed levels of regulatory review.

The Commission requests comment on the costs and benefits of the

proposed approach. Commenters are urged to quantify the costs and

benefits, if practicable. Commenters also may suggest alternatives to

the proposed approach where the commenters believe that the

alternatives would be appropriate under the CEA.

3. Table-Based Method

a. Method of Calculation

Some CSEs might not have the internal technical resources to

develop initial margin models or have simple portfolios for which they

want to avoid the complexity of modeling. The table-based method would

allow a CSE to calculate its initial margin requirements using a

standardized table.\79\ The table specifies the minimum initial margin

amount that must be collected as a percentage of a swap's notional

amount. This percentage varies depending on the asset class of the

swap. Except as described below, a CSE would be required to calculate a

minimum initial margin amount for each swap and sum up all the minimum

initial margin amounts calculated under this section to arrive at the

total amount of initial margin. The table is consistent with

international standards.\80\

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\79\ Proposed Regulation Sec. 23.154(c).

\80\ BCBS/IOSCO Report at Appendix A.

---------------------------------------------------------------------------

b. Net-to-Gross Ratio Adjustment

The Commission recognizes that using a notional amount measure of

initial margin without any adjustment for offsetting exposures,

diversification, and other hedging benefits might not accurately

reflect the size or risks of a CSE's swap-based positions in many

situations. Moreover, not adequately recognizing the benefits of

offsets, diversification, and hedging might lead to large disparities

between model-based and table-based initial margin requirements. These

disparities might give rise to inequities between CSEs that elect to

use an approved model and CSEs that rely on the table for computing

their respective initial margin requirements.

To address these potential inequities, the Commission is proposing

an adjustment to the table-based initial margin requirement.

Specifically, the Commission would allow a CSE to calculate a net-to-

gross ratio adjustment.\81\

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\81\ This calculation is set forth in proposed Regulation Sec.

23.154(c)(2).

---------------------------------------------------------------------------

The net-to-gross ratio compares the net current replacement cost of

the uncleared portfolio (in the numerator) with the gross current

replacement cost of the uncleared portfolio (in the denominator). The

net current replacement cost is the cost of replacing the entire

portfolio of swaps that is covered under an eligible master netting

agreement. The gross current replacement cost is the cost of replacing

those swaps that have a strictly positive replacement cost.

For example, consider a portfolio that consists of two uncleared

swaps in which the mark-to-market value of the first swap is $10 (i.e.,

the CSE is owed $10 from its counterparty) and the mark-to-market value

of the second swap is -$5 (i.e., the CSE owes $5 to its counterparty).

The net current replacement cost is $5 ($10-$5), the gross current

replacement cost is $10, and the net-to-gross ratio would be 5/10 or

0.5.\82\

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\82\ Note that in this example, whether or not the

counterparties have agreed to exchange variation margin has no

effect on the net-to-gross ratio calculation, i.e., the calculation

is performed without considering any variation margin payments. This

is intended to ensure that the net-to-gross ratio calculation

reflects the extent to which the uncleared swaps generally offset

each other and not whether the counterparties have agreed to

exchange variation margin. As an example, if a swap dealer engaged

in a single sold credit derivative with a counterparty, then the

net-to-gross calculation would be 1.0 whether or not the dealer

received variation margin from its counterparty.

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The net-to-gross ratio and gross standardized initial margin

amounts provided in the table are used in conjunction with the notional

amount of the transactions in the underlying swap portfolio to arrive

at the total initial margin requirement as follows:

Standardized Initial Margin = 0.4 x Gross Initial Margin + 0.6 x

NGR x Gross Initial Margin

where:

Gross Initial Margin = the sum of the notional value multiplied by

the applicable initial margin requirement percentage from the table A

for each uncleared swap in the portfolio

and

[[Page 59912]]

NGR = Net-to-Gross Ratio

The Commission notes that the calculation of the net-to-gross ratio

for margin purposes must be applied only to swaps subject to the same

EMNA and that the calculation is performed across transactions in

disparate asset classes within a single netting agreement. (Thus, all

non-cleared swaps subject to the same EMNA can be netted against each

other in the calculation of the net-to-gross ratio. By contrast, under

a model, netting is only permitted within each asset class). This

approach is consistent with the standardized counterparty credit risk

capital requirements.

The Commission also notes that if a counterparty maintains multiple

swap portfolios under multiple EMNAs, the standardized initial margin

amounts would be calculated separately for each portfolio with each

calculation using the gross initial margin and net-to-gross ratio that

is relevant to each portfolio. The total standardized initial margin

would be the sum of the standardized initial margin amounts for each

portfolio.

The proposed net-to-gross ratio adjustment is consistent with

international standards.\83\ The proposed table and adjustment are the

same as the Prudential Regulators' proposal.

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\83\ BCBS/IOSCO Report at 13.

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The Commission seeks comment on all aspects of the proposed table-

based approach. The Commission notes that the BCBS has recently adopted

a new method for the purpose of capitalizing counterparty credit

risk.\84\ The Commission seeks comment on whether the BCBS's recently

adopted standardized approach would represent a material improvement

relative to the proposed method that employs the net-to-gross ratio.

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\84\ See the Basel Committee on Banking Supervision, ``The

standardized approach for measuring counterparty credit risk

exposures,'' (March 31, 2014), available at http://www.bis.org/publ/bcbs279.pdf.

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The Commission requests comment on the costs and benefits of the

proposed approach. Commenters are urged to quantify the costs and

benefits, if practicable. Commenters also may suggest alternatives to

the proposed approach where the commenters believe that the

alternatives would be appropriate under the CEA.

F. Calculation of Variation Margin

1. Means of Calculation

Under the proposal, each CSE would be required to calculate

variation margin for itself and for each covered counterparty using a

methodology and inputs that to the maximum extent practicable and in

accordance with existing Regulation 23.504(b)(4) rely on recently-

executed transactions, valuations provided by independent third

parties, or other objective criteria.\85\ In addition, each CSE would

have to have in place alternative methods for determining the value of

an uncleared swap in the event of the unavailability or other failure

of any input required to value a swap.\86\

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\85\ Proposed Regulation Sec. 23.155(a)(1) and Commission

Regulation Sec. 23.504(b)(4).

\86\ Proposed Regulation Sec. 23.155(a)(2).

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2. Control Mechanisms

The proposal would also set forth several control mechanisms.\87\

Each CSE would be required to create and maintain documentation setting

forth the variation margin methodology with sufficient specificity to

allow the counterparty, the Commission, and any applicable Prudential

Regulator to calculate a reasonable approximation of the margin

requirement independently. Each CSE would be required to evaluate the

reliability of its data sources at least annually, and make

adjustments, as appropriate. The proposal would permit the Commission

to require a CSE to provide further data or analysis concerning the

methodology or a data source.

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\87\ Proposed Regulation Sec. 23.155(b).

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These provisions are consistent with international standards \88\

and the Prudential Regulators' proposed rules. The Commission's

proposal, however, sets forth more detailed requirements. These

requirements are consistent with an approach currently under

consideration by an IOSCO working group.

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\88\ BCBS/IOSCO Report at 14-15.

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The Commission believes that the accurate valuation of positions

and the daily payment of variation margin to remove accrued risk is a

critical element in assuring the safety and soundness of CSEs and in

preserving the financial integrity of the markets. The Commission

believes that its experience with cleared markets \89\ coupled with the

problems in the uncleared markets noted in section II.A. demonstrates

this.

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\89\ For example, in May 2000, a clearing member defaulted to

the New York Clearing Corporation. A significant contributing factor

was the lack of a rigorous settlement price procedure which allowed

prices in an illiquid market to be mismarked and unrealized losses

to accumulate. See Report on Lessons Learned from the Failure of

Klein & Co, Division of Trading and Markets, Commodity Futures

Trading Commission (July 2001).

---------------------------------------------------------------------------

The Commission believes that the proposed provisions avoid

potential miscalculations and would allow the variation margin

calculations to be monitored and, thereby, forestall potential problems

that could exacerbate a crisis. These measures are designed to be

prudent safeguards to be used to address weaknesses that may only

become apparent over time.

The Commission seeks comment on all aspects of the proposed

requirements for calculating variation margin.

The Commission requests comment on the costs and benefits of the

proposed approach. Commenters are urged to quantify the costs and

benefits, if practicable. Commenters also may suggest alternatives to

the proposed approach where the commenters believe that the

alternatives would be appropriate under the CEA.

G. Forms of Margin

1. Initial Margin

In general, the Commission believes that margin assets should share

the following fundamental characteristics. The assets should be liquid

and, with haircuts, hold their value in times of financial stress. The

value of the assets should not exhibit a significant correlation with

the creditworthiness of the counterparty or the value of the swap

portfolio.\90\

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\90\ See BCBS/IOSCO Report at 16.

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Guided by these principles, the Commission is proposing that CSEs

may only post or accept certain assets to meet initial margin

requirements to or from covered counterparties.\91\ These include: U.S.

dollars; cash in a currency in which payment obligations under the swap

are required to be settled; U.S. Treasury securities; certain

securities guaranteed by the U.S.; certain securities issued or

guaranteed by the European Central bank, a sovereign entity, or the

BIS; certain corporate debt securities; certain equity securities

contained in major indices; major currencies,\92\ and gold.

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\91\ Proposed Regulation Sec. 23.156(a)(1).

\92\ Major currencies are defined in Proposed Regulation Sec.

23.151.

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These are assets for which there are deep and liquid markets and,

therefore, assets that can be readily valued and easily liquidated.

This list includes a number of assets that were not included in the

2011 proposal. This is responsive to a number of commenters who

expressed concern about the narrowness of that list and the potential

that there would be insufficient available collateral.

The Commission notes that any debt security issued by a U.S.

Government-sponsored enterprise that is not operating with capital

support or another form of direct financial assistance from the U.S.

government

[[Page 59913]]

would be eligible collateral only if the security met the requirements

for corporate debt securities.

The Commission also notes that eligible collateral would include

other publicly-traded debt that has been deemed acceptable as initial

margin by a Prudential Regulator.\93\ The Prudential Regulators have

indicated that this would include securities that meet the terms of 12

CFR 1.2(d). That provision states that the issuer of a security must

have adequate capacity to meet financial commitments under the security

for the projected life of the asset or exposure. It further states an

issuer has adequate capacity to meet financial commitments if the risk

of default by the obligor is low and the full and timely payment of

principal and interest is expected. For example, municipal bonds that

meet this standard, as determined by a Prudential Regulator, would be

eligible collateral.

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\93\ Proposed Regulation Sec. 23.156(a)(1)(ix).

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Under the proposal, certain assets would be prohibited from use as

initial margin.\94\ These include any asset that is an obligation of

the party providing such asset or an affiliate of that party. These

also include instruments issued by bank holding companies, depository

institutions and market intermediaries. The use of such assets as

initial margin could compound risk. These restrictions reflect the

Commission's view that the price and liquidity of securities issued by

the foregoing entities are very likely to come under significant

pressure during a period of financial stress when a CSE may be

resolving a counterparty's defaulted swap position and present an

additional source of risk.

---------------------------------------------------------------------------

\94\ Proposed Regulation Sec. 23.156(a)(2).

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The Commission requests comment on the securities subject to this

restriction, and, in particular, on whether securities issued by other

entities, such as non-bank systemically important financial

institutions designated by the Financial Stability Oversight Council,

also should be excluded from the list of eligible collateral.

Counterparties that wished to rely on assets that do not qualify as

eligible collateral under the proposed rule still would be able to

pledge those assets with a lender in a separate arrangement, such as

collateral transformation arrangements, using the cash or other

eligible collateral received from that separate arrangement to meet the

minimum margin requirements.

Moreover, the Commission notes that the proposal would not restrict

the types of collateral that could be collected or posted to satisfy

margin terms that are bilaterally negotiated above required amounts.

For example, if, notwithstanding the $65 million threshold, a CSE

decided to collect initial margin to protect itself against the credit

risk of a particular counterparty, the CSE could accept any form of

collateral.

Except for U.S. dollars and the currency in which the payment

obligations of the swap is required, assets posted as required initial

margin would be subject to haircuts in order to address the possibility

that the value of the collateral could decline during the period that

it took to liquidate a swap position in default. The proposed

collateral haircuts have been calibrated to be broadly consistent with

valuation changes observed during periods of financial stress.

Because the value of noncash collateral and foreign currency may

change over time, the proposal would require a CSE to monitor the value

of such collateral previously collected to satisfy initial margin

requirements and, to the extent the value of such collateral has

decreased, to collect additional collateral with a sufficient value to

ensure that all applicable initial margin requirements remain

satisfied.\95\

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\95\ Proposed Regulation Sec. 23.156(a)(4).

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The Commission seeks comment on all aspects of the proposed

requirements for eligible collateral for initial margin. In particular,

the Commission requests comments on whether the list should be expanded

or contracted in any way. If so, subject to what terms and conditions?

The Commission requests comment on the costs and benefits of the

proposed approach. Commenters are urged to quantify the costs and

benefits, if practicable. Commenters also may suggest alternatives to

the proposed approach where the commenters believe that the

alternatives would be appropriate under the CEA.

2. Variation Margin

The proposal would require that variation margin be paid in U.S.

dollars, or a currency in which payment obligations under the swap are

required to be settled.\96\ When determining the currency in which

payment obligations under the swap are required to be settled, a

covered swap entity must consider the entirety of the contractual

obligation. As an example, in cases where a number of swaps, each

potentially denominated in a different currency, are subject to a

single master agreement that requires all swap cash flows to be settled

in a single currency, such as the Euro, then that currency (Euro) may

be considered the currency in which payment obligations are required to

be settled.

---------------------------------------------------------------------------

\96\ Proposed Regulation Sec. 23.156(b).

---------------------------------------------------------------------------

The proposal is narrower than the 2011 proposal which also

permitted U.S. Treasury securities.\97\ This change is designed to

reinforce the concept that variation margin is paid and to reduce the

potential for disputes to arise over the value of assets being used to

meet this margin requirement. This proposed change is consistent with

regulatory and industry initiatives to improve standardization and

efficiency in the OTC derivatives market. For example, in June of 2013,

ISDA published the 2013 Standard Credit Support Annex (``SCSA''). The

SCSA provides for the sole use of cash as eligible collateral for

variation margin. The Commission supports this and other ongoing

regulatory and industry efforts at standardization that improve

operational efficiency and reduce the differences between the bilateral

and cleared OTC derivatives markets.

---------------------------------------------------------------------------

\97\ 76 FR 23732 at 23747.

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In this regard, the Commission notes that central counterparties

generally require that variation margin be paid in cash. U.S. law

applicable to cleared swaps is consistent with this practice. Section

5b(c)(2)(E) of the CEA requires derivatives clearing organizations to

``complete money settlements on a timely basis (but not less frequently

than once each business day).'' CFTC Regulation 39.14(a)(1) defines

``settlement'' as, among other things, ``payment and receipt of

variation margin for futures, options, and swaps.'' CFTC Regulation

39.14(b) requires that ``except as otherwise provided by Commission

order, derivatives clearing organizations shall effect a settlement

with each clearing member at least once each business day.''

The Commission believes that this change from the 2011 proposal is

appropriate because it better reflects that counterparties to swap

transactions generally view variation margin payments as the daily

settlement of their exposure(s) to one another. Additionally, limiting

variation margin to cash should sharply reduce the potential for

disputes over the value of variation margin.

Under this proposed rule, the value of cash paid to satisfy

variation margin requirements is not subject to a haircut. Variation

margin payments reflect gains and losses on a swap transaction, and

payment or receipt of variation margin generally represents a transfer

of ownership. Therefore, haircuts are not a

[[Page 59914]]

necessary component of the regulatory requirements for cash variation

margin.

The proposal is stricter than international standards which do not

require that variation margin be in cash.\98\ It is the same as the

Prudential Regulators' proposal.

---------------------------------------------------------------------------

\98\ BCBS/IOSCO Report at 14-15. The international standards do

not distinguish between initial margin and variation margin in

discussing eligible assets.

---------------------------------------------------------------------------

The Commission seeks comment on all aspects of the proposed

requirements for forms of variation margin.

The Commission requests comment on the costs and benefits of the

proposed approach. Commenters are urged to quantify the costs and

benefits, if practicable. Commenters also may suggest alternatives to

the proposed approach where the commenters believe that the

alternatives would be appropriate under the CEA.

H. Custodial Arrangements

The proposal sets forth requirements for the custodial arrangements

for initial margin posted for transactions between CSEs and covered

counterparties.\99\ Each CSE that posts initial margin with respect to

an uncleared swap would be mandated to require that all funds or other

property that it provided as initial margin be held by one or more

custodians that were not affiliates of the CSE or the counterparty.

Each CSE that collects initial margin with respect to an uncleared swap

would be mandated to require that such initial margin be held at one or

more custodians that were not affiliates of the CSE or the

counterparty.

---------------------------------------------------------------------------

\99\ Proposed Regulation Sec. 23.157.

---------------------------------------------------------------------------

Each CSE would be required to enter into custodial agreements

containing specified terms. These would include a prohibition on

rehypothecating the margin assets and standards for the substitution of

assets.

The proposed rules are consistent with international standards

except that international standards would allow rehypothecation under

certain circumstances.\100\ The proposal is the same as the Prudential

Regulators' proposal. The Commission also notes that the European

Supervisory Authorities have proposed to prohibit rehypothecation.\101\

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\100\ BCBS/IOSCO Report at 19-20.

\101\ See ``Draft Regulatory Technical Standards on Risk-

mitigation Techniques for OTC-derivative Contracts Not Cleared by a

CCP under Article 11(15) of Regulation (EU) No. 648/2012,'' pp. 11,

42-43 (April 14, 2014).

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The proposed approach is grounded in several provisions of section

4s(e) of the CEA. First, section 4s(e)(3)(A)(i) mandates that margin

rules ``help ensure the safety and soundness of [SDs] and [MSPs].''

Maintaining margin collateral at an independent custodian subject to

specified terms protects both parties to a transaction by preventing

assets from being lost or misused. In particular, a prohibition on

rehypothecation enhances safety by avoiding the possibility that a

margin asset will be lost because of the failure of a third party who

was not a party to the original transaction.

Second, section 4s(e)(3)(C) mandates that margin rules preserve

``the financial integrity of the markets trading swaps'' and ``the

stability of the United States financial system.'' Maintaining margin

collateral at an independent custodian preserves financial integrity

and financial stability by preventing the same asset from supporting

multiple positions. If an SD could take collateral posted by a

counterparty for one swap and reuse it to margin a second swap with

another SD, and that SD could, in turn, do the same, this would

increase leverage in the system and create the possibility of a cascade

of defaults if one of these firms failed.

