2022-16684

[Federal Register Volume 87, Number 151 (Monday, August 8, 2022)]
[Proposed Rules]
[Pages 48092-48118]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2022-16684]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Chapter I


Notice of Proposed Order and Request for Comment on an 
Application for a Capital Comparability Determination From the 
Financial Services Agency of Japan

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed order and request for comment.

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SUMMARY: The Commodity Futures Trading Commission is soliciting public 
comment on an application submitted by the Financial Services Agency of 
Japan requesting that the Commission determine that registered swap 
dealers organized and domiciled in Japan that are subject to, and 
comply with, certain capital and financial reporting requirements in 
Japan may comply with certain capital and financial reporting 
requirements under the Commodity Exchange Act via compliance with 
corresponding capital and financial reporting requirements of Japan. 
The Commission also is soliciting public comment on a proposed order 
providing for the conditional availability of substituted compliance in 
connection with the application.

DATES: Comments must be received on or before October 7, 2022.

ADDRESSES: You may submit comments, identified by ``Japan Swap Dealer 
Capital Comparability Determination'', by any of the following methods:
    CFTC Comments Portal: https://comments.cftc.gov. Select the 
``Submit Comments'' link for this proposed order and follow the 
instructions on the Public Comment Form.
    Mail: Send to Christopher Kirkpatrick, Secretary of the Commission, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street NW, Washington, DC 20581.
    Hand Delivery/Courier: Follow the same instructions as for Mail, 
above.
    Please submit your comments using only one of these methods. To 
avoid possible delays with mail or in-person deliveries, submissions 
through the CFTC Comments Portal are encouraged.
    All comments must be submitted in English, or if not, accompanied 
by an English translation. Comments will be posted as received to 
https://comments.cftc.gov. You should submit only information that you 
wish to make available publicly. If you wish the Commission to consider 
information that you believe is exempt from disclosure under the 
Freedom of Information Act (``FOIA''), a petition for confidential 
treatment of the exempt information may be submitted according to the 
procedures established in Regulation 145.9.\1\
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    \1\ 17 CFR 145.9. Commission regulations referred to in this 
release are found at 17 CFR chapter I, and are accessible on the 
Commission's website at https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm.
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    The Commission reserves the right, but shall have no obligation, to 
review, pre-screen, filter, redact, refuse or remove any or all of your 
submission from https://comments.cftc.gov that it may deem to be 
inappropriate for publication, such as obscene language. All 
submissions that have been redacted or removed that contain comments on 
the merits of the proposed determination and order will be retained in 
the public comment file and will be considered as required under the 
Administrative Procedure Act and other applicable laws, and may be 
accessible under the FOIA.

FOR FURTHER INFORMATION CONTACT: Amanda L. Olear, Director, 202-418-
5283, [email protected]; Thomas Smith, Deputy Director, 202-418-5495, 
[email protected]; Rafael Martinez, Associate Director, 202-418-5462, 
[email protected]; Joshua Beale, Associate Director, 202-418-5446, 
[email protected]; Warren Gorlick, Associate Director, 202-418-5195, 
[email protected]; Jennifer C.P. Bauer, Special Counsel, 202-418-5472, 
[email protected]; Carmen Moncada-Terry, Special Counsel, 202-418-5795, 
[email protected]; Liliya Bozhanova, Special Counsel, 202-418-
6232, [email protected]; Joo Hong, Risk Analyst, 202-418-6221, 
[email protected]; Justin McPhee, Risk Analyst, 202-418-6223; 
[email protected], Market Participants Division; Commodity Futures 
Trading Commission, Three Lafayette Centre, 1155 21st Street NW, 
Washington, DC 20581.

SUPPLEMENTARY INFORMATION: The Commodity Futures Trading Commission 
(``Commission'' or ``CFTC'') is soliciting public comment on an 
application submitted by the Financial Services Agency of Japan 
(``FSA''), dated September 30, 2021 (``FSA Application''), requesting 
that the Commission determine that registered nonbank \2\ swap dealers 
(``SDs'') organized and domiciled in Japan (``Japanese nonbank SDs'') 
may satisfy certain capital and financial reporting requirements under 
the Commodity Exchange Act (``CEA'') \3\ by being subject to and 
complying with comparable capital and financial reporting requirements 
under Japanese laws and regulations.\4\ The Commission also is 
soliciting public comment on a proposed Commission Comparability 
Determination order that would allow Japanese nonbank SDs, subject to 
certain conditions, to comply with certain CFTC SD capital and 
financial reporting requirements in the manner as set forth in the 
proposed order.
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    \2\ As discussed in Section I.A. below, the Commission has 
capital jurisdiction over registered SDs that are not subject to the 
regulation of a U.S. banking regulator (i.e., nonbank SDs).
    \3\ 7 U.S.C. 1 et seq. The CEA may be accessed through the 
Commission's website, www.cftc.gov.
    \4\ See Letter from Yuji Yamashita, Deputy Commissioner for 
International Affairs, Financial Services Agency of Japan, dated 
September 30, 2021. The FSA Application is available on the 
Commission's website at: https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm.
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I. Introduction

A. Regulatory Background--CFTC Capital, Margin, and Financial Reporting 
Requirements for Swap Dealers and Major Swap Participants

    Section 4s(e) of the CEA \5\ directs the Commission and 
``prudential regulators'' \6\ to impose capital requirements on SDs and 
major swap participants (``MSPs'') registered with the Commission. 
Section 4s(e) of the CEA also directs the Commission and prudential 
regulators to adopt regulations imposing initial and variation margin 
requirements on swaps entered into by SDs and MSPs that are not cleared 
by a registered derivatives clearing organization (``uncleared 
swaps'').
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    \5\ 7 U.S.C. 6s(e).
    \6\ The term ``prudential regulators'' is defined in the CEA to 
mean the Board of Governors of the Federal Reserve System (``Federal 
Reserve Board''); the Office of the Comptroller of the Currency; the 
Federal Deposit Insurance Corporation; the Farm Credit 
Administration; and the Federal Housing Finance Agency. See 7 U.S.C. 
1a(39).
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    Section 4s(e) applies a bifurcated approach with respect to the 
above Congressional directives, requiring each SD and MSP that is 
subject to the regulation of a prudential regulator (``bank SD'' and 
``bank MSP,'' respectively) to meet the minimum capital requirements 
and uncleared swaps margin requirements adopted by the applicable 
prudential regulator, and requiring each SD and MSP that is not

[[Page 48093]]

subject to the regulation of a prudential regulator (``nonbank SD'' and 
``nonbank MSP,'' respectively) to meet the minimum capital requirements 
and uncleared swaps margin requirements adopted by the Commission.\7\ 
Therefore, the Commission's authority to impose capital requirements 
and margin requirements for uncleared swap transactions extends to 
nonbank SDs and nonbank MSPs, including nonbanking subsidiaries of bank 
holding companies regulated by the Federal Reserve Board.
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    \7\ 7 U.S.C. 6s(e)(2).
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    The prudential regulators implemented Section 4s(e) in 2015 by 
amending existing capital requirements applicable to bank SDs and bank 
MSPs to incorporate swap transactions into their respective bank 
capital frameworks, and by adopting rules imposing initial and 
variation margin requirements on bank SDs and bank MSPs that engage in 
uncleared swap transactions.\8\ The Commission adopted final rules 
imposing initial and variation margin obligations on nonbank SDs and 
nonbank MSPs for uncleared swap transactions on January 6, 2016.\9\ The 
Commission also approved final capital requirements for nonbank SDs and 
nonbank MSPs on July 24, 2020, which were published in the Federal 
Register on September 15, 2020 with a compliance date of October 6, 
2021 (``CFTC Capital Rules'').\10\
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    \8\ See Margin and Capital Requirements for Covered Swap 
Entities, 80 FR 74840 (Nov. 30, 2015).
    \9\ See Margin Requirements for Uncleared Swaps for Swap Dealers 
and Major Swap Participants, 81 FR 636 (Jan. 6, 2016).
    \10\ See Capital Requirements of Swap Dealers and Major Swap 
Participants, 85 FR 57462 (Sept. 15, 2020).
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    Section 4s(f) of the CEA addresses SD and MSP financial reporting 
requirements.\11\ Section 4s(f) of the CEA authorizes the Commission to 
adopt rules imposing financial condition reporting obligations on all 
SDs and MSPs (i.e., nonbank SDs, nonbank MSPs, bank SDs, and bank 
MSPs). Specifically, Section 4s(f)(1)(A) of the CEA provides, in 
relevant part, that each registered SD and MSP must make financial 
condition reports as required by regulations adopted by the 
Commission.\12\ The Commission's financial reporting obligations were 
adopted with the Commission's nonbank SD and nonbank MSP capital 
requirements, and also had a compliance date of October 6, 2021 (``CFTC 
Financial Reporting Rules'').\13\
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    \11\ 7 U.S.C. 6s(f).
    \12\ 7 U.S.C. 6s(f)(1)(A).
    \13\ See 85 FR 57462.
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B. Commission Capital Comparability Determinations for Non-U.S. Nonbank 
Swap Dealers and Non-U.S. Nonbank Major Swap Participants

    Regulation 23.106 establishes a substituted compliance framework 
whereby the Commission may determine that compliance by a non-U.S. 
domiciled nonbank SD or non-U.S. domiciled nonbank MSP with its home 
country's capital and financial reporting requirements will satisfy all 
or parts of the CFTC Capital Rules and all or parts of the CFTC 
Financial Reporting Rules (such a determination referred to as a 
``Capital Comparability Determination'').\14\ The availability of such 
substituted compliance is conditioned upon the Commission issuing a 
determination that the relevant foreign jurisdiction's capital adequacy 
and financial reporting requirements, and related financial 
recordkeeping and reporting requirements, for non-U.S. nonbank SDs and/
or non-U.S. nonbank MSPs are comparable to the corresponding CFTC 
Capital Rules and CFTC Financial Reporting Rules. The Commission will 
issue a Capital Comparability Determination in the form of a Commission 
order (``Capital Comparability Determination Order'').\15\
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    \14\ 17 CFR 23.106. Regulation 23.106(a)(1) provides that a 
request for a Capital Comparability Determination may be submitted 
by a non-U.S. nonbank SD or non-US nonbank MSP, a trade association 
or other similar group on behalf of its SD or MSP members, or a 
foreign regulatory authority that has direct supervisory authority 
over one or more non-US nonbank SDs or non-U.S. nonbank MSPs. 
Commission regulations provide that any non-U.S. nonbank SD or non-
U.S. nonbank MSP that is dually-registered with the Commission as a 
futures commission merchant (``FCM'') is subject to the capital 
requirements of Regulation 1.17 and may not petition the Commission 
for a Capital Comparability Determination. See 17 CFR 23.101(a)(5) 
and (b)(4), respectively. Furthermore, non-U.S. bank SDs and non-
U.S. bank MSPs may not petition the Commission for a Capital 
Comparability Determination with respect to their respective 
financial reporting requirements under Regulation 23.105(p) (17 CFR 
23.105(p)). Commission staff has issued, however, a time-limited no-
action letter stating the Market Participants Division will not 
recommend enforcement action against a non-U.S. bank SD that files 
with the Commission certain financial information that is provided 
to its home country regulator in lieu of certain financial reports 
required by Regulation 23.105(p). See CFTC Staff Letter 21-18, 
issued on August 31, 2021.
    \15\ 17 CFR 23.106(a)(3).
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    The Commission's approach for conducting a comparability 
determination with respect to the CFTC Capital Rules and the CFTC 
Financial Reporting Rules is a principles-based, holistic approach that 
focuses on whether the applicable foreign jurisdiction's capital and 
financial reporting requirements achieve comparable outcomes to the 
corresponding CFTC requirements.\16\ In this regard, the approach is 
not a line-by-line assessment or comparison of a foreign jurisdiction's 
regulatory requirements with the Commission's requirements.\17\ In 
performing the analysis, the Commission recognizes that jurisdictions 
may adopt differing approaches to achieving comparable outcomes, and 
the Commission will focus on whether the foreign jurisdiction's capital 
and financial reporting requirements are comparable to the Commission's 
in purpose and effect, and not whether they are comparable in every 
aspect or contain identical elements.
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    \16\ 17 CFR 23.106(a)(3)(ii). See also 85 FR 57462 at 57521.
    \17\ See 85 FR 57521.
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    A person requesting a Capital Comparability Determination is 
required to submit an application to the Commission containing: (i) a 
description of the objectives of the relevant foreign jurisdiction's 
capital adequacy and financial reporting requirements applicable to 
entities that are subject to the CFTC Capital Rules and the CFTC 
Financial Reporting Rules; (ii) a description (including specific legal 
and regulatory provisions) of how the relevant foreign jurisdiction's 
capital adequacy and financial reporting requirements address the 
elements of the CFTC Capital Rules and CFTC Financial Reporting Rules, 
including, at a minimum, the methodologies for establishing and 
calculating capital adequacy requirements and whether such 
methodologies comport with any international standards; and (iii) a 
description of the ability of the relevant foreign regulatory authority 
to supervise and enforce compliance with the relevant foreign 
jurisdiction's capital adequacy and financial reporting requirements. 
The applicant must also submit, upon request, such other information 
and documentation as the Commission deems necessary to evaluate the 
comparability of the capital adequacy and financial reporting 
requirements of the foreign jurisdiction.\18\
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    \18\ 17 CFR 23.106(a)(2).
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    The Commission may consider all relevant factors in making a 
Capital Comparability Determination, including: (i) the scope and 
objectives of the relevant foreign jurisdiction's capital and financial 
reporting requirements; (ii) whether the relevant foreign 
jurisdiction's capital and financial reporting requirements achieve 
comparable outcomes to the Commission's corresponding capital