Third, section 4s(e)(3)(A) refers to the ``greater risk'' to SDs,

MSPs, and the financial system ``arising from the use of swaps that are

not cleared.'' It mandates rules ``appropriate for the risk''

associated with uncleared swaps. Margin posted by customers to futures

commission merchants (``FCMs'') and by FCMs to DCOs for cleared swaps

is subject to segregation requirements.\102\ It would be inappropriate

to address the greater risk of uncleared swaps with a lesser standard.

---------------------------------------------------------------------------

\102\ Section 4d(f) of the CEA.

---------------------------------------------------------------------------

The proposed rules can be harmonized with section 4s(l) of the CEA

which authorizes counterparties of an SD or an MSP to request that

margin be segregated. As discussed above, covered counterparties pose

risk to the financial system. The primary purpose of the proposed

custodial arrangements is preservation of the financial integrity of

the markets and the U.S. financial system although the arrangements

will also have the effect of protecting individual market participants.

Section 4s(l) is not made superfluous by the proposed rules because it

would still be available for financial end users with less than

material swaps exposure, for financial end users that post initial

margin in excess of the required amount, and for non-financial end

users that post initial margin. Such entities would be posting margin,

by agreement, with SDs or MSPs. Section 4s(l) would provide them with

an opportunity to obtain additional protection if they desired.

The Commission previously adopted rules implementing section

4s(l).\103\ The Commission is now proposing to amend those rules to

reflect the approach described above where segregation of initial

margin would be mandatory under certain circumstances. The Commission

is proposing three changes.

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\103\ Protection of Collateral of Counterparties to Uncleared

Swaps; Treatment of Securities in a Portfolio Margining Account in a

Commodity Broker Bankruptcy, 78 FR 66621 (Nov. 6, 2013).

---------------------------------------------------------------------------

First, the proposal would amend Sec. 23.701(a)(1) to read as

follows: Notify each counterparty to such transaction that the

counterparty has the right to require that any Initial Margin the

counterparty provides in connection with such transaction be segregated

in accordance with Sec. Sec. 23.702 and 23.703 except in those

circumstances where segregation is mandatory pursuant to Sec. 23.157.

(New language in italics.)

Second, the proposal would amend Sec. 23.701(d) to read as

follows: Prior to confirming the terms of any such swap, the swap

dealer or major swap participant shall obtain from the counterparty

confirmation of receipt by the person specified in paragraph (c) of

this section of the notification specified in paragraph (a) of this

section, and an election, if applicable, to require such segregation or

not. The swap dealer or major swap participant shall maintain such

confirmation and such election as business records pursuant to Sec.

1.31 of this chapter. (New language in italics.)

Third, the proposal would amend Sec. 23.701(f) to read as follows:

A counterparty's election, if applicable, to require segregation of

Initial Margin or not to require such segregation, may be changed at

the discretion of the counterparty upon written notice delivered to the

swap dealer or major swap participant, which changed election shall be

applicable to all swaps entered into between the parties after such

delivery. (New language in italics.)

The Commission seeks comment on all aspects of the proposed

requirements regarding custodial arrangements.

The Commission requests comment on the costs and benefits of the

proposed approach. Commenters are urged to quantify the costs and

benefits, if practicable. Commenters also may suggest alternatives to

the proposed approach where the commenters believe that the

alternatives would be appropriate under the CEA.

I. Documentation

The proposal sets forth documentation requirements for CSEs.\104\

For uncleared swaps between a CSE and a covered counterparty, the

[[Page 59915]]

documentation would be required to provide the CSE with the contractual

right and obligation to exchange initial margin and variation margin in

such amounts, in such form, and under such circumstances as are

required by Sec. 23.150 through Sec. 23.160 of this part. For

uncleared swaps between a CSE and a non-financial entity, the

documentation would be required to specify whether initial and/or

variation margin will be exchanged and, if so, to include the

information set forth in the rule. That information would include the

methodology and data sources to be used to value positions and to

calculate initial margin and variation margin, dispute resolution

procedures, and any margin thresholds.

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\104\ Proposed Regulation Sec. 23.158.

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The international standards do not contain a specific requirement

for documentation. The requirements in the Prudential Regulators'

proposal are consistent with the Commission proposal but the Commission

proposal contains additional elements.

The Commission proposal contains a cross-reference to an existing

Commission rule which already imposes documentation requirements on SDs

and MSPs.\105\ Consistent with that rule, the proposal would apply

documentation requirements not only to covered counterparties but also

to non-financial end users. Having comprehensive documentation in

advance concerning these matters would allow each party to a swap to

manage its risks more effectively throughout the life of the swap and

to avoid disputes regarding issues such as valuation during times of

financial turmoil. This would benefit not only the CSE but the non-

financial end user as well.

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\105\ Commission Regulation Sec. 23.504.

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The Commission seeks comment on all aspects of the proposed

requirements for documentation.

The Commission requests comment on the costs and benefits of the

proposed approach. Commenters are urged to quantify the costs and

benefits, if practicable. Commenters also may suggest alternatives to

the proposed approach where the commenters believe that the

alternatives would be appropriate under the CEA.

J. Implementation Schedule

The proposed rules establish the following implementation schedule:

\106\

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\106\ Proposed Regulation Sec. 23.160.

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December 1, 2015 for the requirements in Sec. 23.153 for variation

margin;

December 1, 2015 for the requirements in Sec. 23.152 for initial

margin for any uncleared swaps where both (i) the CSE combined with all

its affiliates and (ii) its counterparty combined with all its

affiliates, have an average daily aggregate notional amount of

uncleared swaps, uncleared security-based swaps, foreign exchange

forwards, and foreign exchange swaps in June, July, and August 2015

that exceeds $4 trillion, where such amounts are calculated only for

business days;

December 1, 2016 for the requirements in Sec. 23.152 for initial

margin for any uncleared swaps where both (i) the CSE combined with all

its affiliates and (ii) its counterparty combined with all its

affiliates, have an average daily aggregate notional amount of

uncleared swaps, uncleared security-based swaps, foreign exchange

forwards, and foreign exchange swaps in June, July and August 2016 that

exceeds $3 trillion, where such amounts are calculated only for

business days;

December 1, 2017 for the requirements in Sec. 23.152 for initial

margin for any uncleared swaps where both (i) the CSE combined with all

its affiliates and (ii) its counterparty combined with all its

affiliates have an average daily aggregate notional amount of uncleared

swaps, uncleared security-based swaps, foreign exchange forwards, and

foreign exchange swaps in June, July and August 2017 that exceeds $2

trillion, where such amounts are calculated only for business days;

December 1, 2018 for the requirements in Sec. 23.152 for initial

margin for any uncleared swaps where both (i) the CSE combined with all

its affiliates and (ii) its counterparty combined with all its

affiliates have an average daily aggregate notional amount of uncleared

swaps, uncleared security-based swaps, foreign exchange forwards, and

foreign exchange swaps in June, July and August 2018 that exceeds $1

trillion, where such amounts are calculated only for business days;

December 1, 2019 for the requirements in Sec. 23.152 for initial

margin for any other CSE with respect to uncleared swaps entered into

with any other counterparty.

This extended schedule is designed to give market participants

ample time to develop the systems and procedures necessary to exchange

margin and to make arrangements to have sufficient assets available for

margin purposes. The requirements would be phased-in in steps from the

largest covered parties to the smallest.

Variation margin would be implemented on the first date for two

reasons. First, a significant part of the market currently pays

variation margin so full implementation would be less disruptive.

Second, the elimination of current exposures through the daily use of

variation margin would be an effective first step in enhancing the

safety and soundness of market participants and the financial integrity

of the markets.

The proposal is consistent with international standards except for

the 8 billion euro threshold, discussed above, that would apply

starting Dec. 1, 2019 under the international standards.\107\ The

proposal is the same as the proposal of the Prudential Regulators.

---------------------------------------------------------------------------

\107\ BCBS/IOSCO Report at 23-24.

---------------------------------------------------------------------------

The Commission requests comment on the costs and benefits of the

proposed approach. Commenters are urged to quantify the costs and

benefits, if practicable. Commenters also may suggest alternatives to

the proposed approach where the commenters believe that the

alternatives would be appropriate under the CEA.

K. Request for Comment

The Commission requests comment on all aspects of the proposed

rules. In particular, as noted above, the Commission invites comments

on the potential costs and benefits of each provision. Commenters are

urged to quantify the costs and benefits, if practicable. Commenters

also may suggest alternatives to the proposed approach where the

commenters believe that the alternatives would be appropriate under the

CEA.

III. Advance Notice of Proposed Rulemaking on the Cross-Border

Application of the Proposed Margin Rules

A. Alternative Options

Section 2(i) of the CEA \108\ provides that the provisions of the

CEA relating to swaps that were enacted by the Wall Street Transparency

and Accountability Act of 2010 (including any rule prescribed or

regulation promulgated under that Act, shall not apply to activities

outside the United States unless those activities (1) have a direct and

significant connection with activities in, or effect on, commerce of

the United States or (2) contravene such rules or regulations as the

Commission may prescribe or promulgate as are necessary or appropriate

to prevent the evasion of any provision of this chapter that was

enacted by the Wall Street Transparency and Accountability Act of 2010.

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\108\ 7 U.S.C. 2(i).

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Section 2(i) provides the Commission with express authority over

activities outside the United States relating to swaps when certain

conditions are met.

[[Page 59916]]

As discussed in part I.A. above, the primary purpose of the margin

provision in section 4s(e) is to address risk to SDs, MSPs, and the

financial system arising from uncleared swaps. Given the risk-

mitigation function of the margin rules for uncleared swaps, the

Commission believes that the rules should apply on a cross-border basis

in a manner that effectively addresses risks to the registered SD or

MSP. At the same time, it may be appropriate, consistent with

principles of international comity and statutory objectives underlying

the margin requirements, to allow SDs and MSPs to satisfy the margin

requirements by complying with a comparable regime in the relevant

foreign jurisdiction, or to not apply the margin requirements under

certain circumstances.

In this Advance Notice of Proposed Rulemaking, the Commission is

considering three approaches to applying the margin requirements to

Commission-registered SDs and MSPs, consistent with section 2(i): (1) A

transaction-level approach that is consistent with the Commission's

cross-border guidance (``Guidance Approach''); \109\ (2) the Prudential

Regulators' approach; and (3) an entity-level approach (``Entity-Level

Approach''). The general framework for each of these approaches is

described below. The Commission is not endorsing at this time any

particular approach and invites comments on all aspects of the three

approaches and welcomes any suggestions on other possible approaches.

The Commission may propose and ultimately adopt one of the three

approaches with modifications.

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\109\ Interpretative Guidance and Policy Statement Regarding

Compliance with Certain Swap Regulations, 78 FR 45292 (July 26,

2013) (``Guidance''). The Commission addressed, among other things,

how the swap provisions in the Dodd-Frank Act (including the margin

requirement for uncleared swaps) would apply on a cross-border

basis. In this regard, the Commission stated that as a general

policy matter it would apply the margin requirement as a

transaction-level requirement.

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1. The Cross-Border Guidance Approach

Under the first option, the Commission would apply the margin

requirements consistent with the Cross-Border Guidance. The Commission

stated in the Guidance that it would generally treat the margin

requirements (for uncleared swaps) as a transaction-level requirement.

Consistent with the rationale stated in the Guidance, under this

approach, the proposed margin requirements would apply to a U.S. SD/MSP

(other than a foreign branch of a U.S. bank that is a SD/MSP) for all

of their uncleared swaps (as applicable), irrespective of whether the

counterparty is a U.S. person \110\ or not, without substituted

compliance.

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\110\ The scope of the term ``U.S. person'' as used in the

Cross-Border Guidance Approach and the Entity-Level Approach would

be the same as under the Guidance. See Guidance at 45316-45317 for a

summary of the Commission's interpretation of the term ``U.S.

person.''

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On the other hand, under this approach, the proposed margin

requirements would apply to a non-U.S. SD/MSP (whether or not it is a

``guaranteed affiliate'' \111\ or an ``affiliate conduit'' \112\) only

with respect to its uncleared swaps with a U.S. person counterparty

(including a foreign branch of U.S. bank that is a SD/MSP) and a non-

U.S. counterparty that is guaranteed by a U.S. person or is an

affiliate conduit. Where the counterparty is a guaranteed affiliate or

is an affiliate conduit, the Commission would allow substituted

compliance (i.e., the non-U.S. SD/MSP would be permitted to comply with

the margin requirements of its home country's regulator if the

Commission determines that such requirements are comparable to the

Commission's margin requirements).

---------------------------------------------------------------------------

\111\ Under the Guidance, id. at 45318, the term ``guaranteed

affiliate'' refers to a non-U.S. person that is an affiliate of a

U.S. person and that is guaranteed by a U.S. person. The scope of

the term ``guarantee'' under the Cross-Border Guidance Approach and

the Entity-Level Approach would be the same as under note 267 of the

Guidance and accompanying text.

\112\ Under the Guidance, id. at 45359, the factors that are

relevant to the consideration of whether a person is an ``affiliate

conduit'' include whether: (i) The non-U.S. person is majority-

owned, directly or indirectly, by a U.S. person; (ii) the non-U.S.

person controls, is controlled by, or is under common control with

the U.S. person; (iii) the non-U.S. person, in the regular course of

business, engages in swaps with non-U.S. third party(ies) for the

purpose of hedging or mitigating risks faced by, or to take

positions on behalf of, its U.S. affiliate(s), and enters into

offsetting swaps or other arrangements with such U.S. affiliate(s)

in order to transfer the risks and benefits of such swaps with

third-party(ies) to its U.S. affiliates; and (iv) the financial

results of the non-U.S. person are included in the consolidated

financial statements of the U.S. person. Other facts and

circumstances also may be relevant.

---------------------------------------------------------------------------

For trades between a non-U.S. SD/MSP (whether or not it is a

guaranteed affiliate or an affiliate conduit) and a non-U.S.

counterparty that is not a guaranteed affiliate or affiliate conduit,

the Commission would not apply the margin requirements to such swaps.

In the case of a foreign branch of a U.S. bank that is a SD/MSP,

the proposed margin requirements would apply with respect to all of its

uncleared swaps, regardless of the counterparty. However, where the

counterparty to the trade is another foreign branch of a U.S. bank that

is a SD/MSP or is a non-U.S. person counterparty (whether or not it is

a guaranteed affiliate or an affiliate conduit), the Commission would

allow substituted compliance (i.e., the foreign branch of a U.S. bank

that is a SD/MSP would be permitted to comply with the margin

requirements of the regulator in the foreign jurisdiction where the

foreign branch is located if the Commission determines that such

requirements are comparable to the Commission's margin

requirements).\113\

---------------------------------------------------------------------------

\113\ Under a limited exception, where a swap between the

foreign branch of a U.S. SD/MSP and a non-U.S. person (that is not a

guaranteed or conduit affiliate) takes place in a foreign

jurisdiction other than Australia, Canada, the European Union, Hong

Kong, Japan, or Switzerland, the counterparties generally may comply

only with the transaction-level requirements in the foreign

jurisdiction where the foreign branch is located if the aggregate

notional value of all the swaps of the U.S. SD's foreign branches in

such countries does not exceed 5% of the aggregate notional value of

all of the swaps of the U.S. SD, and the U.S. person maintains

records with supporting information for the 5% limit and can

identify, define, and address any significant risk that may arise

from the non-application of the Transaction-Level Requirements.

---------------------------------------------------------------------------

Below is a summary of how the margin requirements would apply under

the Cross-Border Guidance Approach.

----------------------------------------------------------------------------------------------------------------

U.S. person (other

than Foreign Foreign Branch of Non-U.S. person Non-U.S. person

Branch of U.S. U.S. Bank that is guaranteed by, or not guaranteed by,

Bank that is a a Swap Dealer or affiliate conduit and not an

Swap Dealer or MSP of, a U.S. person affiliate conduit

MSP) of, a U.S. person

----------------------------------------------------------------------------------------------------------------

U.S. Swap Dealer or MSP Apply............. Apply............. Apply............. Apply

(including an affiliate of a

non-U.S. person).

Foreign Branch of U.S. Bank that Apply............. Substituted Substituted Substituted

is a Swap Dealer or MSP. Compliance. Compliance. Compliance

Non-U.S. Swap Dealer or MSP Apply............. Substituted Substituted Do Not Apply

(including an affiliate of a Compliance. Compliance.

U.S. person).

----------------------------------------------------------------------------------------------------------------

[[Page 59917]]

2. Prudential Regulators' Approach

Under the second option, the Commission would adopt the Prudential

Regulators' approach to cross-border application of the margin

requirements.\114\ Under the Prudential Regulators' proposal, the

Prudential Regulators would not assert authority over trades between a

non-U.S. SD/MSP \115\ that is not guaranteed by a U.S. person and

either a (i) non-U.S. SD/MSP that is not guaranteed by a U.S. person or

(ii) a non-U.S. person that is not guaranteed by a U.S. person. The

Prudential Regulators' approach is generally consistent with the

Entity-Level Approach described below, with the exception of the

application of the margin requirements to certain non-U.S. SD/MSPs.

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\114\ See Section 9 of Margin and Capital Requirements for

Covered Swap Entities, 12 CFR Part 237 (Sept. 3, 2014), available at

http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20140903c1.pdf.

\115\ Under the Prudential Regulators' approach, if an SD/MSP is

under the control of a U.S. person, it would not be considered a

non-U.S. SD/MSP.

---------------------------------------------------------------------------

However, the Prudential Regulators' proposal in this regard would

be consistent with the Commission's Cross-Border Guidance Approach to

margin requirements with respect to a trade between a non-U.S. SD/MSP

and a non-U.S. person that is not guaranteed by a U.S. person. But

under the definition of ``foreign covered swap entity'' in the

Prudential Regulators' approach, a non-U.S. SD/MSP controlled by a U.S.

person would not be a foreign covered swap entity, and thus, would not

qualify for the exclusion from the margin requirement. In addition, the

Prudential Regulators' proposal incorporates a ``control'' test for

purposes of determining whether a registered SD/MSP (or in the

Prudential Regulators' proposal, a ``covered swap entity'') is not a

``foreign'' entity.

3. Entity-Level Approach

Under the third option, the Commission would treat the margin

requirements as an entity-level requirement. Under this Entity-Level

Approach, the Commission would apply its cross-border rules on margin

on a firm-wide level, irrespective of whether the counterparty is a

U.S. person.\116\ At the same time, in recognition of international

comity, the Commission is considering, where appropriate, to allow SDs/

MSPs to satisfy the margin requirements by complying with a comparable

regime in the relevant foreign jurisdiction, as described in the table

below. This approach would be intended to address the concern that the

source of the risk to a firm--given that the non-U.S. SD/MSP has

sufficient contact with the United States to require registration as an

SD/MSP--is not confined to its uncleared swaps with U.S. counterparties

or to its uncleared swaps executed within the United States. A firm's

losses in uncleared swaps with non-U.S. counterparties, for example,

could have a direct and significant impact on the firm's financial

integrity and on the U.S. financial system.

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\116\ However, substituted compliance may be available under

certain circumstances, as described in the Guidance for entity-level

requirements.