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requirements and financial reporting requirements; (iii) the ability of 
the relevant foreign regulatory authority or authorities to supervise 
and enforce compliance with the relevant foreign jurisdiction's capital 
adequacy and financial reporting requirements; and (iv) any other facts 
or circumstances the Commission deems relevant, including whether the 
Commission and foreign regulatory authority or authorities have a 
memorandum of understanding (``MOU'') or similar arrangement that would 
facilitate supervisory cooperation.\19\
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    \19\ See 17 CFR 23.106(a)(3) and 85 FR 57520-57522.
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    In performing the comparability assessment for foreign nonbank SDs, 
the Commission's review will include the extent to which the foreign 
jurisdiction's requirements address: (i) the process of establishing 
minimum capital requirements for nonbank SDs and how such process 
addresses risk, including market risk and credit risk of the nonbank 
SD's on-balance sheet and off-balance sheet exposures; (ii) the types 
of equity and debt instruments that qualify as regulatory capital in 
meeting minimum requirements; (iii) the financial reports and other 
financial information submitted by a nonbank SD to its relevant 
regulatory authority and whether such information provides the 
regulatory authority with the means necessary to effectively monitor 
the financial condition of the nonbank SD; and (iv) the regulatory 
notices and other communications between a nonbank SD and its foreign 
regulatory authority that address potential adverse financial or 
operational issues that may impact the firm. With respect to the 
ability of the relevant foreign regulatory authority to supervise and 
enforce compliance with the foreign jurisdiction's capital adequacy and 
financial reporting requirements, the Commission's review will include 
a review of the foreign jurisdiction's surveillance program for 
monitoring nonbank SDs' compliance with such capital adequacy and 
financial reporting requirements, and the disciplinary process imposed 
on firms that fail to comply with such requirements.
    In performing the comparability assessment for foreign nonbank 
MSPs,\20\ the Commission's review will include the extent to which the 
foreign jurisdiction's requirements address: (1) the process of 
establishing minimum capital requirements for nonbank MSPs and how such 
process establishes a minimum level of capital to ensure the safety and 
soundness of the nonbank MSP; (ii) the financial reports and other 
financial information submitted by a nonbank MSP to its relevant 
regulatory authority and whether such information provides the 
regulatory authority with the means necessary to effectively monitor 
the financial condition of the nonbank MSP; and (iii) the regulatory 
notices and other communications between a nonbank MSP and its foreign 
regulatory authority that address potential adverse financial or 
operational issues that may impact the firm. With respect to the 
ability of the relevant foreign regulatory authority to supervise and 
enforce compliance with the foreign jurisdiction's capital adequacy and 
financial reporting requirements, the Commission's review will include 
a review of the foreign jurisdiction's surveillance program for 
monitoring nonbank MSPs' compliance with such capital adequacy and 
financial reporting requirements, and the disciplinary process imposed 
on firms that fail to comply with such requirements.
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    \20\ Regulation 23.101(b) requires a nonbank MSP to maintain 
positive tangible net worth. There are no MSPs currently registered 
with the Commission.
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    Regulation 23.106 further provides that the Commission may impose 
any terms or conditions that it deems appropriate in issuing a Capital 
Comparability Determination.\21\ Any specific terms or conditions with 
respect to capital adequacy or financial reporting requirements will be 
set forth in the Commission's Capital Comparability Determination 
Order. As a general condition to all Capital Comparability 
Determination Orders, the Commission expects to require notification 
from applicants of any material changes to information submitted by the 
applicants in support of a comparability finding, including, but not 
limited to, changes in the relevant foreign jurisdiction's supervisory 
or regulatory regime.
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    \21\ See 17 CFR 23.106(a)(5).
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    The Commission's capital adequacy and financial reporting 
requirements are designed to address and manage risks that arise from a 
firm's operation as a SD and MSP. Given their functions, both sets of 
requirements and rules must be applied on an entity-level basis 
(meaning that the rules apply on a firm-wide basis, irrespective of the 
type of transactions involved) in order to effectively address risk to 
the firm as a whole. Therefore, in order to rely on a Capital 
Comparability Determination, a nonbank SD or nonbank MSP domiciled in 
the foreign jurisdiction and subject to supervision by the relevant 
regulatory authority (or authorities) in the foreign jurisdiction must 
file a notice with the Commission of its intent to comply with the 
applicable capital adequacy and financial reporting requirements of the 
foreign jurisdiction set forth in the Capital Comparability 
Determination in lieu of all or parts of the CFTC Capital Rules and/or 
CFTC Financial Reporting Rules.\22\ Notices must be filed 
electronically with the Commission's Market Participants Division 
(``MPD'').\23\ The filing of a notice by a non-U.S. nonbank SD or non-
U.S. nonbank MSP provides MPD staff, acting pursuant to authority 
delegated by the Commission,\24\ with the opportunity to engage with 
the firm and to obtain representations that it is subject to, and 
complies with, the laws and regulations cited in the Capital 
Comparability Determination and that it will comply with any listed 
conditions. MPD will issue a letter under its delegated authority from 
the Commission confirming that the non-U.S. nonbank SD or non-U.S. 
nonbank MSP may comply with the foreign laws and regulations cited in 
the Capital Comparability Determination in lieu of complying with the 
CFTC Capital Rules and CFTC Financial Reporting Rules upon MPD's 
determination that the firm is subject to and complies with such 
foreign laws and regulations, is subject to the jurisdiction of the 
applicable foreign regulatory authority (or authorities), and can meet 
all of the conditions in the Capital Comparability Determination.
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    \22\ 17 CFR 23.106(a)(4).
    \23\ Notices must be filed in electronic form to the following 
email address: [email protected]
    \24\ See 17 CFR 140.91(a)(11).
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    Each non-U.S. nonbank SD and/or non-U.S. nonbank MSP that receives, 
in accordance with the applicable Commission Capital Comparability 
Determination, confirmation from the Commission that it may comply with 
a foreign jurisdiction's capital adequacy and/or financial reporting 
requirements will be deemed by the Commission to be in compliance with 
the corresponding CFTC Capital Rules and/or CFTC Financial Reporting 
Rules.\25\ Accordingly, if a nonbank SD or nonbank MSP fails to comply 
with the foreign jurisdiction's capital adequacy and/or financial 
reporting requirements, the Commission may initiate an action for a 
violation of the corresponding CFTC Capital Rules and/or CFTC Financial 
Reporting Rules.\26\ In addition, a non-U.S. nonbank SD or

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non-U.S. nonbank MSP that receives confirmation of its ability to use 
substituted compliance remains subject to the Commission's examination 
and enforcement authority.\27\
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    \25\ 17 CFR 23.106(a)(4)(ii). Confirmation will be issued by MPD 
under authority delegated by the Commission. See Regulation 
140.91(a)(11) (17 CFR 140.91(a)(11)).
    \26\ Id.
    \27\ Id.
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    The Commission will consider an application for a Capital 
Comparability Determination to be a representation by the applicant 
that the laws and regulations of the foreign jurisdiction that are 
submitted in support of the application are finalized and in force, 
that the description of such laws and regulations is accurate and 
complete, and that, unless otherwise noted, the scope of such laws and 
regulations encompasses the relevant non-U.S. nonbank SDs and/or non-
U.S. nonbank MSPs domiciled in the foreign jurisdiction.\28\ A non-U.S. 
nonbank SD or non-U.S. nonbank MSP that is not legally required to 
comply with a foreign jurisdiction's laws or regulations determined to 
be comparable in a Capital Comparability Determination may not 
voluntarily comply with such laws or regulations in lieu of compliance 
with the CFTC Capital Rules or the CFTC Financial Reporting Rules. Each 
non-U.S. nonbank SD or non-U.S. nonbank MSP that seeks to rely on a 
Capital Comparability Determination Order is responsible for 
determining whether it is subject to the foreign laws and regulations 
found comparable in the Order.
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    \28\ The Commission has provided the FSA with an opportunity to 
review for accuracy and completeness, and comment on, the 
Commission's description of relevant Japanese laws and regulations 
on which this proposed Capital Comparability Determination is based. 
The Commission relies on this review and any corrections received 
from the FSA in making its proposal. A comparability determination 
based on an inaccurate description of foreign laws and regulations 
may not be valid.
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C. Japan Financial Services Agency's Application for a Capital 
Comparability Determination for Japanese-Domiciled Nonbank Swap Dealers

    The FSA Application requests that the Commission issue a Capital 
Comparability Determination finding that compliance with certain 
designated capital requirements of Japan (the ``Japanese Capital 
Rules'') and certain designated financial reporting requirements of 
Japan (the ``Japanese Financial Reporting Rules'') by a Japanese 
nonbank SD registered with the FSA as a Type I Financial Instruments 
Business Operator (``FIBO'') satisfies corresponding CFTC Capital Rules 
and CFTC Financial Reporting Rules applicable to a nonbank SD under 
Sections 4s(e) and (f) of the CEA and Regulations 23.101 and 
23.105.\29\ There are currently three Japanese nonbank SDs registered 
with Commission, and the FSA has represented that each of the three 
Japanese nonbank SDs are FSA-registered and regulated FIBOs.\30\ The 
FSA Application requests that the Commission's Capital Comparability 
Determination cover each of the three Japanese nonbank SDs and any 
future Japanese registered and domiciled FIBOs that register with the 
Commission as nonbank SDs.
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    \29\ The FSA's application did not request a Capital 
Comparability Determination with respect to nonbank MSPs as 
currently there are no MSPs registered with the Commission and, 
accordingly, no nonbank MSPs domiciled in Japan and registered with 
the FSA. Accordingly, the Commission's Capital Comparability 
Determination and proposed Order does not address nonbank MSPs.
    \30\ FSA Application, pp. 4-5 (footnote 11).
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    The FSA has represented that the capital adequacy and financial 
reporting requirements for swap activities in Japan are governed by the 
Japanese legal framework for financial regulation, which is mainly 
composed of Acts, Cabinet Orders, Ministerial Orders, and FSA 
Notices.\31\ With regard to the Japanese Capital Rules and the Japanese 
Financial Reporting Rules, the Financial Instruments and Exchange Act 
(Act No. 25 of 1948) (``FIEA'') and its related order, Cabinet Office 
Order on Financial Instruments Business (Cabinet Office Order No. 52 of 
2007) (``COO''), stipulate the prudential capital and financial 
reporting requirements applicable to FIBOs, including Japanese nonbank 
SDs.\32\ FIEA, COO, and related FSA Notices impose mandatory capital 
and reporting requirements on FIBOs, including Japanese nonbank SDs. 
Comprehensive Guidelines for Supervision of Financial Instruments 
Business Operators, etc. (``Supervisory Guidelines for FIBO'') also 
supplement the framework.\33\ The technical requirements for FIBOs, 
including Japanese nonbank SDs, to calculate capital adequacy ratios 
are specified in the FSA Notice No. 59 of 2007 (``Notice on Capital'') 
in accordance with Article 177(8) and Article 178(1) of the COO.
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    \31\ Id., p. 4.
    \32\ Businesses categorized as Type I Financial Instruments 
Business (Article 28(1) of the FIEA) can only be conducted by Type I 
FIBOs registered under Article 29 of the FIEA. Type I Financial 
Instruments Business includes market transactions of derivatives and 
foreign market derivatives transactions pertaining to certain highly 
liquid securities and over-the-counter transactions of derivatives.
    \33\ In order to implement and reinforce the legal framework, 
the FSA has developed and published supervisory guidelines. The 
supervisory guidelines are meant for FSA staff, but are public 
documents, which are expected to be followed by the applicable 
financial institutions. Financial institutions are consulted in 
connection with the establishment of, and any amendments to, the 
supervisory guidelines. Supervision and enforcement are conducted 
based on the supervisory guidelines.
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II. General Overview of CFTC and Japanese Nonbank Swap Dealer Capital 
Rules

A. General Overview of CFTC Nonbank Swap Dealer Capital Rules

    The CFTC Capital Rules provide nonbank SDs with three alternative 
capital approaches: (i) the Tangible Net Worth Capital Approach (``TNW 
Approach''); (ii) the Net Liquid Assets Capital Approach (``NLA 
Approach''); and (iii) the Bank-Based Capital Approach (``Bank-Based 
Approach'').\34\
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    \34\ 17 CFR 23.101.
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    Nonbank SDs that are ``predominantly engaged in non-financial 
activities'' may elect the TNW Approach.\35\ The TNW Approach requires 
a nonbank SD to maintain a level of ``tangible net worth'' \36\ equal 
to or greater than the higher of: (i) $20 million plus the amount of 
the nonbank SD's ``market risk exposure requirement'' \37\ and ``credit 
risk exposure requirement'' \38\ associated with the nonbank SD's swap

[[Page 48096]]