------------------------------------------------------------------------

Applicable

Counterparty A Counterparty B requirements

------------------------------------------------------------------------

1. U.S. SD/MSP.................. U.S. person....... U.S. (All).

2. U.S. SD/MSP.................. Non U.S. person U.S. (All).

guaranteed by a

U.S. person.

3. Non-U.S. SD/MSP guaranteed by U.S. person not U.S. (All).

a U.S. person. registered as an

SD/MSP.

4. Non-U.S. SD/MSP guaranteed by Non-U.S. person U.S. (All).

a U.S. person. guaranteed by a

U.S. person.

5. U.S. SD/MSP.................. Non-U.S. person U.S. (Initial

not guaranteed by Margin collected

a U.S. person. by U.S. SD/MSP).

Substituted

Compliance

(Initial Margin

collected by non-

U.S. person not

guaranteed by a

U.S. person).

U.S. (Variation

Margin).

6. Non-U.S. SD/MSP guaranteed by Non-U.S. person U.S. (Initial

a U.S. person. not guaranteed by Margin collected

a U.S. person. by non-U.S. SD/

MSP guaranteed by

a U.S. person).

Substituted

Compliance

(Initial Margin

collected by non-

U.S. person not

guaranteed by a

U.S. person).

U.S. (Variation

Margin).

7. Non-U.S. SD/MSP not U.S. person not Substituted

guaranteed by a U.S. person. registered as an Compliance (All).

SD/MSP.

8 Non-U.S. SD/MSP not guaranteed Non-U.S. person Substituted

by a U.S. person. guaranteed by a Compliance (All).

U.S. person.

9. Non-U.S. SD/MSP not Non-U.S. SD/MSP Substituted

guaranteed by a U.S. person. not guaranteed by Compliance (All).

a U.S. person.

10. Non-U.S. SD/MSP not Non-U.S. person Substituted

guaranteed by a U.S. person. not registered as Compliance (All).

an SD/MSP and not

guaranteed by a

U.S. person.

------------------------------------------------------------------------

B. Questions

In this Advance Notice of Proposed Rulemaking, the Commission

requests comment on all aspects of these options to the cross-border

application of the margin requirements. In particular, the Commission

is interested in comments relating to the costs and benefits of the

various approaches so that it can take that into consideration when

developing proposed rules relating to the cross-border application of

the margin rules. Commenters are encouraged to address, among other

things, the following questions:

1. Under the Guidance Approach and Prudential Regulators Approach,

certain trades involving a non-U.S. SD/MSP would be excluded from the

Commission's margin rules. The Commission seeks comment on whether this

exclusion is over- or under-inclusive, and if so, please explain why.

2. Each of the options provides for substituted compliance under

certain situations. In light of the equal or greater supervisory

interest of the foreign regulator in certain circumstances, the

Commission is seeking comment on whether the scope of substituted

compliance under each option is appropriate.

[[Page 59918]]

3. The Commission is seeking comments on whether, in defining a

non-U.S. covered swap entity, it should use the concept of ``control,''

in determining whether a covered swap entity is (or should be treated

as) a non-U.S. covered swap entity. If the Commission uses a concept of

control, should it be the same as that used by the Prudential

Regulators, or should it be different?

4. In the Commission's view, it is the substance, rather than the

form, of an agreement, arrangement or structure that should determine

whether it should be considered a ``guarantee.'' The Commission invites

comment on how the term ``guarantee'' should be construed or defined in

the context of these margin rules. For example, should the definition

cover the multitude of different agreements, arrangements and

structures that transfer risk directly back to the United States with

respect to financial obligations arising out of a swap? Should the

definition cover such agreements, arrangements and structures even if

they do not specifically reference the relevant swap or affirmatively

state that it does not apply to such swap? Should the definition cover

agreements, arrangements and structures even if the other party to the

swap terminates, waives, or revokes the benefit of such agreements,

arrangements or structures?

5. The Commission seeks comments on the costs and benefits of

harmonization with the Prudential Regulators' proposal.

6. The Commission invites commenters to comment in particular on

the benefits of each of the approaches with respect to the statutory

goal of protecting the financial system against the risks associated

with uncleared swaps.

7. Given that some foreign jurisdictions may not adopt comparable

margin requirements, the Commission seeks comment on the costs and

benefits of not requiring substituted compliance in emerging markets

with respect to certain transactions and what might be an appropriate

threshold percentage of a swap portfolio of participants or other

standard for a de minimis level. In particular, the Commission is

seeking comment on potential competitive impacts. Commenters are

encouraged to quantify, if practical.

8. The Commission seeks comment, including quantitative estimates

in terms of notional volumes of swap activity, about how the different

cross-border alternatives may impact the competitive landscape between

U.S. entities and non-U.S. entities participating in swap markets.

Specifically, the Commission seeks quantitative estimates of costs of

transacting uncleared swaps with each category of counterparties, and/

or access specific geographical markets, under each of the different

alternatives. Commission seeks quantitative estimates of such impact on

the ability of the affected market participants (who might be unable to

access specific markets or counterparties) to hedge their risks using

uncleared swaps. As the proposed margins on uncleared swaps are

designed to strengthen market integrity, the Commission seeks comments

on potential impact of each of these alternatives on market

participants' business models and trading strategies that could

potentially compromise this policy goal. Commenters are encouraged to

quantify and provide institutional details.

9. The Commission is seeking comments on how the different

alternatives impact price discovery? Commenters are encouraged to

quantify, if practical. For instance, will different cross-border

alternatives impact the ability of different categories of market

participants, as contemplated in these alternatives, to transact

uncleared swaps with each other? The Commission seeks quantitative

estimates of such impact on transacted volumes and the pricing of

uncleared swaps.

10. The Commission is seeking comments on the relative costs and

difficulty of compliance associated with each of the three approaches.

Is one of the approaches preferable to the others in this regard?

11. The Commission is seeking comments on the impact of each of the

three approaches on a SD/MSP's risk management practices.

IV. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA'') requires that agencies

consider whether the regulations they propose will have a significant

economic impact on a substantial number of small entities.\117\ The

Commission previously has established certain definitions of ``small

entities'' to be used in evaluating the impact of its regulations on

small entities in accordance with the RFA.\118\ The proposed

regulations would affect SDs and MSPs and their counterparties to

uncleared swaps. As the only counterparties of SDs and MSPs to

uncleared swaps can be other SDs, MSPs or ECPs, the following RFA will

only discuss these entities.

---------------------------------------------------------------------------

\117\ 5 U.S.C. 601 et seq.

\118\ 47 FR 18618 (Apr. 30, 1982).

---------------------------------------------------------------------------

The Commission previously has determined that SDs and MSPs are not

small entities for purposes of the RFA.\119\ The Commission also

previously has determined that ECPs are not small entities for RFA

purposes.\120\ Because ECPs are not small entities, and persons not

meeting the definition of ECP may not conduct transactions in uncleared

swaps, the Commission need not conduct a regulatory flexibility

analysis respecting the effect of these proposed rules on ECPs.

---------------------------------------------------------------------------

\119\ See 77 FR 30596, 30701 (May 23, 2012).

\120\ See 66 FR 20740, 20743 (April 25, 2001).

---------------------------------------------------------------------------

Accordingly, this proposed rule will not have a significant

economic effect on any small entity. Therefore, the Chairman, on behalf

of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that

the proposed regulations will not have a significant economic impact on

a substantial number of small entities.

B. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 (``PRA'') \121\ imposes certain

requirements on Federal agencies, including the Commission, in

connection with their conducting or sponsoring any collection of

information, as defined by the PRA. This proposed rulemaking would

result in the collection of information requirements within the meaning

of the PRA, as discussed below. The proposed rulemaking contains

collections of information for which the Commission has previously

received control numbers from OMB. The titles for these collections of

information are ``Regulations and Forms Pertaining to Financial

Integrity of the Market Place, OMB control number 3038-0024'' and

``Swap Trading Relationship Documentation Requirements for Swap Dealers

and Major Swap Participants, OMB control number 3038-0088.''

---------------------------------------------------------------------------

\121\ 44 U.S.C. 3501 et seq.

---------------------------------------------------------------------------

The collections of information that are proposed by this rulemaking

are necessary to implement section 4s(e) of the CEA, which expressly

requires the Commission to adopt rules governing margin requirements

for SDs and MSPs. If adopted, responses to this collection of

information would be mandatory. An agency may not conduct or sponsor,

and a person is not required to respond to, a collection of information

unless it displays a currently valid control number.

1. Clarification of Collection 3038-0088

This proposed rulemaking clarifies the existing collection of

information found in OMB Control Number 3038-

[[Page 59919]]

0088.\122\ Regulation 23.151 defines terms used in the proposed rule,

including the definition of ``eligible master netting agreement,''

which provides that a CSE that relies on the agreement for purpose of

calculating the required margin must (1) conduct sufficient legal

review of the agreement to conclude with a well-founded basis that the

agreement meets specified criteria and (2) establish and maintain

written procedures for monitoring relevant changes in the law and to

ensure that the agreement continues to satisfy the requirements of this

section. The term ``eligible master netting agreement'' is used

elsewhere in the proposed rule to specify instances in which a CSE may

(1) calculate variation margin on an aggregate basis across multiple

non-cleared swaps and (2) calculate initial margin requirements under

an initial margin model for one or more swaps.

---------------------------------------------------------------------------

\122\ See OMB Control No. 3038-0088, available at http://www.reginfo.gov/public/do/PRAOMBHistory?ombControlNumber=3038-0088.

---------------------------------------------------------------------------

Proposed Regulations Sec. Sec. 23.152(c) and 23.153(d) specify

that a CSE shall not be deemed to have violated its obligation to

collect or post initial and variation margin, respectively, from or to

a counterparty if the CSE has made the necessary efforts to collect or

post the required margin, including the timely initiation and continued

pursuit of formal dispute resolution mechanisms, or has otherwise

demonstrated upon request to the satisfaction of the Commission that it

has made appropriate efforts to collect or post the required margin.

Proposed Regulation Sec. 23.154 establishes standards for initial

margin models. These standards include (1) a requirement that a CSE

review its initial margin model annually (Sec. 23.154(b)(4)); (2) a

requirement that the covered swap entity validate its initial margin

model initially and on an ongoing basis, describe to the Commission any

remedial actions being taken, and report internal audit findings

regarding the effectiveness of the initial margin model to the CSE's

board of directors or a committee thereof (Sec. Sec. 23.154(b)(5)(ii)

through 23.154(b)(5)(iv)); (3) a requirement that the CSE adequately

documents all material aspects of its initial margin model (Sec.

23.154(b)(6)); and (4) a requirement that the CSE adequately documents

internal authorization procedures, including escalation procedures that

require review and approval of any change to the initial margin

calculation under the initial margin model, demonstrable analysis that

any basis for any such change is consistent with the requirements of

this section, and independent review of such demonstrable analysis and

approval (Sec. 23.154(b)(7)).

Proposed Regulation Sec. 23.155(b) requires a covered swap entity

to create and maintain documentation setting forth the variation margin

methodology, evaluate the reliability of its data sources at least

annually, and make adjustments, as appropriate, and provides that the

Commission at any time may require a covered swap entity to provide

further data or analysis concerning the methodology or a data source.

Proposed Regulation Sec. 23.158 requires a covered swap entity to

execute trading documentation with each counterparty that is either a

swap entity or financial end user regarding credit support arrangements

that (1) provides the contractual right to collect and post initial

margin and variation margin in such amounts, in such form, and under

such circumstances as are required; and (2) specifies the methods,

procedures, rules, and inputs for determining the value of each non-

cleared swap or non-cleared security-based swap for purposes of

calculating variation margin requirements, and the procedures for

resolving any disputes concerning valuation. The reporting and

recordkeeping requirements of proposed Regulation Sec. 23.158,

proposed Regulations Sec. 23.154(b)(4) through (7), and proposed

Regulation Sec. 23.155(b) are contained in the provisions of

Commission Regulations 23.500 through 23.506, which were adopted on

September 11, 2012, and part of OMB Control No. 3038-0088.\123\ Thus,

the requirements in this proposal that are subject to collection 3038-

0088 were previously addressed by the Commission in adopting the swap

documentation trading requirements and simply further clarified in this

proposal.

---------------------------------------------------------------------------

\123\ 77 FR 55904 (Sept. 12, 2012).

---------------------------------------------------------------------------

To be sure, Commission Regulation Sec. 23.504(b) requires an SD or

MSP to maintain written swap trading relationship documentation that

must include all terms governing the trading relationship between the

SD or MSP and its counterparty, and Commission Regulation Sec.

23.504(d) requires that each SD and MSP maintain all documents required

to be created pursuant to Commission Regulation 23.504. Also,

Commission Regulation Sec. 23.502(c) requires each SD and MSP to

notify the Commission and any applicable Prudential Regulator of any

swap valuation dispute in excess of $20 million if not resolved in

specified timeframes. Accordingly, this proposed rulemaking,

specifically the requirements found in proposed Regulation Sec.

23.154(b)(4) through (7), proposed Regulations Sec. Sec. 23.155(b) and

23.158, would not impact the burden estimates currently provided for in

OMB Control No. 3038-0088.

2. Revisions to Collection 3038-0024

Collection 3038-0024 is currently in force with its control number

having been provided by OMB. The proposal would revise collection 3038-

0024 as discussed below.

Proposed Regulation Sec. 23.154(b)(1) requires CSEs that wish to

use initial margin models to obtain the Commission's approval, and to

demonstrate to the Commission that the models satisfy standards

established in Sec. 23.154.\124\ These standards include (1) a

requirement that a CSE receive approval from the Commission based on a

demonstration that the initial margin model meets specific requirements

(Sec. 23.154(b)(1)); (2) a requirement that a CSE notify the

Commission in writing 60 days before extending the use of the model to

additional product types, making certain changes to the initial margin

model, or making material changes to modeling assumptions (Sec.

23.154(b)(1)); and (3) a variety of quantitative requirements,

including requirements that the CSE validate and demonstrate the

reasonableness of its process for modeling and measuring hedging

benefits, demonstrate to the satisfaction of the Commission that the

omission of any risk factor from the calculation of its initial margin

is appropriate, demonstrate to the satisfaction of the Commission that

incorporation of any proxy or approximation used to capture the risks

of the covered swap entity's non-cleared swaps or non-cleared security-

based swaps is appropriate, periodically review and, as necessary,

revise the data used to calibrate the initial margin model to ensure

that the data incorporate an appropriate period of significant

financial stress (Sec. 23.154(b)(3)).

---------------------------------------------------------------------------

\124\ The Commission previously proposed to adopt regulations

governing standards and other requirements for initial margin models

that would be used by SDs and MSPs to margin uncleared swap

transactions. See Capital Requirements of Swap Dealers and Major

Swap Participants, 76 FR 27,802 (May 12, 2011). As part of the

proposal, the Commission submitted proposed revisions to collection

3038-0024 for the estimated burdens associated with the margin model

to OMB. The Commission is resubmitting new estimated burden as part

of this re-proposal of the regulations.

---------------------------------------------------------------------------

The requirement of proposed Regulation Sec. 23.154(b)(1) that a

CSE

[[Page 59920]]

must obtain the Commission's approval to use an initial margin model by

submitting documentation demonstrating that the initial margin model

meets the standards set forth in Sec. 23.154, and the requirement that

a CSE must provide the Commission with written notice 60 days prior to

extending the use of the initial margin model to additional product

types or making material changes to the model would result in revisions

to the collection.

Currently, there are approximately 100 SDs and MSPs provisionally

registered with the Commission. The Commission further estimates that

approximately 60 of the SDs and MSPs will be subject to the

Commission's margin rules as they are not subject to a Prudential

Regulator. The Commission further estimates that all SDs and MSPs will

seek to obtain Commission approval to use models for computing initial

margin requirements. The Commission estimates that the initial margin

model requirements will impose an average of 240 burden hours per

registrant.

Based upon the above, the estimated additional hour burden for

collection 3038-0024 was calculated as follows:

Number of registrants: 60.

Frequency of collection: Initial submission and periodic updates.

Estimated annual responses per registrant: 1.

Estimated aggregate number of annual responses: 60.

Estimated annual hour burden per registrant: 240 hours.

Estimated aggregate annual hour burden: 14,400 hours [60

registrants x 240 hours per registrant].

3. Information Collection Comments

The Commission invites the public and other Federal agencies to

comment on any aspect of the reporting burdens discussed above.

Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments

in order to: (1) Evaluate whether the proposed collection of

information is necessary for the proper performance of the functions of

the Commission, including the information will have practical utility;

(2) evaluate the accuracy of the Commission's estimate of the burden of

the proposed collection of information; (3) determine whether there are

ways to enhance the quality, utility, and clarity of the information to

be collected; and (4) minimize the burden of the collection of

information on those who are to respond, including through the use of

automated collection techniques or other forms of information

technology.

Comments may be submitted directly to the Office of Information and

Regulatory Affairs, by fax at (202) 395-6566 or by email at

[email protected]. Please provide the Commission with a copy

of submitted comments so that all comments can be summarized and

addressed in the final rule preamble. Refer to the ADDRESSES section of

this notice of proposed rulemaking for comment submission instructions

to the Commission. A copy of the supporting statements for the

collections of information discussed above may be obtained by visiting

RegInfo.gov. OMB is required to make a decision concerning the

collection of information between 30 and 60 days after publication of

this document in the Federal Register. Therefore, a comment is best

assured of having its full effect if OMB receives it within 30 days of

publication.

C. Cost-Benefit Considerations

1. Introduction

Section 15(a) of the CEA requires the Commission to consider the

costs and benefits of its actions before promulgating a regulation

under the CEA or issuing certain orders.\125\ Section 15(a) further

specifies that the costs and benefits shall be evaluated in light of

five broad areas of market and public concern: (1) Protection of market

participants and the public; (2) efficiency, competitiveness, and

financial integrity of futures markets; (3) price discovery; (4) sound

risk management practices; and (5) other public interest

considerations. The Commission considers the costs and benefits

resulting from its discretionary determinations with respect to the

section 15(a) factors.

---------------------------------------------------------------------------

\125\ 7 U.S.C. 19(a).

---------------------------------------------------------------------------

The Commission recognizes that there is an inherent trade-off

involved in setting minimum collateral standards. Such standards could

increase margin requirements, which in turn would require market

participants to post additional collateral. Posting additional

collateral may result in opportunity costs in terms of lost returns

from investing the funds in collateral, or in interest expenses

incurred to raise additional funds. Such costs may reduce the

investment returns for market participants posting collateral. On the

other hand, minimum collateral standards help to mitigate counterparty

credit risk. This is achieved by requiring market participants to post

collateral that is sufficient to cover potential losses from default

most of the time. The potential reduction in investment returns for

market participants posting collateral might also be offset to some

degree by improvements in pricing as a result of the reduction in risk

of the swap. The reduction in counterparty credit risk from the posting

of collateral may result in tighter spreads quoted by liquidity

providers.\126\ From a regulatory perspective, minimum collateral

standards introduce a trade-off between potentially lowering

anticipated returns for market participants and lowering systemic risk

from counterparty defaults. A substantial loss from a default might

induce a cascade of defaults in a financial network, and perhaps,

induce a liquidity crisis and the seizing up of parts of the financial

system. In developing this proposal, the Commission has sought to

reduce the potential lowering of investment returns of market

participants by allowing them to use approved models to set margin

collateral for certain swap transactions while still guarding against

the dangers of systemic risk from counterparty defaults, along with

other parts of the rule.