and related hedge positions that are part of the nonbank SD's swap 
dealing activities; (ii) eight percent of the nonbank SD's ``uncleared 
swap margin'' amount; \39\ or (iii) the amount of capital required by a 
registered futures association of which the nonbank SD is a member.\40\ 
The TNW Approach is intended to ensure the safety and soundness of a 
qualifying nonbank SD by requiring the firm to maintain a minimum level 
of tangible net worth that is based on the nonbank SD's swap dealing 
activities to provide a sufficient level of capital to absorb losses 
resulting from its swap dealing and other business activities.
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    \35\ 17 CFR 23.101(a)(2). The term ``predominantly engaged in 
non-financial activities'' is defined in Regulation 23.100 (17 CFR 
23.100) and generally provides that: (i) the nonbank SD's, or its 
parent entity's, annual gross financial revenues for either of the 
previous two completed fiscal years represents less than 15 percent 
of the nonbank SD's or the nonbank SD's parent's, annual gross 
revenues for all operations (i.e., commercial and financial) for 
such years, and (ii) the nonbank SD's, or its parent entity's, total 
financial assets at the end of its two most recently completed 
fiscal years represents less than 15 percent of the nonbank SD's, or 
its parent's, total consolidated financial and nonfinancial assets 
as of the end of such years.
    \36\ The term ``tangible net worth'' is defined in Regulation 
23.100 and generally means the net worth (i.e., assets less 
liabilities) of a nonbank SD, computed in accordance with applicable 
accounting principles, with assets further reduced by a nonbank SD's 
recorded goodwill and other intangible assets.
    \37\ The terms ``market risk exposure'' and ``market risk 
exposure requirement'' are defined in Regulation 23.100 (17 CFR 
23.100) and generally mean the risk of loss in a financial position 
or portfolio of financial positions resulting from movements in 
market prices and other factors. Market risk exposure is the sum of: 
(i) general market risks including changes in the market value of a 
particular asset that results from broad market movements, which may 
include an additive for changes in market value under stressed 
conditions; (ii) specific risk, which includes risks that affect the 
market value of a specific instrument but do not materially alter 
broad market conditions; (iii) incremental risk, which means the 
risk of loss on a position that could result from the failure of an 
obligor to make timely payments of principal and interest; and (iv) 
comprehensive risk, which is the measure of all material price risks 
of one or more portfolios of correlation trading positions.
    \38\ The term ``credit risk exposure requirement'' is defined in 
Regulation 23.100 (17 CFR 23.100) and generally reflects the amount 
at risk if a counterparty defaults before the final settlement of a 
swap transaction's cash flows.
    \39\ The term ``uncleared swap margin'' is defined in Regulation 
23.100 (17 CFR 23.100) to generally mean the amount of initial 
margin that a nonbank SD would be required to collect from each 
counterparty for each outstanding swap position of the nonbank SD. A 
nonbank SD must include all swap positions in the calculation of the 
uncleared swap margin amount, including swaps that are exempt or 
excluded from the scope of the Commission's uncleared swap margin 
regulations. A nonbank SD must compute the uncleared swap margin 
amount in accordance with the Commission's margin rules for 
uncleared swaps. See 17 CFR 23.154.
    \40\ The National Futures Association (``NFA'') is currently the 
only entity that is a registered futures association. The Commission 
will refer to NFA in this document when referring to the 
requirements or obligations of a registered futures association.
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    The TNW approach requires a nonbank SD to compute its market risk 
exposure requirement and credit risk exposure requirement using 
standardized capital charges set forth in Securities and Exchange 
Commission (``SEC'') Rule 18a-1 (17 CFR 240.18a-1) that are applicable 
to entities registered with the SEC as security-based swap dealers 
(``SBSDs'') or standardized capital charges set forth in CFTC 
Regulation 1.17 applicable to entities registered as FCMs or entities 
dually-registered as an FCM and nonbank SD.\41\ Nonbank SDs that have 
received Commission or NFA approval pursuant to Regulation 23.102 may 
use internal models to compute market risk and/or credit risk capital 
charges in lieu of the SEC or CFTC standardized capital charges.\42\
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    \41\ 17 CFR 23.101(a)(2)(ii)(A).
    \42\ Id.
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    A nonbank SD that elects the NLA Approach is required to maintain 
``net capital'' in an amount that equals or exceeds the greater of: (i) 
$20 million; (ii) 2 percent of the nonbank SD's uncleared swap margin 
amount; or (iii) the amount of capital required by NFA.\43\ The NLA 
Approach is intended to ensure the safety and soundness of a nonbank SD 
by requiring the firm to maintain at all times at least one dollar of 
highly liquid assets to cover each dollar of the nonbank SD's 
liabilities.
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    \43\ 17 CFR 23.101(a)(1)(ii)(A). ``Net capital'' consists of a 
nonbank SD's highly liquid assets (subject to haircuts) less all of 
the firm's liabilities, excluding certain qualified subordinated 
debt. See 17 CFR 240.18a-1 for the calculation of ``net capital.''
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    A nonbank SD is required to reduce the value of its highly liquid 
assets by the market risk exposure requirement and/or the credit risk 
exposure requirement in computing its net capital.\44\ A nonbank SD 
that does not have Commission or NFA approval to use internal models 
must compute its market risk exposure requirement and/or credit risk 
exposure requirement using the standardized capital charges contained 
in SEC Rule 18a-1 (17 CFR 240.18a-1) as modified by the Commission's 
rule.\45\
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    \44\ See 17 CFR 240.18a-1(c) and (d).
    \45\ See 17 CFR 23.101(a)(1)(ii).
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    A nonbank SD that has obtained Commission or NFA approval, may use 
internal market risk and/or credit risk models to compute market risk 
and/or credit risk capital charges in lieu of the standardized capital 
charges.\46\ A nonbank SD that is approved to use internal market risk 
and/or credit risk models is further required to maintain a minimum of 
$100 million of ``tentative net capital.'' \47\
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    \46\ See 17 CFR 23.102.
    \47\ 17 CFR 23.101(a)(1)(ii)(A)(1). The term ``tentative net 
capital'' is defined in Regulation 23.101(a)(1)(ii)(A)(1) by 
reference to SEC Rule 18a-1 and generally means a nonbank SD's net 
capital prior to deducting market risk and credit risk capital 
charges.
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    The Commission's NLA Approach is consistent with the SEC's SBSD 
capital rule, and is based on the Commission's capital rule for FCMs 
and the SEC's capital rule for securities broker-dealers (``BDs''). The 
quantitative and qualitative requirements for NLA Approach internal 
market and credit risk models are also consistent with the quantitative 
and qualitative requirements of the Commission's Bank-Based Approach as 
described below.
    The Commission's Bank-Based Approach for computing regulatory 
capital for nonbank SDs is based on certain capital requirements 
imposed by the Federal Reserve Board for bank holding companies.\48\ 
The Bank-Based Approach also is consistent with the Basel Committee on 
Banking Supervision's (``BCBS'') international framework for bank 
capital requirements.\49\ The Bank-Based Approach requires a nonbank SD 
to maintain regulatory capital equal to or in excess of each of the 
following requirements: (i) $20 million of common equity tier 1 
capital; (ii) an aggregate of common equity tier 1 capital, additional 
tier 1 capital, and tier 2 capital (including qualifying subordinated 
debt) equal to or greater than 8 percent of the nonbank SD's risk-
weighted assets (provided that common equity tier 1 capital comprises 
at least 6.5 percent of the 8 percent minimum requirement); (iii) an 
aggregate of common equity tier 1 capital, additional tier 1 capital, 
and tier 2 capital equal to or greater than 8 percent of the nonbank 
SD's uncleared swap margin amount; and (iv) an amount of capital 
required by NFA.\50\ The Bank-Based Approach is intended to ensure that 
the safety and soundness of a nonbank SD by requiring the firm to 
maintain at all times qualifying capital in an amount sufficient to 
absorb unexpected losses, expenses, decrease in firm assets, or 
increases in firm liabilities without the firm becoming insolvent.
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    \48\ See 17 CFR 23.101(a)(1)(i).
    \49\ The BCBS is the primary global standard-setter for the 
prudential regulation of banks and provides a forum for cooperation 
on banking supervisory matters. Institutions represented on the BCBS 
include the Federal Reserve Board, the European Central Bank, 
Deutsche Bundesbank, Bank of England, Bank of France, Bank of Japan, 
Banco de Mexico, and Bank of Canada.
    \50\ 17 CFR 23.101(a)(1)(i).
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    The terms used in the Commission's Bank-Based Approach are defined 
by reference to regulations of the Federal Reserve Board.\51\ 
Specifically, the term ``common equity tier 1 capital'' is defined for 
purposes of the CFTC Capital Rules to generally mean the sum of a 
nonbank SD's common stock instruments and any related surpluses, 
retained earnings, and accumulated other comprehensive income.\52\ The 
term ``additional tier 1 capital'' is defined to include the nonbank 
SD's common equity tier 1 capital and further includes such additional 
equity instruments as preferred stock.\53\ The term ``tier 2 capital'' 
is defined to include certain types of instruments that include both 
debt and equity characteristics (e.g., certain perpetual preferred 
stock instruments and subordinated term debt instruments).\54\ 
Subordinated debt also must meet certain requirements to qualify as 
tier 2 capital, including that the term of the subordinated debt 
instrument is for a minimum of one year (with the exception of approved 
revolving subordinated debt agreements which may have a maturity term 
that is less than one year), and the debt instrument is an effective 
subordination of the

[[Page 48097]]

rights of the lender to receive any payment, including accrued 
interest, to other creditors.\55\
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    \51\ Id. Regulation 23.101(a)(1)(i) references Federal Reserve 
Board Rule 217.20 (12 CFR 217.20) for purposes of defining the terms 
used in establishing the minimum capital requirements under the 
Bank-Based Approach.
    \52\ See 12 CFR 217.20(b).
    \53\ See 12 CFR 217.20(c).
    \54\ See 12 CFR 217.20(d).
    \55\ The subordinated debt must meet the requirements set forth 
in SEC Rule 18a-1d (17 CFR 240.18a-1d). See 17 CFR 
23.101(a)(1)(i)(B).
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    Common equity tier 1 capital, additional tier 1 capital, and tier 2 
capital are unencumbered and generally long-term or permanent forms of 
capital that help ensure that a nonbank SD will be able to absorb 
losses resulting from its operations and maintain confidence in the 
nonbank SD as a going concern. In addition, in setting an equity ratio 
requirement, this limits the amount of asset growth and leverage a 
nonbank SD can incur, as a nonbank SD must fund its asset growth with a 
certain percentage of regulatory capital.
    A nonbank SD also must compute its risk-weighted assets using 
standardized capital charges or, if approved, internal models. Risk-
weighting assets involves adjusting the notional or carrying value of 
each asset based on the inherent risk of the asset. Less risky assets 
are adjusted to lower values (i.e., have less risk-weight) than more 
risky assets. As a result, nonbank SDs are required to hold lower 
levels of regulatory capital for less risky assets and higher levels of 
regulatory capital for riskier assets.
    Nonbank SDs not approved to use internal models to risk-weight 
their assets must compute market risk capital charges using the 
standardized charges contained in CFTC Regulation 1.17 and SEC Rule 
18a-1, and must compute their credit risk charges using the 
standardized capital charges set forth in regulations of the Federal 
Reserve Board for bank holding companies (Subpart D of 17 CFR part 
217).\56\
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    \56\ See 17 CFR 23.101(a)(1)(i)(B) and the definition of the 
term BHC risk-weighted assets in 17 CFR 23.100.
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    Standardized market risk charges are computed under CFTC Regulation 
1.17 and SEC Rule 18a-1 by multiplying, as appropriate to the specific 
asset schedule, the notional value or market value of the nonbank SD's 
proprietary financial positions (such as swaps, security-based swaps, 
futures, equities, and U.S. Treasuries) by fixed percentages set forth 
in the Regulation or Rule.\57\ Standardized credit risk charges require 
the nonbank SD to multiply on-balance sheet and off-balance sheet 
exposures (such as receivables from counterparties, debt instruments, 
and exposures from derivatives) by predefined percentages set forth in 
the applicable Federal Reserve Board regulations contained in Subpart D 
of 17 CFR part 217.
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    \57\ See 17 CFR 1.17(c)(5) and 17 CFR 240.15c3-1(c)(2).
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    A nonbank SD also may apply to the Commission or NFA for approval 
to use internal models to compute market risk exposure and/or credit 
risk exposure for purposes of determining its total risk-weighted 
assets.\58\ Nonbank SDs approved to use internal models for the 
calculation of credit risk or market risk, or both, must follow the 
model requirements set forth in Federal Reserve Board regulations for 
bank holding companies (Subpart E and F, respectively, of 17 CFR part 
217). Credit risk and market risk capital charges computed with 
internal models require the estimation of potential losses, with a 
certain degree of likelihood, within a specified time period, of a 
portfolio of assets. Internal models allow for consideration of 
potential co-movement of prices across assets in the portfolio, leading 
to offsets of gains and losses. Internal credit risk models can also 
further include estimation of the likelihood of default of 
counterparties.
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    \58\ See 17 CFR 23.102.
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B. General Overview of Capital Rules for Japanese Nonbank SDs

    The Japanese Capital Rules impose bank-like capital requirements on 
a Japanese nonbank SD that are consistent with the BCBS framework for 
international bank-based capital standards.\59\ The Japanese Capital 
Rules are intended to require each Japanese nonbank SD to hold a 
sufficient amount of qualifying equity and subordinated debt to absorb 
decreases in the value of firm assets and to cover losses from its 
activities, including possible counterparty defaults and margin 
collateral shortfalls associated with its swap dealing activities, 
without the firm becoming insolvent.
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    \59\ FSA Application, p. 9.
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    The Japanese Capital Rules require each Japanese nonbank SD to hold 
and maintain a ``capital adequacy amount'' equal to 120 percent or more 
of the Japanese nonbank SD's ``risk equivalent amount.'' \60\ A 
Japanese nonbank SD's ``capital adequacy amount'' is composed of the 
firm's equity classified as ``Basic Items'' and ``Supplemental Items.'' 
\61\ Basic Items are composed of the firm's balance sheet capital 
including: (i) issued and outstanding shares; (ii) the payment for an 
application for new shares; (iii) the capital surplus; (iv) the earned 
surplus; (v) the negative valuation difference on available-for-sale 
securities; and (vi) the firm's own treasury stock.\62\ Supplemental 
Items provide an additional layer of capital beyond Basic Items and are 
composed of the positive valuation difference on available-for-sale 
securities and certain subordinated debt instruments.\63\
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    \60\ Article 46-6(2) of the FIEA, Article 176 of the COO and 
Section IV-2-1 (Preciseness of Capital Adequacy Ratio) of the 
Supervisory Guidelines for FIBO.
    \61\ FSA Application, p. 14.
    \62\ Article 176(1)(i) through (vi) of the COO.
    \63\ Article 176(1)(vii) of the COO.
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    A Japanese nonbank SD's capital adequacy amount must be composed of 
at least 50 percent Basic Items, and limits are imposed on the 
aggregate amount of subordinated debt that may be used to meet the 
capital adequacy amount.\64\ Subordinated debt also must satisfy 
specified conditions in order to be included in the Japanese nonbank 
SD's capital. Specifically, the subordinated debt instrument must: (i) 
contain special provisions subordinating the rights of the lender to 
the payment of principal and interest; (ii) not be secured by the 
Japanese nonbank SD; (iii) have a minimum original maturity of more 
than five years for long term subordinated debt, and at least two years 
for short term subordinated debt; (iv) provide that any early 
redemption must be done voluntarily by the Japanese nonbank SD and must 
be approved by the FSA; and (v) contain special provisions setting 
forth that no interest payment shall be made to the lender if such 
payment would result in the Japanese nonbank SD capital adequacy ratio 
falling below certain thresholds.\65\
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    \64\ The Japanese Capital Rules provide that the total amount of 
Supplemental Items must be less than the total amount of the 
Japanese nonbank SD's Basic Items. See Article 176(1)(vii) of the 
COO.
    \65\ Article 176(2) and (3) of the COO.
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    A Japanese nonbank SD's ``risk equivalent amount'' is calculated as 
the sum of the firm's: (i) market risk equivalent amount, which is the 
amount equivalent to possible risks which may accrue due to 
fluctuations in the prices of securities and other proprietary assets 
and transactions held; \66\ (ii) counterparty risk equivalent amount, 
which is the amount equivalent to possible risks which may accrue due 
to the default in performance of contracts by the counterparties to 
transactions or any other reason; \67\ and (iii) basic risk equivalent 
amount, which is the amount equivalent to possible risk which may 
accrue in the ordinary course of

[[Page 48098]]

executing business, such as errors in business handling.\68\ The risk 
equivalent amount is a method of risk-weighting the Japanese nonbank 
SD's assets by adjusting the notional or carrying value of each asset 
based on the inherent risk of the asset. Less risky assets have a lower 
risk equivalent amount than assets with higher risk. As a result, 
Japanese nonbank SDs are required to hold lower levels of regulatory 
capital for assets with a lower risk equivalent amount and higher 
levels of regulatory capital for assets with a higher level of risk 
equivalent amount.
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    \66\ Article 178(1)(i) of the COO and Article 10 through 14 of 
the Notice on Capital. The ``market risk equivalent amount'' 
corresponds to ``market risk'' in the BCBS and Bank-Based Approach 
frameworks.
    \67\ Article 178(1)(ii) of the COO and Article 15 through 15-7 
of the Notice on Capital. The ``counterparty risk equivalent 
amount'' corresponds to ``credit risk'' in the BCBS and Bank-Based 
Approach frameworks.
    \68\ Article 178(1)(iii) of the COO and Article 16 of the Notice 
on Capital.
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    To calculate its risk equivalent amount, a Japanese nonbank SD 
risk-weights its assets and exposures using specified standardized 
weights or approved internal model-based methodologies. The Japanese 
Capital Rules, including various ordinances, notices \69\ and 
guidelines,\70\ set out quantitative and qualitative requirements that 
internal models must meet in order to obtain and maintain approval. 
Topics addressed by the quantitative and qualitative requirements 
include model governance, validation, monitoring, and review.
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    \69\ Article 13 of the Notice on Capital.
    \70\ Principles for Model Risk Management, Financial Services 
Agency of Japan (November 12, 2021).
---------------------------------------------------------------------------

    Modeled credit risk and market risk capital charges require the 
estimation of potential losses, with a certain degree of likelihood, 
within a specified time period, of a portfolio of assets.\71\ Internal 
models allow for consideration of potential co-movement of prices 
across assets in the portfolio, leading to offsets of gains and losses. 
Internal credit risk models can also further include estimation of the 
likelihood of default of counterparties.
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    \71\ The Japanese Capital Rules require Japanese nonbank SDs 
with model approval for market risk to use a VaR model with a 99 
percent, one-tailed confidence interval with (i) price changes 
equivalent to a ten business-day movement in rates and prices, (ii) 
effective historical observation periods of at least one year, and 
(iii) at least monthly data set updates. See Article 13(3)(i), (ii), 
and (iv) of the Notice on Capital. Japanese nonbank SDs approved to 
use credit risk models are required to use specified formulas to 
calculate the expected exposure at default of the counterparty. See 
Article 15-2 of the Notice on Capital.
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III. Commission Analysis of the Comparability of the Japanese Capital 
Rules and Japanese Financial Reporting Rules With the CFTC Capital 
Rules and CFTC Financial Reporting Rules