---------------------------------------------------------------------------

\126\ Posting collateral for swap transactions may result in

other changes in the relationship between the CSE and counterparty

instead of just pricing terms of swap contracts. For instance, bank

CSEs might lower the required minimum balance on checking accounts

that counterparty maintain with the bank, instead.

---------------------------------------------------------------------------

2. Rule Summary

This proposed rulemaking is a re-proposal of prior CFTC proposed

rulemaking.\127\ It is the result of a working group consultation paper

issued by BCBS-IOSCO on margin for OTC-derivative contracts not cleared

by a CCP (uncleared derivatives).\128\ This proposed rulemaking would

implement the new statutory framework of section 4s(e) of the CEA,

added by section 731 of the Dodd-Frank Act, which requires the

Commission to adopt capital and initial and variation margin

requirements for certain SDs and MSPs. Generally, the proposed rule

would require the exchange (collection, posting, and payment) of margin

by SDs and MSPs for trades with other SDs, MSPs and financial end-

users. Initial margin is required to be held at third-party custodians

with no rehypothecation. These CSEs would not be required to collect

margin from or post margin to commercial end-users.

---------------------------------------------------------------------------

\127\ See 76 FR 23732 (April 28, 2011).

\128\ Margin requirements for non-centrally cleared derivatives

at http://www.bis.org/publ/bcbs261.pdf, September 2013. The proposed

rule establishes minimum standards for margin requirements for non-

centrally cleared derivatives as agreed by BIS and IOSCO.

---------------------------------------------------------------------------

Generally, the CFTC's margin rules will apply to a SD or MSP

whenever

[[Page 59921]]

there is no Prudential Regulator for that covered swap entity.\129\ The

CFTC's margin rules will apply to swaps that are not cleared and that

are executed subsequent to applicable compliance dates set out below,

based on an entity's level of uncleared swaps activity during a

particular period.

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\129\ For this rulemaking, a swap entity is either a swap dealer

or a major swap participant.

---------------------------------------------------------------------------

Generally, a CSE must collect IM from a counterparty that is (i) a

swap entity, or (ii) a financial end-user with material swaps exposure

($3 billion notional during June, July and August of the previous year)

in an amount that is no less than the greater of: (i) Zero (0) or (ii)

the IM collection amount for such swap less the IM threshold amount

($65 million--not including any portion of the IM threshold amount

already applied by the covered swap entity or its affiliates to other

swaps with the counterparty or its affiliates).

Generally, a CSE must post IM for any swap with a counterparty that

is a financial end-user with material swaps exposure (see above). A CSE

is not required to collect IM from or post IM to commercial end-users.

There are two general methods for calculating initial margin, the

standardized approach and the model-based approach. Under the

standardized approach, the CSE must calculate IM collection amounts

using a table/grid that is set out in the proposed rule.

The model-based approach calculates an amount of IM that is equal

to the potential future exposure (``PFE'') of a swap or a netting set

of swaps. PFE is an estimate of the one-tailed 99% confidence interval

for an increase in the value of the swap over a 10 day period (i.e.,

VaR model for a 10 day period). The model-based approach must meet the

following requirements: (1) The model must have prior written approval

by the Commission; (2) a CSE must demonstrate that the initial margin

model continuously satisfies the rule's requirements; (3) a covered

swap entity must notify the Commission in writing prior to making

material changes to the model, such as: (a) Extending the use of the

model to an additional product type; (b) making any change that results

in material changes to the amount of IM; or (c) making any material

changes to the assumptions of the model. The Commission may rescind its

approval in whole or in part of an entity's margin model at any time.

The rules for variation margin are as follows: (1) On or before the

business day after execution of an uncleared swap between a covered

swap entity and a counterparty that is a swap entity or a financial end

user, the covered swap entity must collect variation margin from or pay

variation margin to the counterparty; (2) a CSE is not required to

collect or pay variation from commercial end-users; and (3) a CSE is

not required to collect, post, or pay margin unless and until the total

amount of margin transfer to be collected or posted for an individual

counterparty exceeds the minimum transfer amount.

The eligible collateral for variation margin is cash funds

denominated in (a) USD, or (b) a currency in which payment under the

swap contracts is required. The eligible collateral for initial margin

includes (subject to haircuts on value) financial instruments in

various categories, including cash, Treasury securities, and various

publicly traded debt and equity instruments. A CSE may not collect or

post as initial margin any asset that is a security issued by (i) the

party providing such asset or an affiliate of that party; (ii) various

banking entities as listed in the proposed rule; or (iii) certain

government-sponsored enterprises unless an exception applies.

As defined in the rule, a financial end-user is any counterparty

that is not a covered swap entity and includes, among others: (i) A

commodity pool, commodity trading advisor and commodity pool operator

(all defined in the CEA); (ii) a private fund (defined in Investment

Advisers Act); (iii) an employee benefit plan, as defined in ERISA

section 3; (iv) a person predominantly engaged in activities that are

in the business of banking, or in activities that are financial in

nature (defined in section 4(k) of the BHCA); (v) a person defined in

(a)-(d), if that person organized under the laws of the U.S.; and (vi)

any other entity that in the Commission's discretion is a financial

end-user. A non-financial end-user is any entity that is not a

financial end-user or an SD/MSP.

Generally, a CSE entering into a swap with a swap entity or a

financial end-user with material swap exposure who posts initial margin

to the counterparty must comply with the following conditions: (1) All

funds posted as initial margin must be held by a third-party custodian

(unaffiliated with either party in the swap); (2) the third-party

custodian is prohibited from re-hypothecating (or otherwise

transferring) the initial margin; (3) the third-party custodian is

prohibited from reinvesting the initial margin in any asset that would

not qualify as eligible collateral; and (4) the custodial agreement is

legal, valid, binding and enforceable in the event of bankruptcy,

insolvency, or similar proceedings.

Generally, a CSE entering into a swap with a swap entity or a

financial end-user with a material swap exposure that collects initial

margin from the counterparty must require the same conditions listed

above for initial margin posted.

Generally, CSEs must comply with the minimum margin requirements

for uncleared swaps on or before the following dates. For variation

margin, covered swap entities must comply by December 1, 2015. Initial

margin is subject to a phased-in period. The compliance date is

December 1, 2015 when both (i) the CSE and its affiliates and (ii) its

counterparty and its affiliates, have an average daily aggregate

notional amount of uncleared swaps, uncleared security-based swaps,

foreign exchange forwards and foreign exchange swaps for each business

day in June, July and August 2015 that exceeds $4 trillion. The

compliance date is December 1, 2016 when both (i) the CSE and its

affiliates and (ii) its counterparty and its affiliates, have an

average daily aggregate notional amount of uncleared swaps, uncleared

security-based swaps, foreign exchange forwards and foreign exchange

swaps for each business day in June, July and August 2016 that exceeds

$3 trillion. The compliance date is December 1, 2017 when both (i) the

CSE and its affiliates and (ii) its counterparty and its affiliates,

have an average daily aggregate notional amount of uncleared swaps,

uncleared security-based swaps, foreign exchange forwards and foreign

exchange swaps for each business day in June, July and August 2017 that

exceeds $2 trillion. The compliance date is December 1, 2018 when both

(i) the CSE and its affiliates and (ii) its counterparty and its

affiliates, have an average daily aggregate notional amount of

uncleared swaps, uncleared security-based swaps, foreign exchange

forwards and foreign exchange swaps for each business day in June, July

and August 2018 that exceeds $1 trillion. The compliance date is

December 1, 2019 for any other covered swap entity with respect to

uncleared swaps and uncleared security-based swaps entered into with

any other counterparty.

3. Status Quo Baseline

The baseline against which this proposed rule will be compared is

the status quo. This requires the Commission to assess what is the

current practice within the swaps industry. At present, swap market

participants are not legally required to post either initial or

variation margin

[[Page 59922]]

when engaging in uncleared swaps. Nevertheless, for risk management

purposes, many market participants currently undertake this practice.

In determining the current market practices, the Commission

utilized several sources of swaps market data. These sources include

(i) the ISDA Margin Survey 2014 (``ISDA Survey''), (ii) BIS's

Quantitative impact study on margin requirements for non-centrally-

cleared OTC derivatives (``BCBS/IOSCO Quantitative Impact Study''), and

(iii) Swap Data Repository data (``SDR Data''). Although the data the

Commission is considering might not be complete, the Commission

requests comments regarding whether there is additional data that it

should consider when developing its baseline.

a. ISDA Margin Survey

A resource containing current market practice for uncleared swaps

is the ISDA Survey.\130\ The use of collateral agreements (those with

exposure and/or collateral balances) is substantial. The ISDA Survey

estimates that roughly 90% of all global uncleared OTC derivatives

trades have collateral agreements. 97% and 86% of global bilateral

transactions involving credit and fixed income, respectively, are

subject to collateral agreements or credit support annexes. The survey

reports that the use of cash and government securities accounts for

roughly 90% of uncleared global OTC derivative collateral, as has been

the case in prior years. The total global collateral related to

uncleared derivatives has decreased 14% from $3.7 trillion at the end

of 2012 to $3.2 trillion at the end of 2013. The survey asserts that

this decrease can be largely attributed to mandatory clearing

requirements.

---------------------------------------------------------------------------

\130\ See http://www2.isda.org/functional-areas/research/surveys/margin-surveys.

---------------------------------------------------------------------------

b. BCBS/IOSCO's Quantitative Impact Study

Another source containing current market practices for uncleared

swaps is the BCBS/IOSCO Quantitative Impact Study.\131\ According to

the Study, BCBS/IOSCO Quantitative Impact Study respondents have

roughly [euro]319 trillion (approximately $415 trillion) in total

outstanding notional derivative positions, are collecting a total of

roughly [euro]95 billion (approximately $124 billion) in initial margin

and are posting roughly [euro]6 billion (approximately $7.8 billion) in

initial margin. Hence, average margin represents about 0.03% of the

gross notional exposure.'' \132\ The large difference between collected

and posted margin reflects the fact that the BCBS/IOSCO Quantitative

Impact Study respondents tend to be large derivative dealers with large

swap portfolios with transactions that on aggregate mostly offset, have

substantial capital, and who have high credit ratings, this generally

leads to lower margins.

---------------------------------------------------------------------------

\131\ Bank for International Settlements, February 2013, page

31, see http://www.bis.org/publ/bcbs242.pdf.

\132\ Bank for International Settlements, February 2013, page

31. See http://www.bis.org/publ/bcbs242.pdf.

---------------------------------------------------------------------------

In light of the definition of potential future exposure in this

proposal, it is useful to examine current practice. The table below,

reproduced from the BCBS/IOSCO Quantitative Impact Study provides some

statistics on potential future exposure, and related industry

practices.

Table 4b--Current Margin Practices for Uncleared Swaps

----------------------------------------------------------------------------------------------------------------

Number of

Average Median respondents

----------------------------------------------------------------------------------------------------------------

Margin period of risk (or risk horizon) in days................. 8.1 10.0 15

Confidence level (%) used....................................... 96.2% 96.3% 14

Length of the look-back period (in years) used in calibration of 2.9 2.0 13

model..........................................................

Level of initial margin as a percentage of potential future 97.5% 100.0% 10

exposure.......................................................

Margin frequency (in days) Variation margin..................... 2.3 1.0 31

Initial margin.................................................. 1.0 1.0 21

----------------------------------------------------------------------------------------------------------------

Respondents have provided information on initial margin frequency. Eight (8) of these respondents collect

initial margin at deal inception. One (1) of them collects initial margin on an event-driven basis. The

remaining 12 respondents collect initial margin daily.

The Commission seeks comment on the representativeness of the BCBS/

IOSCO's Quantitative Impact Study. How do the calculations in the BCBS/

IOSCO's Quantitative Impact Study compare to the experience of

financial institutions? Commenters are encouraged to quantify when

possible.

c. Estimates Using SDR Data

Finally, the Commission reports aggregated data derived from data

submitted to swap data repositories in a weekly swaps market

report.\133\ Open swap positions in credit and interest rates as of

June 27, 2014 for CFTC regulated CSEs (59 entities) are presented

below. The table also includes total notional amount of swaps

transacted by these entities in credit and interest rates during the

period January to June 2014:

---------------------------------------------------------------------------

\133\ See http://www.cftc.gov/MarketReports/SwapsReports/index.htm.

Open Swaps as of June 27, 2014

[Notional amount in US$ billions (double count)]

------------------------------------------------------------------------

Uncleared Cleared

------------------------------------------------------------------------

Interest Rates.......................... 253,434 223,744

Credit.................................. 10,039 879

------------------------------------------------------------------------

[[Page 59923]]

Aggregate Notional Swaps Transaction (January to June 2014)

[Notional amount in US$ billions (double count)]

------------------------------------------------------------------------

Uncleared Cleared

------------------------------------------------------------------------

Interest Rates.......................... 12,630 39,816

Credit.................................. 1,362 5,717

------------------------------------------------------------------------

The Commission notes that OCC's Economic Impact Analysis for Swaps

Margin Proposed Rule \134\ has estimated that in year one, OCC-

supervised institutions will have to post total initial margin of

approximately $331 billion with approximately $283 billion in interest

rate and credit swaps. Using annualized notional swaps activity for

just interest rate and credit, and adopting a similar methodology to

the OCC's Economic Impact Analysis, the Commission estimates that the

59 CFTC regulated CSEs will have to post initial margin in year one of

approximately $340 billion or possibly less as noted below. The OCC's

estimate and the Commission's estimate are not based on the same data.

The OCC's estimates are based on transactions activity implied by the

open swaps positions from Call Report schedule RC-L. The Commission's

estimates are based on transaction data reported to SDRs. To the extent

SDR data includes financial end users without material swaps exposure,

nonfinancial end users, sovereigns, and multilateral development banks

who do not have to post collateral, the amount of required initial

margin would be less than the Commission's estimate of approximately

$340 billion. Further, the amount of required initial margin will be

lower as a result of the $65 million threshold, too. While the OCC has

made certain assumptions regarding coverage of the swaps activity by

its regulated entities during the different compliance dates, the

Commission does not have access to relevant data to make similar

estimates. The Commission's initial margin estimates assume that

uncleared swaps activities by CFTC regulated CSEs in these two asset

classes will remain the same. These differences in approaches and the

data sources means that the Commission's estimates will likely have

overstated the actual margins that will be posted in year one after

enactment.

---------------------------------------------------------------------------

\134\ See http://www.regulations.gov/#!documentDetail;D=OCC-

2011-0008-0131.

---------------------------------------------------------------------------

The Commission points out that prudentially regulated CSEs, CFTC

regulated CSEs, and SEC regulated CSEs will trade with each other.

Thus, one cannot simply add the margin estimates by various regulators

as this will double count the amount of initial margin collateral for

swap transactions between differently regulated CSEs. The Commission

seeks comment on how it should consider or allocate the common costs

and benefits of the margin collateral that is required by more than one

CSE regulator. Further, the Commission seeks comments on all aspects of

its initial margin estimates and methods. Commenters are encouraged to

quantify, if practical.

4. Section 15(a) Factors

a. Protection of Market Participants and the Public

Margin helps to protect market participants from counterparty

credit risk. It also helps to protect the public by lowering the

probability of a financial crisis, because margin helps to impede or

contain the risk of a cascade of defaults occurring. A cascade occurs

when one participant defaulting causes subsequent defaults by its

counterparties, and so on, resulting in a domino effect and a potential

financial crisis.

The derivatives positions of swap market participants are limited

by their ability to post margin. If the ability to post margin is

binding, then required margin may reduce swap market exposures for some

participants. In many cases, reduced swap market exposure for a

participant may lower their probability of default, all else equal.

Further, when a swap participant defaults, the margin can be used to

absorb the losses to the counterparty. This facilitates the non-

defaulting party reestablishing a similar position with a new

counterparty.

In requiring daily variation margin payments, the proposed rule

would require counterparties to mark-to-market all open swap positions.

The process of marking swap contracts to market or model, forces

participants to recognize losses promptly and to adjust collateral

accordingly. This helps to prevent the accumulation of large

unrecognized losses and exposures. Consequently, this frequent settling

up may reduce the probability of default of the party who has been

experiencing losses on the contract. The proposed rule however,

requires a minimum payment amount of $650,000, which provides

counterparties with operational relief. This minimum payment does not

lower the amount owed, but permits deferral of margin exchanges until

it is operationally efficient. In providing this relief the Commission

believes that it will lower the overall burden on the financial system,

but as a result of this amount being relatively small the Commission

believes this deferral would not noticeably increase the overall risk

to the financial system and the general public.

The proposed rule also provides that initial margin must be held at

a third-party custodian. The margin amount held there cannot be

rehypothecated with both parties having access to the collateral. This

access is designed to prevent a liquidity event, inducing a cascading

event. With rehypothecation, the collateral of some parties may be

linked or used as collateral posted for other positions--the same

collateral is posted for many positions for many different entities,

resulting in a rehypothecation chain. When a default or liquidity event

occurs at one link along the rehypothecation chain, it might induce

further defaults or liquidity events for other links in the

rehypothecation chain, because access to the collateral for other

positions may be obstructed by a default along the chain, which may

result in a liquidity event along the entire chain.

The cost of providing initial margin collateral reflects the cost

of obtaining the assets used as collateral, which is either the cost of

raising external funds, or the foregone income that could been earned

had the firm invested in a different asset (opportunity cost). The

effective cost is the difference between the relevant cost of obtaining

eligible assets and the return on the assets that can be pledged as

collateral. The effective cost will likely differ between entities and

even desks in the same entity as well as over time as conditions

change. At one extreme, it may be that some entities providing initial

margin, such as pension funds and asset managers, will provide assets

as initial margin that they already own and would have owned even if no

requirements were in place. In such cases the economic cost of

providing initial margin collateral is anticipated to be low. In other

cases, entities engaging

[[Page 59924]]

in uncleared swaps will have to raise additional funds to secure assets

that can be pledged as initial margin. The greater the costs of their

funding, relative to the rates of return on the initial margin

collateral, the greater the cost of providing collateral assets. It is

difficult, however, to estimate these costs due to differences in

funding costs across different types of entities as well as differences

in funding costs over time, and differences in the rate of return on

different collateral assets that may be used to satisfy the initial

margin requirements. In addition, as a result of the fact that posting

margin reduces the risk of default, the posting party could receive a

benefit in the form of improved pricing of the swap or other beneficial

changes to the relationship between the CSE and the counterparty. To

the extent any such benefit is realized, it would offset a portion of

the cost incurred in posting collateral.