    The following section provides a description and comparative 
analysis of the regulatory requirements of the Japanese Capital Rules 
and Japanese Financial Reporting Rules to the CFTC Capital Rules and 
CFTC Financial Reporting Rules. Immediately following a description of 
the requirement(s) of the CFTC Capital Rules or the CFTC Financial 
Reporting Rules for which a comparability determination was requested 
by the FSA, the Commission provides a description of Japan's 
corresponding laws, regulations, or rules. The Commission then provides 
a comparative analysis of the Japanese Capital Rules or the Japanese 
Financial Reporting Rules with the corresponding CFTC Capital Rules or 
CFTC Financial Reporting Rules. The Commission identifies any material 
differences between the respective rules.
    The Commission performed this proposed Capital Comparability 
Determination by assessing the comparability of the Japanese Capital 
Rules for Japanese nonbank SDs as set forth in the FSA Application and 
in the English language translation of certain Japanese laws and 
regulations, with the Commission's Bank-Based Approach. For clarity, 
the Commission did not assess the comparability of the Japanese Capital 
Rules to the Commission's TNW Approach or NLA Approach as the 
Commission understands that all Japanese nonbank SDs, as of the date of 
the FSA Application, are subject to the current bank-based capital 
approach of the Japanese Capital Rules. Accordingly, for clarity, when 
the Commission makes a preliminary determination herein about the 
comparability of the Japanese Capital Rules with the CFTC Capital 
Rules, the determination pertains to the comparability of the Japanese 
Capital Rules with the Bank-Based Approach under the CFTC Capital 
Rules.
    As described below, it is proposed that any material changes to the 
Japanese Capital Rules will require notification to the Commission. 
Therefore, if there are subsequent material changes to the Japanese 
Capital Rules to include, for example, another capital approach,--the 
Commission will review and assess the impact of such changes on the 
Capital Comparability Determination Order as it is then in effect, and 
may amend or supplement the Order.\72\
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    \72\ The Commission also may amend or supplement the Order to 
address any material changes to the CFTC Capital Rules and CFTC 
Financial Reporting Rules that are adopted after a final Order is 
issued.
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    In addition, although the BCBS bank capital standards establish 
minimum capital standards that are consistent with the requirements of 
the Commission's Bank-Based Approach, the Commission notes that 
consistency with the BCBS standards is not determinative of a finding 
of comparability with the CFTC Capital Rules. In the Commission's view, 
a foreign jurisdiction's consistency with the BCBS international bank 
standards is an element in the Commission's comparability assessment, 
but, in and of itself, it may not be sufficient to demonstrate 
comparability with the CFTC Capital Rules without an assessment of the 
individual elements of the foreign jurisdiction's capital framework.
    Capital and financial reporting regimes are complex structures 
comprised of a number of interrelated regulatory components. 
Differences in how jurisdictions approach and implement these regimes 
are expected, even among jurisdictions that base their requirements on 
the principles and standards set forth in the BCBS international 
framework. Therefore, the Commission's comparability determination 
involves a detailed assessment of the relevant requirements of the 
foreign jurisdiction and whether those requirements, viewed in the 
aggregate, lead to an outcome that is comparable to the outcome of the 
CFTC's corresponding requirements. Consistent with this approach, the 
Commission has grouped the CFTC Capital Rules and the CFTC Financial 
Reporting Rules into key categories that focus the analysis on whether 
the Japanese capital and financial reporting requirements are 
comparable to the Commission's requirements in purpose and effect, and 
not whether the Japanese requirements meet every aspect or contain 
identical elements as the Commission's requirements.
    Specifically, as discussed in detail below, the Commission used the 
following key categories in its review: (i) the quality of the equity 
and debt instruments that qualify as regulatory capital, and the extent 
to which the regulatory capital represents committed and permanent 
capital that would be available to absorb unexpected losses or 
counterparty defaults; (ii) the process of establishing minimum capital 
requirements for a Japanese nonbank SD and how such process addresses 
market risk and credit risk of the firm's on-balance sheet and off-
balance sheet exposures; (iii) the financial reports and other 
financial information submitted by a Japanese nonbank SD to its 
relevant regulatory authorities to effectively monitor the financial 
condition of the firm; and (iv) the regulatory notices and other 
communications between the Japanese nonbank SD and its relevant 
regulatory authorities that detail

[[Page 48099]]

potential adverse financial or operational issues that may impact the 
firm. The Commission also reviewed the manner in which compliance by a 
Japanese nonbank SD with the Japanese Capital Rules and Japanese 
Financial Reporting Rules is monitored and enforced. The Commission 
invites public comment on all aspects of the FSA Application and on the 
Commission's proposed Capital Comparability Determination discussed 
below.

A. Regulatory Objectives of CFTC Capital Rules and CFTC Financial 
Reporting Rules and Japanese Capital Rules and Japanese Financial 
Reporting Rules

1. Regulatory Objectives of CFTC Capital Rules and CFTC Financial 
Reporting Rules
    The regulatory objectives of the CFTC Capital Rules and the CFTC 
Financial Reporting Rules are to further the Congressional mandate to 
ensure the safety and soundness of nonbank SDs to mitigate the greater 
risk to nonbank SDs and the financial system arising from the use of 
swaps that are not cleared.\73\ A primary function of the nonbank SD's 
capital is to protect the solvency of the firm from decreases in the 
value of firm assets and from losses, including losses resulting from 
counterparty defaults and margin collateral failures, by requiring the 
firm to maintain an appropriate level of capital, including qualifying 
subordinated debt, to absorb such losses without becoming insolvent. 
With respect to swap positions, capital and margin perform 
complementary risk mitigation functions by protecting nonbank SDs, 
containing the amount of risk in the financial system as a whole, and 
reducing the potential for contagion arising from uncleared swaps.
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    \73\ See 7 U.S.C. 6s(e)(3)(A).
---------------------------------------------------------------------------

    The objective of the CFTC Financial Reporting Rules is to provide 
the Commission with the means to monitor and assess a nonbank SD's 
financial condition, including the nonbank SD's compliance with minimum 
capital requirements. The CFTC Financial Reporting Rules are designed 
to provide the Commission and NFA, which along with the Commission 
oversees nonbank SDs' compliance with Commission regulations, with a 
comprehensive view of the financial health and activities of the 
nonbank SD. The Commission's rules require nonbank SDs to file 
financial information, including periodic unaudited and annual audited 
financial statements, specific financial position information, and 
notices of certain events that may indicate a potential financial or 
operational issue that may adversely impact the nonbank SD's ability to 
meet its obligations to counterparties and other creditors in the swaps 
market, or impact the firm's solvency.
2. Regulatory Objective of Japanese Capital Rules and Japanese 
Financial Reporting Rules
    The regulatory objective of the Japanese Capital Rules is to ensure 
the safety and soundness of FIBOs, including Japanese nonbank SDs. The 
Japanese Capital Rules are designed to preserve the financial stability 
and solvency of a Japanese nonbank SD by requiring the firm to maintain 
a sufficient amount of qualifying equity and subordinated debt to 
absorb decreases in the value of firm assets and to cover losses from 
business activities, including counterparty defaults and margin 
collateral shortfalls associated with the firm's swap dealing 
activities. The Japanese Capital Rules also place an emphasis on high 
quality equity, as a Japanese nonbank SD must maintain at least 50 
percent of its minimum capital requirement in the form of Basic 
Items.\74\ The Japanese Capital Rules further enhance a Japanese 
nonbank SD's capital available to meet its minimum capital requirements 
by requiring the firm to subtract the balance sheet carrying value of 
its fixed assets from the firm's Basic Items in computing its minimum 
capital.\75\
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    \74\ The Japanese Capital Rules provide that the total amount of 
Supplemental Items must be less than the total amount of the 
Japanese nonbank SD's Basic Items. See Article 176(1)(vii) of the 
COO.
    \75\ Article 177 of the COO. The Japanese Capital Rules require 
a Japanese nonbank SD to deduct fixed assets from the firm's Basic 
Items to better ensure that the Japanese nonbank's regulatory 
capital represents more liquid assets that may be promptly 
liquidated at values comparable to carrying value to meet 
obligations to creditors and to cover losses.
---------------------------------------------------------------------------