The Commission seeks comment on the appropriate cost or a proxy for

the costs to posting collateral for CFTC regulated entities,

recognizing that CFTC entities may have different costs for pledging

collateral. The Commission also seeks comments on the quantitative

impact of these proposed rules on the pricing of swaps or other changes

in the relationships between CSEs and counterparties.

The proposal also requires that variation margin be exchanged

between covered swap entities and other swap entities and financial

end-users. The Commission preliminarily believes that the impact of

such requirements are low in the aggregate because: (i) regular

exchange of variation margin is already a well-established market

practice among a large number of market participants, and (ii) exchange

of variation margin simply redistributes resources from one entity to

another in a manner that imposes no aggregate liquidity costs. An

entity that suffers a reduction in liquidity from posting variation

margin is offset by an increase in the liquidity enjoyed by the entity

receiving the variation margin because variation margin is posted with

cash. The Commission notes that if the margin payments are not

instantaneous, however, there may be a slight loss in liquidity while

payments are being posted.

Posting margin may discourage some parties from hedging certain

risks because it is no longer cost effective for them to do so.

Consequently, this may reduce liquidity for some swap contracts. This

concern is mitigated somewhat by exempting non-financial end users from

having to post margin. Furthermore, not requiring parties to exchange

variation margin when the change in valuation is small enough,

$650,000, achieves additional cost savings. The proposed rule will

create additional demand for eligible collateral to post as margin.

Some advocates have expressed concern regarding the future availability

of eligible assets for market participants to post as margin; \135\

however, in developing this proposal, the Commission has added

additional types of financial instruments to the list of eligible

collateral in an attempt to mitigate this concern. That being said, it

is too early to tell the extent to which eligible collateral will

become more expensive to obtain. Even if higher demand for collateral

does increase the price of certain existing assets, the Commission

surmises that markets for various forms of collateral will clear.

Higher prices may create incentives for creators of high quality assets

to supply more in the future. For instance, sovereigns and credit

worthy corporations may find it advantageous to issue more debt; as

demand increases for their debt, prices will rise with corresponding

borrowing rates decreasing. In addition, mutual funds and hedge funds

may be willing for a fee to lend out assets that they hold in their

portfolios to be pledged as initial margin. Some financial

intermediaries may set up services to transform other financial

instruments into eligible collateral, too.

---------------------------------------------------------------------------

\135\ See, for instances, Singh (2010), ``Under-

collateralisation and rehypothecation in the OTC derivatives

markets,'' Banque de France Financial Stability Review (14);

Sidanius and Zikes (2012), ``OTC derivatives reform and collateral

demand impact,'' Financial Stability Paper (18); and Duffie,

Scheicher, and Vuillemey (2014), ``Central Clearing and Collateral

Demand,'' working paper, Stanford University.

---------------------------------------------------------------------------

According to the Committee on the Global Financial System, there

seems to be sufficient eligible collateral at present and in the near

term, as they noted that ``Current estimates suggest that the combined

impact of liquidity regulation and OTC derivatives reforms could

generate additional collateral demand to the tune of $4 trillion. At

the same time, the supply of collateral assets is known to have risen

significantly since end-2007. Outstanding amounts of AAA- and AA-rated

government securities alone--based on the market capitalization of

widely used benchmark indices--increased by $10.8 trillion between 2007

and 2012. Other measures suggest even greater increases in supply.''

\136\ As discussed above, there may be a reduction in the number of

swap contracts due to the cost of posting margin. Indeed, this may be

the case even if the cost of posting eligible collateral does not

increase in price. Finally, the proposed margin rules will be phased in

gradually. This gives regulators the ability to make adjustments, if

necessary.

---------------------------------------------------------------------------

\136\ Committee on the Global Financial System, ``Asset

encumbrance and the demand for collateral assets'', CGFS Papers, no.

49, May 2013, http://www.bis.org/publ/cgfs49.pdf.

---------------------------------------------------------------------------

b. The Efficiency, Competitiveness, and Integrity of Markets

The proposed margin requirements make cleared swaps relatively more

attractive. The Commission is requiring ten day initial margins for

uncleared swaps and only five day margin for cleared swaps. In

addition, the Commission is only allowing limited netting for uncleared

swaps. All else equal, due to multilateral netting, less collateral may

be required in a cleared environment relative to an uncleared

environment.\137\

---------------------------------------------------------------------------

\137\ Anderson and Joeveer (2014), ``The Economics of

Collateral,'' working paper, London School of Economics.

---------------------------------------------------------------------------

The Commission is allowing only limited netting for uncleared

swaps. Limited netting may encourage participants to use a small number

of counterparties for multiple swap transactions, because participants

can only net swaps from those made with the same counterparty. This may

encourage the concentration of risk among a few counterparties.

However, these concerns may be mitigated somewhat by performing

frequent portfolio compression exercises that facilitate multilateral

netting.

Another cost of the rules may be a reduction in the efficacy of

hedging. Rules that make standardized swaps relatively less expensive

may induce some entities to forego some customized swaps that may

better match their exposures. However, before an entity decides to use

a standardized swap over a customized uncleared swap, it must weigh the

potentially lower margin costs from using standardized swaps against

potentially losses from imperfect hedges. Consequently, market

participants will still use customized swaps when they believe such

swaps are superior for their hedging needs.

All the market protection benefits discussed above may help to

improve the integrity of markets, because they make it more likely that

swap market participants will be able to perform on their contractual

obligations. This comes with potential losses to participants who have

to place their capital into margin and, hence potentially receive lower

anticipated returns on their capital.

[[Page 59925]]

The Commission has endeavored to harmonize this rulemaking with the

domestic prudential regulators, as well as with foreign regulators. Two

of the goals of harmonization are to satisfy the statute as well as to

create a more level playing field thereby promoting fairer competition

between entities regulated in different jurisdictions or by different

regulators. Otherwise, regulatory arbitrage opportunities might be

substantial. Price arbitrage occurs when an identical asset

simultaneously has two different prices, so that an arbitrager may buy

that asset where it is cheaper and sell it where it is more expensive

to garner a risk free profit. Similarly, a regulatory arbitrager takes

advantage of regulatory discrepancies by adapting activities so as to

locate them in jurisdictions to increase the arbitrager's regulatory

profits (i.e., regulatory benefits minus regulatory burdens).

The Commission is in discussion with domestic and foreign

regulators on the material swap exposure threshold for financial end

users to be required to post margin collateral. The Commission notes

that some foreign regimes have proposed a higher threshold than $3

billion. In addition, the Commission realizes that setting a threshold

lower than another jurisdiction may result in some market participants

conducting some swaps in the jurisdiction with a lower threshold. The

Commission is required, to the maximum extent practicable, to harmonize

with prudential regulators, and domestic regulators are endeavoring to

harmonize with foreign regulators, as well. Therefore, the Commission

expects to consider the relative benefits that might come from having

consistent standards against those that might come from having

different thresholds. The Commission is seeking comment on the costs

and benefits of setting the threshold for material swap exposure for

financial end users to be required to post margin collateral at various

levels. In particular, commenters are encouraged to discuss competitive

impacts and to quantify, if practical. In addition, the Commission is

seeking comments on the costs and benefits of not fully harmonizing its

rules with those of the prudential regulators. Commenters are

encouraged to discuss the operational difficulties and to quantify, if

practical.

Inasmuch as larger banks tend to have a lower cost of capital than

smaller banks, the posting of margin for uncleared swaps may result in

a competitive advantage for larger banks when engaging in swaps, all

else equal. Even though they are exempted from clearing as financial

end users, small banks that have a material swaps exposure generally

will have to post margin collateral when engaging in uncleared swaps

with CFTC regulated CSEs. Thus, small banks may have to fund additional

collateral to post as margin for uncleared swaps or engage in more

cleared swaps that require relatively less collateral to post. The

Commission is seeking comment on the costs and benefits of requiring

small banks with material swaps exposures to post collateral with CFTC

regulated CSEs. Commenters may choose to recognize that under the

prudential regulators' proposal, small banks that have a material swaps

exposure and that engage in swaps with prudentially regulated CSEs

would have to post margin collateral for uncleared swaps, too. Further,

commenters may also choose to recognize that the Commission is required

to harmonize this rulemaking, to the maximum extent practicable, with

the prudential regulators. Comments are encouraged to quantify, if

practical.

c. Price Discovery

The Commission is requiring ten day initial margins for uncleared

swaps and only five day margin for cleared swaps. In addition, the

Commission is only allowing limited netting for uncleared swaps.

Consequently, these rules promote the use of more standardized cleared

swaps at the expense of more customized and opaque swaps.

To the extent traders increase the use of standardized cleared

swaps in response to these rules, it may lead to greater transparency,

overall, in the swaps markets. Compared to uncleared swaps,

standardized swaps' prices tend to be more transparent and the price

discovery process for such swaps may improve with higher volumes.

Conversely, lower volumes for uncleared swaps may negatively impact the

price discovery process for such swaps. However, the Commission

believes that the potential reduction in the efficacy of the price

discovery process for uncleared swaps is less of a concern, because the

price-setting process for uncleared swaps is not conducted on a

regulated platform or pursuant to rules requiring transparency and is

therefore relatively opaque in the current environment, anyway.

The Commission recognizes that another way the rules may affect

price discovery is by promoting confidence in the market. As such, the

margin collateral rules may protect, prophylactically, the price

discovery process of some swap contracts in some circumstances. The

rules might protect price discovery by reducing the frequency of

trading interruptions in segments of the swap market due to credit risk

concerns. This rulemaking might improve price discovery in these

instances, because the presence of collateral mitigates credit risk

concerns, and thereby allows these swap contract markets to remain

functioning. In turn, this permits market participants to continue to

observe the prices of these swaps.

The Commission requests comment on potential effects of the rule on

price discovery as well as on the relative use of cleared and uncleared

swaps, and on whether particular types of market participants,

including intermediaries such as regulated trading platforms, will be

impacted differently by the rule. Commenters are urged to quantify the

costs and benefits, if practicable.

d. Sound Risk Management Practices

Margin helps to mitigate the credit risk exposure resulting from

swap contracts. Further, it is a sound practice to regularly mark to

market or model to prevent the accumulation of unrecognized losses and

exposures (through the exchange of variation margin). At the same time,

requiring margin may help deter traders from taking advantage of the

inherent leverage in certain swap transactions.

The Commission is requiring ten day initial margins for uncleared

swaps and only five day initial margin for cleared swaps. Thus, the

rule may result in the use of more standardized cleared swaps at the

expense of more customized swaps which may be harder to evaluate and

risk manage; however, this may result in market participants using non-

optimal hedging techniques, as noted above, which may increase overall

risk at a firm.

Prohibiting rehypothecation at third-party custodians when both

parties have access to the collateral will be helpful in the time of

default. Otherwise, a liquidity event might occur that induces a

cascading event, in which the positions will be linked to other

positions and counterparties. The policy of not allowing

rehypothecation, however, requires that more collateral be available to

post as margin. As discussed above, this does not seem to be a serious

problem at present, but it might become one in the future. In addition,

to protect parties against the circumstance when pledged collateral

might be appropriated by the counterparty, margins must be held at

third parties. Facilitating the use of more customized models might

induce market participants to more thoroughly analyze the risks of

their swap transactions, and may lead to better risk

[[Page 59926]]

management practices overall. The Commission is allowing various

methods to model the amount of collateral required as initial margin

for uncleared swap transactions, including Commission-approved standard

models or more customized ones.

In this proposal, the Commission has added flexibility to what

constitutes eligible collateral, allowing participants in uncleared

swap transactions to `optimize' their collateral inasmuch as they may

reduce their opportunity cost losses from pledging assets with lower

anticipated returns. This may result in market participants focusing on

improving their margin and risk management practices.

e. Other Public Interest Considerations

The Commission has not identified any other public interest

considerations.

List of Subjects

17 CFR Part 23

Swaps, Swap dealers, Major swap participants, Capital and margin

requirements.

17 CFR Part 140

Authority delegations (Government agencies), Organization and

functions (Government agencies).

For the reasons discussed in the preamble, the Commodity Futures

Trading Commission proposes to amend 17 CFR chapter I as set forth

below:

PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

0

1. The authority citation for part 23 continues to read as follows:

Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,

9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.

0

2. Add subpart E to part 23 to read as follows:

Subpart E--Capital and Margin Requirements for Swap Dealers and

Major Swap Participants

Sec.

23.100-23.149 [Reserved]

23.150 Scope.

23.151 Definitions applicable to margin requirements.

23.152 Collection and posting of initial margin.

23.153 Collection and payment of variation margin.

23.154 Calculation of initial margin.

23.155 Calculation of variation margin.

23.156 Forms of margin.

23.157 Custodial arrangements.

23.158 Margin documentation.

23.159 Compliance dates.

23.160-23.199 [Reserved]

Sec. Sec. 23.100-23.149 [Reserved]

Sec. 23.150 Scope.

The margin requirements set forth in Sec. 23.150 through Sec.

23.159 shall apply to uncleared swaps, as defined in Sec. 23.151, that

are executed after the applicable compliance dates set forth in Sec.

23.159.

Sec. 23.151 Definitions applicable to margin requirements.

For the purposes of Sec. Sec. 23.150 through 23.159:

Affiliate means any company that controls, is controlled by, or is

under common control with another company.

Bank holding company has the meaning specified in section 2 of the

Bank Holding Company Act of 1956 (12 U.S.C. 1841).

Broker dealer means an entity registered with the Securities and

Exchange Commission under section 15 of the Securities Exchange Act of

1934 (15 U.S.C. 78o).

Control of another company means:

(1) Ownership, control, or power to vote 25 percent or more of a

class of voting securities of the company, directly or indirectly or

acting through one or more other persons;

(2) Ownership or control of 25 percent or more of the total equity

of the company, directly or indirectly or acting through one or more

other persons; or

(3) Control in any manner of the election of a majority of the

directors or trustees of the company.

Counterparty means the other party to a swap to which a covered

swap entity is a party.

Covered counterparty means a financial end user with material swaps

exposure, a swap dealer, or a major swap participant that enters into a

swap with a covered swap entity.

Covered swap entity means a swap dealer or major swap participant

for which there is no prudential regulator.

Cross-currency swap means a swap in which one party exchanges with

another party principal and interest rate payments in one currency for

principal and interest rate payments in another currency, and the

exchange of principal occurs upon the inception of the swap, with

reversal of the exchange of principal at a later date that is agreed

upon at the inception of the swap.

Data source means an entity and/or method from which or by which a

covered swap entity obtains prices for swaps or values for other inputs

used in a margin calculation.

Depository institution has the meaning specified in section 3(c) of

the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).

Eligible collateral means collateral described in Sec. 23.157.

Eligible master netting agreement means a written, legally

enforceable agreement provided that:

(1) The agreement creates a single legal obligation for all

individual transactions covered by the agreement upon an event of

default, including upon an event of receivership, insolvency,

liquidation, or similar proceeding, of the counterparty;

(2) The agreement provides the covered swap entity the right to

accelerate, terminate, and close out on a net basis all transactions

under the agreement and to liquidate or set off collateral promptly

upon an event of default, including upon an event of receivership,

insolvency, liquidation, or similar proceeding, of the counterparty,

provided that, in any such case, any exercise of rights under the

agreement will not be stayed or avoided under applicable law in the

relevant jurisdictions, other than in receivership, conservatorship,

resolution under the Federal Deposit Insurance Act (12 U.S.C. 1811 et

seq.), Title II of the Dodd-Frank Act (12 U.S.C. 4617) or under any

similar insolvency law applicable to U.S. Government-sponsored

enterprises (12 U.S.C. 2183 and 2279cc);

(3) The agreement does not contain a walkaway clause (that is, a

provision that permits a non-defaulting counterparty to make a lower

payment than it otherwise would make under the agreement, or no payment

at all, to a defaulter or the estate of a defaulter, even if the

defaulter or the estate of the defaulter is a net creditor under the

agreement); and

(4) A covered swap entity that relies on the agreement for purposes

of calculating the margin required by this part:

(i) Conducts sufficient legal review (and maintains sufficient

written documentation of that legal review) to conclude with a well-

founded basis that:

(A) The agreement meets the requirements of paragraphs (1) through

(3) of this definition; and

(B) In the event of a legal challenge (including one resulting from

default or from receivership, insolvency, liquidation, or similar

proceeding) the relevant court and administrative authorities would

find the agreement to be legal, valid, binding, and enforceable under

the law of the relevant jurisdictions; and

(ii) Establishes and maintains written procedures to monitor

possible changes in relevant law and to ensure that the agreement

continues to satisfy the requirements of this definition.

Financial end user means

[[Page 59927]]

(1) A counterparty that is not a swap entity and that is:

(i) A bank holding company or an affiliate thereof; a savings and

loan holding company; or a nonbank financial institution supervised by

the Board of Governors of the Federal Reserve System under Title I of

the Dodd-Frank Act (12 U.S.C. 5323);

(ii) A depository institution; a foreign bank; a Federal credit

union or State credit union as defined in section 2 of the Federal

Credit Union Act (12 U.S.C. 1752(1) and (6)); an institution that

functions solely in a trust or fiduciary capacity as described in

section 2(c)(2)(D) of the Bank Holding Company Act (12 U.S.C.

1841(c)(2)(D)); an industrial loan company, an industrial bank, or

other similar institution described in section 2(c)(2)(H) of the Bank

Holding Company Act (12 U.S.C. 1841(c)(2)(H));

(iii) An entity that is state-licensed or registered as:

(A) A credit or lending entity, including a finance company; money

lender; installment lender; consumer lender or lending company;

mortgage lender, broker, or bank; motor vehicle title pledge lender;

payday or deferred deposit lender; premium finance company; commercial

finance or lending company; or commercial mortgage company; except

entities registered or licensed solely on account of financing the

entity's direct sales of goods or services to customers;

(B) A money services business, including a check casher; money

transmitter; currency dealer or exchange; or money order or traveler's

check issuer;

(iv) A regulated entity as defined in section 1303(20) of the

Federal Housing Enterprises Financial Safety and Soundness Act of 1992

(12 U.S.C. 4502(20)) and any entity for which the Federal Housing

Finance Agency or its successor is the primary federal regulator;

(v) Any institution chartered and regulated by the Farm Credit

Administration in accordance with the Farm Credit Act of 1971, as

amended, 12 U.S.C. 2001 et seq.;

(vi) A securities holding company; a broker or dealer; an

investment adviser as defined in section 202(a) of the Investment

Advisers Act of 1940 (15 U.S.C. 80b-2(a)); an investment company

registered with the Securities and Exchange Commission under the

Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.).

(vii) A private fund as defined in section 202(a) of the Investment

Advisers Act of 1940 (15 U.S.C. 80-b-2(a)); an entity that would be an

investment company under section 3 of the Investment Company Act of

1940 (15 U.S.C. 80a-3) but for section 3(c)(5)(C); or an entity that is

deemed not to be an investment company under section 3 of the

Investment Company Act of 1940 pursuant to Investment Company Act Rule

3a-7 of the Securities and Exchange Commission (17 CFR 270.3a-7);

(viii) A commodity pool, a commodity pool operator, a commodity

trading advisor, or a futures commission merchant;

(ix) An employee benefit plan as defined in paragraphs (3) and (32)

of section 3 of the Employee Retirement Income and Security Act of 1974

(29 U.S.C. 1002);

(x) An entity that is organized as an insurance company, primarily

engaged in writing insurance or reinsuring risks underwritten by

insurance companies, or is subject to supervision as such by a State

insurance regulator or foreign insurance regulator;

(xi) An entity that is, or holds itself out as being, an entity or

arrangement that raises money from investors primarily for the purpose

of investing in loans, securities, swaps, funds or other assets for

resale or other disposition or otherwise trading in loans, securities,

swaps, funds or other assets;

(xii) A person that would be a financial entity described in

paragraphs (1)(i)-(xi) of this definition if it were organized under

the laws of the United States or any State thereof; or

(xiii) Notwithstanding paragraph (2) of this definition, any other

entity that the Commission determines should be treated as a financial

end user.

(2) The term ``financial end user'' does not include any

counterparty that is:

(i) A sovereign entity;

(ii) A multilateral development bank;

(iii) The Bank for International Settlements;

(iv) An entity that is exempt from the definition of financial

entity pursuant to section 2(h)(7)(C)(iii) of the Act and implementing

regulations; or

(v) An affiliate that qualifies for the exemption from clearing

pursuant to section 2(h)(7)(D) of the Act.

Foreign bank has the meaning specified in section 1 of the

International Banking Act of 1978 (12 U.S.C. 3101).

Foreign exchange forward and foreign exchange swap mean any foreign

exchange forward, as that term is defined in section 1a(24) of the Act,

and foreign exchange swap, as that term is defined in section 1a(25) of

the Act.

Initial margin means collateral collected or posted to secure

potential future exposure under one or more uncleared swaps.

Initial margin threshold amount means an aggregate credit exposure

of $65 million resulting from all uncleared swaps and uncleared

security-based swaps between a covered swap entity and its affiliates,

and a covered counterparty and its affiliates.

Major currencies means

(1) United States Dollar (USD);

(2) Canadian Dollar (CAD);

(3) Euro (EUR);

(4) United Kingdom Pound (GBP);

(5) Japanese Yen (JPY);

(6) Swiss Franc (CHF);

(7) New Zealand Dollar (NZD);

(8) Australian Dollar (AUD);

(9) Swedish Kronor (SEK);

(10) Danish Kroner (DKK);

(11) Norwegian Krone (NOK); and

(12) Any other currency designated by the Commission.

Market intermediary means

(1) A securities holding company;

(2) A broker or dealer;

(3) A futures commission merchant;

(4) A swap dealer; or

(5) A security-based swap dealer.

Material swaps exposure for an entity means that the entity and its

affiliates have an average daily aggregate notional amount of uncleared

swaps, uncleared security-based swaps, foreign exchange forwards, and

foreign exchange swaps with all counterparties for June, July and

August of the previous calendar year that exceeds $3 billion, where

such amount is calculated only for business days.

Minimum transfer amount means an initial margin or variation margin

amount under which no actual transfer of funds is required. The minimum

transfer amount shall be $650,000 or such other amount as the

Commission may establish by order.

Multilateral development bank means

(1) The International Bank for Reconstruction and Development;

(2) The Multilateral Investment Guarantee Agency;

(3) The International Finance Corporation;

(4) The Inter-American Development Bank;

(5) The Asian Development Bank;

(6) The African Development Bank;

(7) The European Bank for Reconstruction and Development;

(8) The European Investment Bank;

(9) The European Investment Fund;

(10) The Nordic Investment Bank;

(11) The Caribbean Development Bank;

(12) The Islamic Development Bank;

(13) The Council of Europe Development Bank; and

(14) Any other entity that provides financing for national or

regional

[[Page 59928]]

development in which the U.S. government is a shareholder or

contributing member or which the Commission determines poses comparable

credit risk.

Non-financial end user means a counterparty that is not a swap

dealer, a major swap participant, or a financial end user.

Prudential regulator has the meaning specified in section 1a(39) of

the Act.

Savings and loan holding company has the meaning specified in

section 10(n) of the Home Owners' Loan Act (12 U.S.C. 1467a(n)).

Securities holding company has the meaning specified in section 618

of the Dodd-Frank Act (12 U.S.C. 1850a).

Security-based swap has the meaning specified in section 3(a)(68)

of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(68)).

Sovereign entity means a central government (including the U.S.

government) or an agency, department, ministry, or central bank of a

central government.

State means any State, commonwealth, territory, or possession of

the United States, the District of Columbia, the Commonwealth of Puerto

Rico, the Commonwealth of the Northern Mariana Islands, American Samoa,

Guam, or the United States Virgin Islands.

Subsidiary means a company that is controlled by another company.

Swap entity means a swap dealer or major swap participant.

Uncleared security-based swap means a security-based swap that is

not cleared by a clearing agency registered with the Securities and

Exchange Commission.

Uncleared swap means a swap that is not cleared by a registered

derivatives clearing organization, or by a clearing organization that

has received a no-action letter or other exemptive relief from the

Commission permitting it to clear certain swaps for U.S. persons

without being registered as a derivatives clearing organization.

U.S. Government-sponsored enterprise means an entity established or

chartered by the U.S. government to serve public purposes specified by

federal statute but whose debt obligations are not explicitly

guaranteed by the full faith and credit of the U.S. government.

Variation margin means a payment by a party to its counterparty to

meet an obligation under one or more swaps between the parties as a

result of a change in value of such obligations since the trade was

executed or the previous time such payment was made.

Sec. 23.152 Collection and posting of initial margin.

(a) Collection--(1) Initial obligation. On or before the business

day after execution of an uncleared swap between a covered swap entity

and a covered counterparty, the covered swap entity shall collect

initial margin from the covered counterparty in an amount equal to or

greater than an amount calculated pursuant to Sec. 23.154, in a form

that complies with Sec. 23.156, and pursuant to custodial arrangements

that comply with Sec. 23.157.

(2) Continuing obligation. The covered swap entity shall continue

to hold initial margin from the covered counterparty in an amount equal

to or greater than an amount calculated each business day pursuant to

Sec. 23.154, in a form that complies with Sec. 23.156, and pursuant

to custodial arrangements that comply with Sec. 23.157, until such

uncleared swap is terminated or expires.

(b) Posting--(1) Initial obligation. On or before the business day

after execution of an uncleared swap between a covered swap entity and

a covered counterparty that is a financial end user, the covered swap

entity shall post initial margin with the covered counterparty in an

amount equal to or greater than an amount calculated pursuant to Sec.

23.154, in a form that complies with Sec. 23.156, and pursuant to

custodial arrangements that comply with Sec. 23.157.

(2) Continuing obligation. The covered swap entity shall continue

to post initial margin with the covered counterparty in an amount equal

to or greater than an amount calculated each business day pursuant to

Sec. 23.154, in a form that complies with Sec. 23.156, and pursuant

to custodial arrangements that comply with Sec. 23.157, until such

uncleared swap is terminated or expires.

(c) Satisfaction of collection and posting requirements. A covered

swap entity shall not be deemed to have violated its obligation to

collect or to post initial margin from a covered counterparty if:

(1) The covered counterparty has refused or otherwise failed to

provide, or to accept, the required initial margin to, or from, the

covered swap entity; and

(2) The covered swap entity has:

(i) Made the necessary efforts to collect or to post the required

initial margin, including the timely initiation and continued pursuit

of formal dispute resolution mechanisms, including pursuant to Sec.

23.504(b)(4), if applicable, or has otherwise demonstrated upon request

to the satisfaction of the Commission that it has made appropriate

efforts to collect or to post the required initial margin; or

(ii) Commenced termination of the uncleared swap with the covered

counterparty promptly following the applicable cure period and

notification requirements.

Sec. 23.153 Collection and payment of variation margin.

(a) Initial obligation. On or before the business day after

execution of an uncleared swap between a covered swap entity and a

counterparty that is a swap entity or a financial end user, the covered

swap entity shall collect variation margin from, or pay variation

margin to, the counterparty as calculated pursuant to Sec. 23.155 and

in a form that complies with Sec. 23.156.

(b) Continuing obligation. The covered swap entity shall continue

to collect variation margin from, or to pay variation margin to, the

counterparty as calculated each business day pursuant to Sec. 23.155

and in a form that complies with Sec. 23.156 each business day until

such uncleared swap is terminated or expires.

(c) Netting. To the extent that more than one uncleared swap is

executed pursuant to an eligible master netting agreement between a

covered swap entity and a counterparty, a covered swap entity may

calculate and comply with the variation margin requirements of this

section on an aggregate basis with respect to all uncleared swaps

governed by such agreement. If the agreement covers uncleared swaps

entered into before the applicable compliance date set forth in Sec.

23.159, those swaps must be included in the aggregate for the purposes

of calculation and complying with the variation margin requirements of

this section.

(d) Satisfaction of collection and payment requirements. A covered

swap entity shall not be deemed to have violated its obligation to

collect or to pay variation margin from a counterparty if:

(1) The counterparty has refused or otherwise failed to provide or

to accept the required variation margin to or from the covered swap

entity; and

(2) The covered swap entity has:

(i) Made the necessary efforts to collect or to pay the required

variation margin, including the timely initiation and continued pursuit

of formal dispute resolution mechanisms, or has otherwise demonstrated

upon request to the satisfaction of the Commission that it has made

appropriate efforts to collect or to pay the required variation margin;

or

(ii) Commenced termination of the uncleared swap with the

counterparty promptly following the applicable cure period and

notification requirements.

[[Page 59929]]

Sec. 23.154 Calculation of initial margin.

(a) Means of calculation. (1) Each business day each covered swap

entity shall calculate an initial margin amount to be collected from

each covered counterparty using:

(i) A risk-based model that meets the requirements of paragraph (b)

of this section; or

(ii) The table-based method set forth in paragraph (c) of this

section.

(2) Each business day each covered swap entity shall calculate an

initial margin amount to be posted with each covered counterparty that

is a financial end user using:

(i) A risk-based model that meets the requirements of paragraph (b)

of this section; or

(ii) The table-based method set forth in paragraph (c) of this

section.

(3) Each covered swap entity may reduce the amounts calculated

pursuant to paragraphs (a)(1) and (2) of this section by the initial

margin threshold amount provided that the reduction does not include

any portion of the initial margin threshold amount already applied by

the covered swap entity or its affiliates in connection with other

uncleared swaps or uncleared security-based swaps with the counterparty

or its affiliates.

(4) The amounts calculated pursuant to paragraph (a)(3) of this

section shall not be less than zero.

(5) A covered swap entity shall not be required to collect or to

post an amount below the minimum transfer amount.

(6) For risk management purposes, each business day each covered

swap entity shall calculate a hypothetical initial margin requirement

for each swap for which the counterparty is a non-financial end user

that has material swaps exposure to the covered swap entity as if the

counterparty were a covered counterparty and compare that amount to any

initial margin required pursuant to the margin documentation.

(b) Risk-based Models--(1) Commission approval. (i) A covered swap

entity shall obtain the written approval of the Commission to use a

model to calculate the initial margin required in this part.

(ii) A covered swap entity shall demonstrate that the model

satisfies all of the requirements of this section on an ongoing basis.

(iii) A covered swap entity shall notify the Commission in writing

60 days prior to:

(A) Extending the use of an initial margin model that has been

approved to an additional product type;

(B) Making any change to any initial margin model that has been

approved that would result in a material change in the covered swap

entity's assessment of initial margin requirements; or

(C) Making any material change to modeling assumptions used by the

initial margin model.

(iv) The Commission may rescind its approval of the use of any

initial margin model, in whole or in part, or may impose additional

conditions or requirements if the Commission determines, in its sole

discretion, that the model no longer complies with this section.

(2) Applicability to multiple swaps. To the extent that more than

one uncleared swap is executed pursuant to an eligible master netting

agreement between a covered swap entity and a covered counterparty, a

covered swap entity may use its initial margin model to calculate and

comply with the initial margin requirements on an aggregate basis with

respect to all uncleared swaps governed by such agreement. If the

agreement covers uncleared swaps entered into before the applicable

compliance date, those swaps must be included in the aggregate in the

initial margin model for the purposes of calculating and complying with

the initial margin requirements.

(3) Elements of the model. (i) The model shall calculate an amount

of initial margin that is equal to the potential future exposure of the

uncleared swap or netting set of uncleared swaps covered by an eligible

master netting agreement. Potential future exposure is an estimate of

the one-tailed 99 percent confidence interval for an increase in the

value of the uncleared swap or netting set of uncleared swaps due to an

instantaneous price shock that is equivalent to a movement in all

material underlying risk factors, including prices, rates, and spreads,

over a holding period equal to the shorter of ten business days or the

maturity of the swap.

(ii) All data used to calibrate the model shall be based on an

equally weighted historical observation period of at least one year and

not more than five years and must incorporate a period of significant

financial stress for each broad asset class that is appropriate to the

uncleared swaps to which the initial margin model is applied.

(iii) The model shall use risk factors sufficient to measure all

material price risks inherent in the transactions for which initial

margin is being calculated. The risk categories shall include, but

should not be limited to, foreign exchange or interest rate risk,

credit risk, equity risk, agricultural commodity risk, energy commodity

risk, metal commodity risk, and other commodity risk, as appropriate.

For material exposures in significant currencies and markets, modeling

techniques shall capture spread and basis risk and shall incorporate a

sufficient number of segments of the yield curve to capture differences

in volatility and imperfect correlation of rates along the yield curve.

(iv) In the case of an uncleared cross-currency swap, the model

need not recognize any risks or risk factors associated with the fixed,

physically-settled foreign exchange transactions associated with the

exchange of principal embedded in the cross-currency swap. The model

shall recognize all material risks and risk factors associated with all

other payments and cash flows that occur during the life of the

uncleared cross-currency swap.

(v) The model may calculate initial margin for an uncleared swap or

netting set of uncleared swaps covered by an eligible master netting

agreement. It may reflect offsetting exposures, diversification, and

other hedging benefits for uncleared swaps that are governed by the

same eligible master netting agreement by incorporating empirical

correlations within the following broad risk categories, provided the

covered swap entity validates and demonstrates the reasonableness of

its process for modeling and measuring hedging benefits: agriculture,

credit, energy, equity, foreign exchange/interest rate, metals, and

other. Empirical correlations under an eligible master netting

agreement may be recognized by the model within each broad risk

category, but not across broad risk categories.

(vi) If the model does not explicitly reflect offsetting exposures,

diversification, and hedging benefits between subsets of uncleared

swaps within a broad risk category, the covered swap entity shall

calculate an amount of initial margin separately for each subset of

uncleared swaps for which offsetting exposures, diversification, and

other hedging benefits are explicitly recognized by the model. The sum

of the initial margin amounts calculated for each subset of uncleared

swaps within a broad risk category shall be used to determine the

aggregate initial margin due from the counterparty for the portfolio of

uncleared swaps within the broad risk category.

(vii) The sum of the initial margins calculated for each broad risk

category shall be used to determine the aggregate initial margin due

from the counterparty.

[[Page 59930]]

(viii) The model shall not permit the calculation of any initial

margin amount to be offset by, or otherwise take into account, any

initial margin that may be owed or otherwise payable by the covered

swap entity to the counterparty.

(ix) The model shall include all material risks arising from the

nonlinear price characteristics of option positions or positions with

embedded optionality and the sensitivity of the market value of the

positions to changes in the volatility of the underlying rates, prices,

or other material risk factors.

(x) The covered swap entity shall not omit any risk factor from the

calculation of its initial margin that the covered swap entity uses in

its model unless it has first demonstrated to the satisfaction of the

Commission that such omission is appropriate.

(xi) The covered swap entity shall not incorporate any proxy or

approximation used to capture the risks of the covered swap entity's

actual swaps unless it has first demonstrated to the satisfaction of

the Commission that such proxy or approximation is appropriate.

(xii) The covered swap entity shall have a rigorous and well-

defined process for re-estimating, re-evaluating, and updating its

internal models to ensure continued applicability and relevance.

(xiii) The covered swap entity shall review and, as necessary,

revise the data used to calibrate the model at least monthly, and more

frequently as market conditions warrant, ensuring that the data

incorporate a period of significant financial stress appropriate to the

uncleared swaps to which the model is applied.

(xiv) The level of sophistication of the initial margin model shall

be commensurate with the complexity of the swaps to which it is

applied. In calculating an initial margin amount, the model may make

use of any of the generally accepted approaches for modeling the risk

of a single instrument or portfolio of instruments.

(xv) The Commission may in its sole discretion require a covered

swap entity using a model to collect a greater amount of initial margin

than that determined by the covered swap entity's model if the

Commission determines that the additional collateral is appropriate due

to the nature, structure, or characteristics of the covered swap

entity's transactions or is commensurate with the risks associated with

the transaction.

(4) Periodic review. A covered swap entity shall periodically, but

no less frequently than annually, review its model in light of

developments in financial markets and modeling technologies, and

enhance the model as appropriate to ensure that it continues to meet

the requirements for approval in this section.

(5) Control, oversight, and validation mechanisms. (i) The covered

swap entity shall maintain a risk management unit in accordance with

Sec. 23.600(c)(4)(i) that is independent from the business trading

unit (as defined in Sec. 23.600).

(ii) The covered swap entity's risk control unit shall validate its

model prior to implementation and on an ongoing basis. The covered swap

entity's validation process shall be independent of the development,

implementation, and operation of the model, or the validation process

shall be subject to an independent review of its adequacy and

effectiveness. The validation process shall include:

(A) An evaluation of the conceptual soundness of (including

developmental evidence supporting) the model;

(B) An ongoing monitoring process that includes verification of

processes and benchmarking by comparing the covered swap entity's model

outputs (estimation of initial margin) with relevant alternative

internal and external data sources or estimation techniques including

benchmarking against observable margin standards to ensure that the

initial margin is not less than what a derivatives clearing

organization would require for similar cleared transactions; and

(C) An outcomes analysis process that includes back testing the

model.

(iii) If the validation process reveals any material problems with

the model, the covered swap entity shall notify the Commission of the

problems, describe to the Commission any remedial actions being taken,

and adjust the model to insure an appropriately conservative amount of

required initial margin is being calculated.

(iv) In accordance with Sec. 23.600(e)(2), the covered swap entity

shall have an internal audit function independent of the business

trading unit and the risk management unit that at least annually

assesses the effectiveness of the controls supporting the model

measurement systems, including the activities of the business trading

units and risk control unit, compliance with policies and procedures,

and calculation of the covered swap entity's initial margin

requirements under this part. At least annually, the internal audit

function shall report its findings to the covered swap entity's

governing body, senior management, and chief compliance officer.

(6) Documentation. The covered swap entity shall adequately

document all material aspects of its model, including management and

valuation of uncleared swaps to which it applies, the control,

oversight, and validation of the model, any review processes and the

results of such processes.

(7) Escalation procedures. The covered swap entity must adequately

document authorization procedures, including escalation procedures that

require review and approval of any change to the initial margin

calculation under the model, demonstrable analysis that any basis for

any such change is consistent with the requirements of this section,

and independent review of such demonstrable analysis and approval.

(c) Table-based method. If a model meeting the standards set forth

in paragraph (b) of this section is not used, initial margin shall be

calculated in accordance with this paragraph.

(1) Standardized initial margin schedule.

------------------------------------------------------------------------

Initial margin

requirement (%

Asset class of notional

exposure)

------------------------------------------------------------------------

Credit: 0-2 year duration............................... 2

Credit: 2-5 year duration............................... 5

Credit: 5+ year duration................................ 10

Commodity............................................... 15

Equity.................................................. 15

Foreign Exchange/Currency............................... 6

Cross Currency Swaps: 0-2 year duration................. 1

Cross Currency Swaps: 2-5 year duration................. 2

Cross currency Swaps: 5+ year duration.................. 4

Interest Rate: 0-2 year duration........................ 1

Interest Rate: 2-5 year duration........................ 2

Interest Rate: 5+ year duration......................... 4

Other................................................... 15

------------------------------------------------------------------------

(2) Net to gross ratio adjustment. (i) For multiple uncleared swaps

subject to an eligible master netting agreement, the initial margin

amount under the standardized table shall be computed according to this

paragraph.

(ii) Initial Margin = 0.4 x Gross Initial Margin + 0.6 x Net-to-

Gross Ratio x Gross Initial Margin, where

(A) Gross Initial Margin = the sum of the product of each uncleared

swap's effective notional amount and the gross initial margin

requirement for all uncleared swaps subject to the eligible master

netting agreement;

(B) Net-to-Gross Ratio = the ratio of the net current replacement

cost to the gross current replacement cost;

(C) Gross Current Replacement cost = the sum of the replacement

cost for each uncleared swap subject to the eligible master netting

agreement for which the cost is positive; and

[[Page 59931]]

(D) Net Current Replacement Cost = the total replacement cost for

all uncleared swaps subject to the eligible master netting agreement.

Sec. 23.155 Calculation of variation margin.

(a) Means of calculation. (1) Each business day each covered swap

entity shall calculate variation margin for itself and for each

counterparty that is a swap entity or a financial end user using a

methodology and inputs that to the maximum extent practicable rely on

recently-executed transactions, valuations provided by independent

third parties, or other objective criteria.

(2) Each covered swap entity shall have in place alternative

methods for determining the value of an uncleared swap in the event of

the unavailability or other failure of any input required to value a

swap.

(3) For risk management purposes, each business day each covered

swap entity shall calculate a hypothetical variation margin requirement

for each swap for which the counterparty is a non-financial end user

that has material swaps exposure to the covered counterparty as if the

counterparty were a covered swap entity and compare that amount to any

variation margin required pursuant to the margin documentation.

(b) Control mechanisms. (1) Each covered swap entity shall create

and maintain documentation setting forth the variation methodology with

sufficient specificity to allow the counterparty, the Commission, and

any applicable prudential regulator to calculate a reasonable

approximation of the margin requirement independently.

(2) Each covered swap entity shall evaluate the reliability of its

data sources at least annually, and make adjustments, as appropriate.

(3) The Commission at any time may require a covered swap entity to

provide further data or analysis concerning the methodology or a data

source, including:

(i) An explanation of the manner in which the methodology meets the

requirements of this section;

(ii) A description of the mechanics of the methodology;

(iii) The theoretical basis of the methodology;

(iv) The empirical support for the methodology; and

(v) The empirical support for the assessment of the data sources.

Sec. 23.156 Forms of margin.

(a) Initial margin--(1) Eligible collateral. A covered swap entity

shall collect and post as initial margin for trades with a covered

counterparty only the following assets:

(i) U.S. dollars;

(ii) A major currency;

(iii) A currency in which payment obligations under the swap are

required to be settled;

(iv) A security that is issued by, or unconditionally guaranteed as

to the timely payment of principal and interest by, the U.S. Department

of Treasury;

(v) A security that is issued by, or unconditionally guaranteed as

to the timely payment of principal and interest by, a U.S. government

agency (other than the U.S. Department of Treasury) whose obligations

are fully guaranteed by the full faith and credit of the U.S.

government;

(vi) A publicly traded debt security issued by, or an asset-backed

security fully guaranteed as to the timely payment of principal and

interest by, a U.S. government-sponsored enterprise that is operating

with capital support or another form of direct financial assistance

received from the U.S. government that enables the repayments of the

government-sponsored enterprise's eligible securities; or

(vii) A security that is issued by, or fully guaranteed as to the

payment of principal and interest by, the European Central Bank or a

sovereign entity that is assigned no higher than a 20 percent risk

weight under the capital rules applicable to swap dealers subject to

regulation by a prudential regulator;

(viii) A security that is issued by, or fully guaranteed as to the

payment of principal and interest by, the Bank for International

Settlements, the International Monetary Fund, or a multilateral

development bank;

(ix) Other publicly-traded debt that has been deemed acceptable as

initial margin by a prudential regulator; or

(x) A publicly traded common equity security that is included in:

(A) The Standard & Poor's Composite 1500 Index or any other similar

index of liquid and readily marketable equity securities as determined

by the Commission; or

(B) An index that a covered swap entity's supervisor in a foreign

jurisdiction recognizes for purposes of including publicly traded

common equity as initial margin under applicable regulatory policy, if

held in that foreign jurisdiction; or

(xi) Gold.

(2) Prohibition of certain assets. A covered swap entity may not

collect or post as initial margin any asset that is a security issued

by:

(i) The party providing such asset or an affiliate of that party,

(ii) A bank holding company, a savings and loan holding company, a

foreign bank, a depository institution, a market intermediary, a

company that would be any of the foregoing if it were organized under

the laws of the United States or any State, or an affiliate of any of

the foregoing institutions, or

(iii) A U.S. government-sponsored enterprise after the termination

of capital support or another form of direct financial assistance

received from the U.S. government that enables the repayments of the

government-sponsored enterprise's eligible securities unless:

(A) The security meets the requirements of paragraph (a)(1)(iv) of

this section;

(B) The security meets the requirements of paragraph (a)(1)(vii) of

this section; or

(C) The security meets the requirements of paragraph (a)(1)(viii)

of this section.

(3) Haircuts. (i) Each covered swap entity shall apply haircuts to

any asset posted or received as initial margin under this section that

reflect the credit and liquidity characteristics of the asset.

(ii) At a minimum, each covered swap entity shall apply haircuts to

any asset posted or received as initial margin under this section in

accordance with the following table:

Standardized Haircut Schedule

------------------------------------------------------------------------

 

------------------------------------------------------------------------

Cash in same currency as swap obligation....................... 0.0

Eligible government and related debt (e.g., central bank, 0.5

multilateral development bank, GSE securities identified in

paragraph (a)(1)(iv) of this section): Residual maturity less

than one-year.................................................

Eligible government and related debt (e.g., central bank, 2.0

multilateral development bank, GSE securities identified in

paragraph (a)(1)(iv) of this section): Residual maturity

between one and five years....................................

Eligible government and related debt (e.g., central bank, 4.0

multilateral development bank, GSE securities identified in

paragraph (a)(1)(iv) of this section): Residual maturity

greater than five years.......................................

Eligible corporate debt (including eligible GSE debt securities 1.0

not identified in paragraph (a)(1)(iv) of this section):

Residual maturity less than one-year..........................

Eligible corporate debt (including eligible GSE debt securities 4.0

not identified in paragraph (a)(1)(iv) of this section):

Residual maturity between one and five years..................

Eligible corporate debt (including eligible GSE debt securities 8.0

not identified in paragraph (a)(1)(iv) of this section):

Residual maturity greater than five years.....................

Equities included in S&P 500 or related index.................. 15.0

[[Page 59932]]

 

Equities included in S&P 1500 Composite or related index but 25.0

not S&P 500 or related index..................................

Gold........................................................... 15.0

Additional (additive) haircut on asset in which the currency of 8.0

the swap obligation differs from that of the collateral asset.

------------------------------------------------------------------------

(iii) The value of initial margin collateral that is calculated

according to the schedule in paragraph (a)(3)(ii) of this section will

be computed as follows: The value of initial margin collateral for any

collateral asset class will be computed as the product of the total

value of collateral in any asset class and one minus the applicable

haircut expressed in percentage terms. The total value of all initial

margin collateral is calculated as the sum of the value of each type of

collateral asset.

(4) Monitoring Obligation. A covered swap entity shall monitor the

market value and eligibility of all collateral collected and held to

satisfy initial margin required by this part. To the extent that the

market value of such collateral has declined, the covered swap entity

shall promptly collect such additional eligible collateral as is

necessary to bring itself into compliance with the margin requirements

of this part. To the extent that the collateral is no longer eligible,

the covered swap entity shall promptly obtain sufficient eligible

replacement collateral to comply with this part.

(5) Excess initial margin. A covered swap entity may collect

initial margin that is not required pursuant to this part in any form

of collateral.

(b) Variation margin--(1) Eligible assets. A covered swap entity

shall pay and collect as variation margin to or from a covered

counterparty only cash in the form of:

(i) U.S. dollars; or

(ii) A currency in which payment obligations under the swap are

required to be settled.

(2) Collection obligation. A covered swap entity shall not be

deemed to have violated its obligation under this paragraph to collect

variation margin if:

(i) The counterparty has refused or otherwise failed to provide the

variation margin to the covered swap entity; and

(ii) The covered swap entity:

(A) Has made the necessary efforts to collect the variation margin,

including the timely initiation and continued pursuit of formal dispute

resolution mechanisms, including Sec. 23.504(b), if applicable, or has

otherwise demonstrated upon request to the satisfaction of the

Commission that it has made appropriate efforts to collect the

variation margin; or

(B) Has commenced termination of the swap or security-based swap

with the counterparty.

Sec. 23.157 Custodial arrangements.

(a) Initial margin posted by covered swap entities. Each covered

swap entity that posts initial margin with respect to an uncleared swap

shall require that all funds or other property that the covered swap

entity provides as initial margin be held by one or more custodians

that are not affiliates of the covered swap entity or the counterparty.

(b) Initial margin collected by covered swap entities. Each covered

swap entity that collects initial margin required by Sec. 23.152 with

respect to an uncleared swap shall require that such initial margin be

held at one or more custodians that are not affiliates of the covered

swap entity or the counterparty.

(c) Custodial agreement. Each covered swap entity shall enter into

an agreement with each custodian that holds funds pursuant to

paragraphs (a) or (b) of this section that:

(1) Prohibits the custodian from rehypothecating, repledging,

reusing, or otherwise transferring (through securities lending,

repurchase agreement, reverse repurchase agreement or other means) the

funds or other property held by the custodian;

(2) Notwithstanding paragraph (c)(1) of this section, with respect

to collateral posted or collected pursuant to Sec. 23.152, requires

the posting party, when it substitutes or directs the reinvestment of

posted collateral held by the custodian:

(i) To substitute only funds or other property that are in a form

that meets the requirements of Sec. 23.156 and in an amount that meets

the requirements of Sec. 23.152, subject to applicable haircuts; and

(ii) To reinvest funds only in assets that are in a form that meets

the requirements of Sec. 23.156 and in an amount that meets the

requirements of Sec. 23.152, subject to applicable haircuts;

(3) Is legal, valid, binding, and enforceable under the laws of all

relevant jurisdictions including in the event of bankruptcy,

insolvency, or a similar proceeding.

Sec. 23.158 Margin documentation.

(a) General requirement. Each covered swap entity shall execute

documentation with each counterparty that complies with the

requirements of Sec. 23.504 and that complies with this section. For

uncleared swaps between a covered swap entity and a covered

counterparty, the documentation shall provide the covered swap entity

with the contractual right and obligation to exchange initial margin

and variation margin in such amounts, in such form, and under such

circumstances as are required by Sec. Sec. 23.150 through 23.159. For

uncleared swaps between a covered swap entity and a non-financial

entity, the documentation shall specify whether initial and/or

variation margin will be exchanged and, if so, the documentation shall

comply with paragraph (b) of this section.

(b) Contents of the documentation. The margin documentation shall

specify the following:

(1) The methodology and data sources to be used to value uncleared

swaps and collateral and to calculate initial margin for uncleared

swaps entered into between the covered swap entity and the

counterparty;

(2) The methodology and data sources to be used to value positions

and to calculate variation margin for uncleared swaps entered into

between the covered swap entity participant and the counterparty;

(3) The procedures by which any disputes concerning the valuation

of uncleared swaps, or the valuation of assets posted as initial margin

or paid as variation margin may be resolved;

(4) Any thresholds below which initial margin need not be posted by

the covered swap entity and/or the counterparty; and

(5) Any thresholds below which variation margin need not be paid by

the covered swap entity and/or the counterparty.

Sec. 23.159 Compliance dates.

(a) Covered swap entities must comply with the minimum margin

requirements for uncleared swaps on or before the following dates for

uncleared swaps entered into on or after the following dates:

(1) December 1, 2015 for the requirements in Sec. 23.153 for

variation margin.

(2) December 1, 2015 for the requirements in Sec. 23.152 for

initial margin for any uncleared swaps where both the covered swap

entity combined with all its affiliates and its counterparty combined

with all its affiliates, have an average daily aggregate notional

amount of uncleared swaps, uncleared security-based swaps, foreign

exchange forwards, and foreign exchange swaps in June, July, and August

2015 that exceeds $4 trillion, where such amounts are calculated only

for business days.

(3) December 1, 2016 for the requirements in Sec. 23.152 for

initial margin for any uncleared swaps where

[[Page 59933]]

both the covered swap entity combined with all its affiliates and its

counterparty combined with all its affiliates, have an average daily

aggregate notional amount of uncleared swaps, uncleared security-based

swaps, foreign exchange forwards, and foreign exchange swaps in June,

July and August 2016 that exceeds $3 trillion, where such amounts are

calculated only for business days.

(4) December 1, 2017 for the requirements in Sec. 23.152 for

initial margin for any uncleared swaps where both the covered swap

entity combined with all its affiliates and its counterparty combined

with all its affiliates have an average daily aggregate notional amount

of uncleared swaps, uncleared security-based swaps, foreign exchange

forwards, and foreign exchange swaps in June, July and August 2017 that

exceeds $2 trillion, where such amounts are calculated only for

business days.

(5) December 1, 2018 for the requirements in Sec. 23.152 for

initial margin for any uncleared swaps where both the covered swap

entity combined with all its affiliates and its counterparty combined

with all its affiliates have an average daily aggregate notional amount

of uncleared swaps, uncleared security-based swaps, foreign exchange

forwards, and foreign exchange swaps in June, July and August 2018 that

exceeds $1 trillion, where such amounts are calculated only for

business days.

(6) December 1, 2019 for the requirements in Sec. 23.152 for

initial margin for any other covered swap entity with respect to

uncleared swaps entered into with any other counterparty.

(b) Once a covered swap entity and its counterparty must comply

with the margin requirements for uncleared swaps based on the

compliance dates in paragraph (a) of this section, the covered swap

entity and its counterparty shall remain subject to the requirements of

this subpart.

Sec. Sec. 23.160-23.199 [Reserved]

0

3. In Sec. 23.701 revise paragraphs (a)(1), (d), and (f) to read as

follows:

Sec. 23.701 Notification of right to segregation.

(a) * * *

(1) Notify each counterparty to such transaction that the

counterparty has the right to require that any Initial Margin the

counterparty provides in connection with such transaction be segregated

in accordance with Sec. Sec. 23.702 and 23.703 except in those

circumstances where segregation is mandatory pursuant to Sec. 23.157;

* * * * *

(d) Prior to confirming the terms of any such swap, the swap dealer

or major swap participant shall obtain from the counterparty

confirmation of receipt by the person specified in paragraph (c) of

this section of the notification specified in paragraph (a) of this

section, and an election, if applicable, to require such segregation or

not. The swap dealer or major swap participant shall maintain such

confirmation and such election as business records pursuant to Sec.

1.31 of this chapter.

* * * * *

(f) A counterparty's election, if applicable, to require

segregation of Initial Margin or not to require such segregation, may

be changed at the discretion of the counterparty upon written notice

delivered to the swap dealer or major swap participant, which changed

election shall be applicable to all swaps entered into between the

parties after such delivery.

PART 140--ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION

0

4. The authority citation for part 140 continues to read as follows:

Authority: 7 U.S.C. 2(a)(12), 12a, 13(c), 13(d), 13(e), and

16(b).

0

5. In Sec. 140.93, add paragraph (a)(6) to read as follows:

Sec. 140.93 Delegation of authority to the Director of the Division

of Swap Dealer and Intermediary Oversight.

(a) * * *

(6) All functions reserved to the Commission in Sec. Sec. 23.150

through 23.159 of this chapter.

* * * * *

Issued in Washington, DC, on September 23, 2014, by the

Commission.

Christopher J. Kirkpatrick,

Secretary of the Commission.

Note: The following appendices will not appear in the Code of

Federal Regulations.

Appendices to Margin Requirements for Uncleared Swaps for Swap Dealers

and Major Swap Participants--Commission Voting Summary, Chairman's

Statement, and Commissioner's Statement

Appendix 1--Commission Voting Summary

On this matter, Chairman Massad and Commissioners Wetjen, Bowen,

and Giancarlo voted in the affirmative. No Commissioner voted in the

negative.

Appendix 2--Statement of Chairman Timothy G. Massad

I support this proposed rule on margin requirements for uncleared

swaps.

A key mandate of the Dodd-Frank Act was central clearing of swaps.

This is a significant tool to monitor and mitigate risk, and we have

already succeeded in increasing the overall percentage of the market

that is cleared from an estimated 17% in 2007 to 60% last month, when

measured by notional amount.

But cleared swaps are only part of the market. Uncleared, bilateral

swap transactions will continue to be an important part of the

derivatives market. This is so for a variety of reasons. Sometimes,

commercial risks cannot be hedged sufficiently through clearable swap

contracts. Therefore market participants must craft more tailored

contracts that cannot be cleared. In addition, certain products may

lack sufficient liquidity to be centrally risk-managed and cleared.

This may be true even for products that have been in existence for some

time. And there will--and always should be--innovation in the market,

which will lead to new products.

That is why margin for uncleared swaps is important. It is a means

to mitigate the risk of default and therefore the potential risk to the

financial system as a whole. To appreciate the importance of the rule

being proposed, we need only recall how Treasury and the Federal

Reserve had to commit $182 billion to AIG, because its uncleared swap

activities threatened to bring down our financial system.

The proposed rule requires swap dealers and major swap participants

to post and collect margin in their swaps with one another. They must

also do so in their swaps with financial entities, if the level of

activity is above certain thresholds. The proposal does not require

commercial end-users to post or collect margin, nor does it require any

swap dealer or major swap participant to collect margin from or post

margin to commercial end-users. This is an important point.

Today's proposal on margin also reflects the benefit of substantial

collaboration between our staff and our colleagues at the Federal

Reserve, the Office of the Comptroller of the Currency, and the Federal

Deposit Insurance Corporation, as well as significant public comment.

The Dodd-Frank Act directs each of the prudential regulators to propose

rules on margin for the entities for which it is the primary regulator,

whereas the CFTC is directed to propose a rule for other

[[Page 59934]]

entities engaging in uncleared swap transactions. The Dodd-Frank Act

also directed us to harmonize our rules as much as possible. Today's

proposed rule is very similar to the proposal of the prudential

regulators that was published recently. I want to again thank our

staff, as well as the staffs of the prudential regulators, for working

together so well to accomplish that task.

We have also sought to harmonize our proposal with rules being

developed in Europe and Asia. Our proposed rule is largely consistent

with the standards proposed by Basel Committee on Banking Supervision

and the International Organization of Securities Commissions, and we

have been in touch with overseas regulators as we developed our

proposal.

The importance of international harmonization cannot be

understated. It is particularly important to reach harmonization in the

area of margin for uncleared swaps, because this is a new requirement

and we do not want to create the potential for regulatory arbitrage in

the market by creating unnecessary differences. Margin for uncleared

swaps goes hand in hand with the global mandates to clear swaps.

Imposing margin on uncleared swaps will level the playing field between

cleared and uncleared swaps and remove any incentive not to clear swaps

that can be cleared.

Proposing this rule is an important step in our effort to finish

the job of implementing the Dodd-Frank Act and will help us achieve the

full benefit of the new regulatory framework, while at the same time

protecting the interests of--and minimizing the burdens on--commercial

end-users who depend on the derivatives markets to hedge normal

business risks.

We recognize that more stringent margin requirements impose costs

on market participants, and therefore the proposal includes a detailed

cost-benefit analysis. I believe the proposed rule balances the

inherent trade-off between mitigating systemic risk and minimizing

costs on individual participants. I look forward to having public

feedback on that analysis, as well as on the proposal as a whole.

Appendix 3--Statement of Commissioner J. Christopher Giancarlo

I support the issuance of the proposed rules for uncleared

margin. I look forward to reviewing well-considered, responsive and

informative comments from the public. Seeking further public comment

on this proposal is necessary given the passage of time and the

further deliberations with our fellow regulators since the

publishing of our 2011 proposal. For the same reasons, I urge the

Commission to re-propose capital requirements for swap dealers and

major swap participants, which are closely linked to the uncleared

margin rules.

Uncleared over-the-counter swaps (OTC) and derivatives are vital

to the U.S. economy. Used properly, they enable American companies

and the banks they borrow from to manage changing commodity and

energy prices, fluctuating currency and interest rates, and credit

default exposure. They allow our state and local governments to

manage their obligations and our pension funds to support healthy

retirements. Uncleared swaps serve a key role in American business

planning and risk management that cannot be filled by cleared

derivatives. They do so by allowing businesses to avoid basis risk

and obtain hedge accounting treatment for more complex, non-

standardized exposures. While much of the swaps and OTC derivatives

markets will eventually be cleared--a transition I have long

supported--uncleared swaps will remain an important tool for

customized risk management by businesses, governments, asset

managers and other institutions whose operations are essential to

American economic growth.

Advance Notice of Proposed Rulemaking: Cross-Border

I support the Commission's decision to issue an advance notice

of proposed rulemaking to determine how the uncleared margin rule

should apply extraterritorially. I have long advocated that the

Commission take a holistic, global approach to the cross-border

application of its rules. This approach should prioritize the

critical need for international harmony and certainty for American

businesses and other market participants. It is undeniable that the

lack of such certainty in the Commission's cross-border framework is

causing fragmentation of what were once global markets, increasing

systemic risk rather than diminishing it. I therefore applaud the

Commission's decision to seek public comment on the most optimal

cross-border framework with respect to uncleared margin.

In light of the recent decision from the U.S. District Court for

the District of Columbia holding that the Commission's cross-border

guidance is non-binding and that the Commission will have to justify

the cross-border application of its rules each time it brings an

enforcement action,\1\ it is important that the Commission provide

swaps market participants with certainty on how the uncleared margin

rule will apply extraterritorially.

---------------------------------------------------------------------------

\1\ SIFMA v. CFTC, No. 13-cv-1916 slip op. at 72 (D.D.C. Sept.

16, 2014).

---------------------------------------------------------------------------

I believe that the advance notice of proposed rulemaking for the

cross-border application of the uncleared margin rules demonstrates

a pragmatism and flexibility that belies the oft repeated notion

that CFTC rulemaking widely and woodenly overreaches in its

assertion of extraterritorial jurisdiction. I commend it to our

fellow regulators abroad as a portent of greater accord in global

regulatory reform.

I look forward to reading and addressing well-considered

comments on the cross-border issues. In particular, I join

Commissioner Wetjen in welcoming thoughtful comment and analysis on

the potential competitive impacts associated with each of the

different approaches identified in the advance notice of proposed

rulemaking. I encourage commentators to quantify, if practical, and

be specific about particular provisions or concerns.

Furthermore, I think this rulemaking should be a template for

things to come. I urge the Commission to follow the Securities and

Exchange Commission's (SEC) lead and replace its non-binding

guidance with a comprehensive set of rules, supported by a rigorous

cost-benefit analysis, delineating when activities outside the

United States will have a direct and significant connection with

activities in, or effect on, commerce in the United States. Good

regulation requires nothing less.

Notwithstanding my support for the issuance of these proposed

rules and the advance notice of proposed rulemaking on cross-border

issues in order to solicit comment, I have a number of substantive

concerns which I will now address.

Ten-Day Margin Requirement

Today's proposal requires collateral coverage on uncleared swaps

equal to a ten-day liquidation period. This ten-day calculation

comports with rules adopted recently by the U.S. prudential bank

regulators. Yet, it still must be asked: Is ten days the right

calculation? Why not nine days; why not eleven? Should it be the

same ten days for uncleared credit default swaps as it is for

uncleared interest rate swaps and for all other swaps products?

Surely, all non-cleared swap products do not have the same liquidity

characteristics or risk profiles. I encourage commenters to provide

their input on these questions.

SEC Chair Mary Jo White recently stated: ``Our regulatory

changes must be informed by clear-eyed, unbiased, and fact-based

assessments of the likely impacts--positive and negative--on market

quality for investors and issuers.'' \2\ Chair White's standard of

assessment must surely apply to the proposed margin rule on

uncleared swaps. Where is the clear-eyed assessment of the ten-day

margin requirement? Where is the cost benefit analysis? What are the

intended consequences? What will be the unintended ones? Will

American swaps end users wind up paying for the added margin costs

even though they are meant to be exempt? I would be interested to

hear from commentators on this issue.

---------------------------------------------------------------------------

\2\ Phillip Stafford, Sense of Urgency Underpins Fresh Scrutiny

of Markets, Financial Times, Sept. 16, 2014, available at http://www.ft.com/intl/cms/s/0/a373646a-344b-11e4-b81c-00144feabdc0.html?siteedition=intl#axzz3DPM3AEzi.

---------------------------------------------------------------------------

I am troubled by recent press reports of remarks by unnamed Fed

officials that the coverage period may be intentionally ``punitive''

in order to move the majority of trades into a cleared

environment.\3\ I would

[[Page 59935]]

be interested to review any considered analysis of the likely impact

of the ten-day liquidation period and whether or not it may have a

punitive effect on markets for uncleared swaps products.

---------------------------------------------------------------------------

\3\ Mike Kentz, Derivatives: Fed backs off corporate margin

requirements, IFRAsia, Sept. 11, 2014, available at http://www.ifrasia.com/derivatives-fed-backs-off-corporate-margin-requirements/21162697.fullarticle.

---------------------------------------------------------------------------

Any punitive or arbitrary squeeze on non-cleared swaps will

surely have consequences--likely unintended--for American businesses

and their ability to manage risk. With tens of millions of Americans

falling back on part-time work, it is not in our national interest

to deter U.S. employers from safely hedging commercial risk to free

capital for new ventures that create full-time jobs. It is time we

move away from punishing U.S. capital markets toward rules designed

to revive American prosperity. I look forward to reviewing well-

considered comments as to the appropriateness of a ten-day

liquidation period, as well as its estimated costs and benefits,

particularly the impact on American economic growth.

End Users

As noted in the preamble, the Dodd-Frank Act requires the CFTC,

the SEC, and the prudential regulators to establish comparable

initial and variation margin requirements for uncleared swaps.\4\ In

2011, however, the Commission and the prudential regulators issued

proposals that varied significantly in several respects. In

particular, the rules proposed by the prudential regulators in 2011

would have required non-financial end users to pay initial and

variation margin to banks, while the Commission's rules exempted

these entities in accordance with Congressional intent.\5\

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\4\ CEA section 4s(e)(3)(D)(ii).

\5\ Margin Requirements for Uncleared Swaps for Swap Dealers and

Major Swap Participants, 76 FR 23732, 23736-37 (Apr. 28, 2011).

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I am pleased that the prudential regulators have moved in the

CFTC's direction and will not require that non-financial end users

pay margin unless necessary to address the credit risk posed by the

counterparty and the risks of the swap.\6\ It is widely recognized

that non-financial end users, that generally use swaps to hedge

their commercial risk, pose less risk as counterparties than

financial entities. It is my hope that upon finalization of these

rules, swap dealers and major swap participants will treat non-

financial end users consistently when it comes to margin, no matter

which set of rules apply.

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\6\ The prudential regulator's proposal contains the following

provision: ``A covered swap entity is not required to collect

initial margin with respect to any non-cleared swap or non-cleared

security-based swap with a counterparty that is neither a financial

end user with material swaps exposure nor a swap entity but shall

collect initial margin at such times and in such forms (if any) that

the covered swap entity determines appropriately address the credit

risk posed by the counterparty and the risks of such non-cleared

swaps and non-cleared security-based swaps.'' Margin and Capital

Requirements for Covered Swap Entities, slip copy at 167, available

at http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20140903c1.pdf. This is somewhat different, but not

inconsistent with the Commission's proposal, which will allow the

parties to exchange margin by agreement, or to arrange other types

of collateral agreements consistent with their needs.

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Threshold for Swaps Exposure

I am also pleased that our collaboration with the BCBS/IOSCO \7\

international working group has resulted in proposed rules that are

largely harmonious with the 2013 international framework. There is a

particular and significant difference that troubles me, however. The

CFTC and the prudential regulators have set the threshold for

material swaps exposure by financial end users at $3 billion, while

the 2013 international framework sets the threshold at [euro]8

billion (approximately $11 billion). This means that a whole middle-

tier of American financial end users could be subject to margin

requirements that will not be borne by similar firms overseas. It

may well limit the number of counterparties willing to enter into

swaps with these important lenders to American business. I am

concerned that this could potentially reduce the utility of risk

reducing strategies for a class of middle-tier, U.S. financial

institutions that have already been hit hard by new capital

constraints, among other rules.

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\7\ Basel Committee on Banking Supervision/International

Organization of Securities Commissions.

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In this time of dismal economic growth, it is hard to justify

placing higher burdens on America's medium-sized financial firms

than those their overseas competitors face. We have not, in my

opinion, sufficiently addressed in our cost benefit analysis the

impact of this threshold difference on American firms and their

customers. Where is the clear-eyed analysis of the impact of this

rule on the American economy? I hope that the Commission will not

perpetuate this divergence in the final rules without carefully

weighing the costs and benefits. I encourage commenters to address

this point and to supply any data and analysis that may be

illuminating. It is time our rules were designed less to punish and

more to promote U.S. capital markets. Punishment as a singular

regulatory policy is getting old and counterproductive. It is time

our rules focused on returning America to work and prosperity.

Increase Reliance on International Collaboration

Similarly, I want to echo Commissioner Wetjen's call for

comments on two areas where the Commission can harness international

collaboration. First, I welcome comments on whether the Commission

should exclude from the scope of this rulemaking any derivative

cleared by a central counterparty (CCP) that is subject to

regulation and supervision consistent with the CPSS-IOSCO Principles

for Financial Market Infrastructures (PFMIs), an alternative on

which the Commission seeks comment in the preamble. It is reported

that at least one U.S. financial firm is a member at 70 different

CCPs around the globe. The present proposal, if finalized, could

result in trades cleared on many of these CCPs being treated as if

they are uncleared.\8\ This would seem to be a needlessly costly and

burdensome imposition on American commerce. Global regulators have

already agreed on international standards in the PFMIs to determine

how CCPs should be regulated and supervised. It makes sense to

leverage these standards where we can. I encourage comment on this

issue.

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\8\ Sam Fleming and Phillip Stafford, JPMorgan Tells Clearers to

Build Bigger Buffers, Financial Times, Sept. 11, 2014 available at

http://www.ft.com/intl/cms/s/0/48aa6b02-38f9-11e4-9526-00144feabdc0.html#axzz3DPM3AEzi.

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I would also be interested in commenters' views on how the

Commission should conduct its comparability analysis under this

rulemaking. In the advance notice of proposed rulemaking, the

Commission proposes to permit market participants to comply with

foreign rules, if such rules are comparable to the Commission's

margin requirements. Yet, a better approach may be to compare a

foreign regime to the international standards put forward by the

BCBS/IOSCO international working group that included participation

from over 20 regulatory authorities. Doing so would give the

Commission some comfort that foreign rules meet a necessary

baseline, but could avoid unnecessary and potentially destabilizing

disputes over comparability in the future. I hope the insights of

interested parties will guide not only the Commission, but also the

prudential regulators. I further hope all concerned parties can use

this rulemaking as an opportunity to promote international comity at

a time when it is sorely needed.

Treatment of Small Financial Entities

Another aspect of the proposed rules that concerns me is the

treatment of financial entities that qualify for the small bank

exemption from clearing and financial cooperatives. Section

2(h)(7)(C)(ii) of the CEA directed the Commission to consider

whether to exempt from the definition of ``financial entity'' small

banks, savings associations, farm credit system institutions and

credit unions with total assets of $10 billion or less. In response,

the Commission exempted these small financial institutions from the

definition of financial entity for purposes of clearing. It

recognized that these institutions serve a crucial function in the

markets for hedging the commercial risk of non-financial end users.

Moreover, the Commission acknowledged that the costs associated with

clearing, including margin and other fees and expenses, may be

prohibitive relative to the small number of swaps these firms

execute over a given period of time.\9\ In addition, using its

Section 4(c) exemptive authority, the Commission permits cooperative

financial entities, including those with total assets exceeding $10

billion, to elect an exemption from mandatory clearing for swaps

executed in connection with originating loans for their members, or

that hedge or mitigate commercial risk related to loans or swaps

with their members.\10\

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\9\ End-User Exception to the Clearing Requirement for Swaps, 77

FR 42560, 42578 (Jul. 19, 2012); 17 CFR 50.50(d).

\10\ Clearing Exemption for Certain Swaps Entered into by

Cooperatives, 78 FR 52286 (Aug. 22, 2013); 17 CFR 50.51.

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Despite the CFTC's otherwise appropriate treatment of these

small banks and financial cooperatives, the proposed margin rules

treat them as financial institutions required to post

[[Page 59936]]

margin when their swaps exposure exceeds the $3 billion threshold.

This means that small banks and cooperative financial institutions

entitled to a clearing exemption will have to pay margin for their

uncleared activity with swap dealers or major swap participants when

they have material swaps exposure. It makes no sense to provide

these entities with an exemption from clearing on the one hand, only

to turn around and require them to bear the potentially even greater

costs associated with uncleared swaps. They deserve the full benefit

of their clearing exemption, which they may not get if they have to

post margin. I encourage comment on this issue, which I will weigh

carefully in the process of considering a final rule.

Inter-Affiliate Exemption

The proposed rules may also diminish the utility of the

critically important, inter-affiliate clearing exemption the

Commission adopted last year for certain eligible affiliate

counterparties.\11\ The exemption was premised on recognition that

transactions between affiliates do not present the same risks as

market-facing swaps, and generally provide risk-mitigating, hedging,

and netting benefits within a corporate group.\12\ I welcome

comments addressing the impact the proposed rules may have on the

ability of affiliated entities to efficiently manage their risk.\13\

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\11\ Clearing Exemption for Swaps Between Certain Affiliated

Entities, 78 FR 21750 (Apr. 11, 2013); 17 CFR 50.52.

\12\ Id. at 21751-54.

\13\ Separately, I also welcome comments on the sufficiency of

the no-action relief issued by the Division of Clearing and Risk for

swaps entered into by treasury affiliates, and whether it may serve

as a model for future rulemaking to provide greater certainty in

this area. See CFTC Letter No. 13-22 (Jun. 4, 2013).

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Use of Approved Models to Calculate Capital

Finally, I believe it is important to allow the use of models

when calculating initial margin. The proposed rules require the

Commission's prior written approval before a model can be used, even

though the Commission lacks adequate staff and expertise for

evaluating models. We recognize in the preamble that many covered

swap entities are affiliates of entities whose margin models are

reviewed by one of the prudential regulators, the SEC, or a foreign

regulator, and to avoid duplicative efforts we plan to coordinate

with other regulators in an effort to expedite our review. Rather

than go through a special approval process, however, I believe we

should accept models approved by our fellow regulators, so long as

they contain the required elements. Alternatively, as mentioned in

the preamble and discussed at the open meeting, this may be an area

in which the National Futures Association can provide assistance,

and I am interested in hearing its views on the issue. I also join

Commissioner Wetjen's call for discussion on the circumstances in

which the Commission may permit market participants to continue

using models while Commission staff is reviewing them. Given the

CFTC's limited resources, I believe we should make every effort to

leverage the expertise of other qualified regulators before asking

for more tax dollars from Americans working two jobs just to stay

afloat.

Conclusion

In spite of my stated concerns, I support the issuance of these

proposed rules in order to solicit comment. They raise a number of

important issues, particularly in their impact on the U.S. economy

and job creation and the extent of their application across the

globe. It is vital that we hear from interested parties on how to

get them right. I commend the Chairman and my fellow Commissioners

for their thoughtfulness and open-mindedness in arriving at the

final proposals. I look forward to receiving and reviewing comments

on the issues discussed above and all aspects of the rules.

[FR Doc. 2014-22962 Filed 10-2-14; 8:45 am]

BILLING CODE 6351-01-P

 

Last Updated: October 3, 2014