    The objective of the Japanese Financial Reporting Rules is to 
enable the FSA to assess the financial condition and safety and 
soundness of Japanese nonbank SDs. The Japanese Financial Reporting 
Rules aim to achieve this objective by requiring each Japanese nonbank 
SD to provide financial reports and other financial position and 
capital information to the FSA on a regular basis. The financial 
reporting by a Japanese nonbank SD provides the FSA with information 
necessary to effectively monitor the Japanese nonbank SD's overall 
financial condition and its ability to meet its regulatory obligations 
as a FIBO.
3. Commission Analysis
    The Commission has reviewed the FSA Application and the relevant 
Japanese laws and regulations, and has preliminarily determined that 
the overall objectives of Japanese Capital Rules and CFTC Capital Rules 
are comparable in that both sets of rules are intended to ensure the 
safety and soundness of nonbank SDs by establishing a regulatory regime 
that requires nonbank SDs to maintain a sufficient amount of qualifying 
regulatory capital to absorb losses, including losses from swaps and 
other trading activities, and to absorb decreases in the value of firm 
assets without the nonbank SDs becoming insolvent. The Japanese Capital 
Rules and CFTC Capital Rules are also based on, and consistent with, 
the BCBS international bank capital framework, which was designed to 
ensure that banking entities hold sufficient levels of capital to 
absorb losses and decreases in the value of assets without the banks 
becoming insolvent.
    The Japanese Capital Rules are comparable in purpose and effect to 
the CFTC Capital Rules in that both regulatory approaches compute the 
minimum capital requirements based on the level of a nonbank SD's on-
balance sheet and off-balance sheet exposures, with the objective and 
purpose of ensuring that the nonbank SD's capital is adequate to absorb 
losses resulting from such exposures. The Japanese Capital Rules and 
CFTC Capital Rules also provide for a comparable approach to the 
calculation of on-balance sheet and off-balance sheet risk exposures 
using standardized or internal model-based approaches that result in 
comparable risk exposure amounts. The Japanese Capital Rules' and CFTC 
Capital Rules' requirements for identifying and measuring on-balance 
sheet and off-balance sheet exposures under standardized or internal 
model-based approaches are also consistent with the requirements set 
forth under the BCBS international bank capital framework for 
identifying and measuring on-balance sheet and off-balance sheet 
exposures.
    The Japanese Capital Rules and CFTC Capital Rules further achieve 
comparable outcomes and are comparable in purpose and effect in that 
both limit the types of capital instruments that may qualify as 
regulatory capital to cover the on-balance sheet and off-balance sheet 
risk exposures to high quality equity capital and qualifying 
subordinated debt instruments that meet conditions designed to ensure 
that the holders of

[[Page 48100]]

the debt have effectively subordinated their claims to other creditors 
of the nonbank SD. Both the Japanese Capital Rules and the CFTC Capital 
Rules define high quality capital by the degree to which the capital 
represents permanent capital that is contributed, or readily available 
to a nonbank SD, on an unrestricted basis to absorb unexpected losses, 
including losses from swaps trading and other activities, without the 
nonbank SD becoming insolvent.
    The Japanese Financial Reporting Rules are also comparable in 
purpose and effect with the CFTC Financial Reporting Rules as both the 
FSA and CFTC require nonbank SDs to file periodic financial reports, 
including unaudited financial reports and an annual audited financial 
report, detailing their financial operations and demonstrating their 
compliance with minimum capital requirements. In addition to providing 
the CFTC and FSA with information necessary to comprehensively assess 
the financial condition of a nonbank SD on an ongoing basis, the 
financial reports further provide the CFTC and FSA with information 
regarding potential changes in a nonbank SD's risk profile by 
disclosing changes in account balances reported over a period of time. 
Such changes in account balances may indicate that the nonbank SD has 
entered into new lines of business, has increased its activity in an 
existing line of business relative to other activities, or has 
terminated a previous line of business.
    The prompt and effective monitoring of the financial condition of 
nonbank SDs through the receipt and review of periodic financial 
reports supports the Commission and FSA in meeting their respective 
objectives of ensuring the safety and soundness of nonbank SDs. In this 
connection, the early identification of potential financial issues 
provides the Commission and FSA with an opportunity to address such 
issues with the nonbank SD before they develop to a state where the 
financial condition of the firm is impaired such that it may no longer 
hold a sufficient amount of qualifying regulatory capital to absorb 
decreases in the value of firm assets or cover losses from its business 
activities, including the firm's swap dealing activities and 
obligations to swap counterparties.
    The Commission invites public comment on its analysis above, 
including comment on the FSA Application and relevant Japanese laws and 
regulations.

B. Nonbank Swap Dealer Qualifying Capital

1. CFTC Capital Rules: Qualifying Capital Under Bank-Based Approach
    The CFTC Capital Rules require a nonbank SD electing the Bank-Based 
Approach to maintain regulatory capital in the form of common equity 
tier 1 capital, additional tier 1 capital, and tier 2 capital in 
amounts that meet certain stated minimum requirements set forth in 
Regulation 23.101.\76\ Common equity tier 1 capital, additional tier 1 
capital, and tier 2 capital are composed of certain defined forms of 
equity of the nonbank SD, including common stock, retained earnings, 
and qualifying subordinated debt.\77\ The Commission's requirement for 
a nonbank SD to maintain a minimum amount of defined qualifying capital 
and subordinated debt is intended to ensure that the firm maintains a 
sufficient amount of regulatory capital to absorb decreases in the 
value of the firm's assets and to cover losses resulting from the 
firm's swap dealing and other activities, without the firm becoming 
insolvent.
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    \76\ See 17 CFR 23.101(a)(1)(i).
    \77\ The terms ``common equity tier 1 capital,'' ``additional 
tier 1 capital,'' and ``tier 2 capital'' are defined in the bank 
holding company regulations of the Federal Reserve Board. See 12 CFR 
217.20.
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    Common equity tier 1 capital is generally composed of an entity's 
common stock instruments and any related surpluses, retained earnings, 
and accumulated other comprehensive income, and is a more conservative 
or permanent form of capital than additional tier 1 and tier 2 
capital.\78\ Additional tier 1 capital is generally composed of equity 
instruments such as preferred stock and certain hybrid securities that 
may be converted to common stock if triggering events occur.\79\ Total 
tier 1 capital is composed of common equity tier 1 capital and further 
includes additional tier 1 capital.\80\ Tier 2 capital includes certain 
types of instruments that include both debt and equity characteristics 
such as qualifying subordinated debt.\81\
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    \78\ 12 CFR 217.20.
    \79\ Id.
    \80\ Id.
    \81\ Id.
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    Subordinated debt must meet certain conditions to qualify as tier 2 
capital under the CFTC Capital Rules. Specifically, subordinated debt 
instruments must have a term of at least one year (with the exception 
of approved revolving subordinated debt agreements which may have a 
maturity term that is less than one year), and contain terms that 
effectively subordinate the rights of lenders to receive any payments, 
including accrued interest, to other creditors of the firm.\82\
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    \82\ The subordinated debt must meet the requirements set forth 
in SEC Rule 18a-1d (17 CFR 240.18a-1d). See 17 CFR 
23.101(a)(1)(i)(B).
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    Common equity tier 1 capital, additional tier 1 capital, and tier 2 
capital are permitted to be included in a nonbank SD's regulatory 
capital and used to meet the firm's minimum capital requirement due to 
their characteristics of being permanent forms of capital that are 
subordinate to the claims of other creditors, which ensures that a 
nonbank SD will have this regulatory capital to absorb decreases in the 
value of the firm's assets and losses from business activities, 
including swap dealing activities, without the firm becoming insolvent.
2. Japanese Capital Rules: Qualifying Capital
    The Japanese Capital Rules require each Japanese nonbank SD to 
maintain a ``capital adequacy amount'' (i.e., Basic Items and 
Supplemental Items) that equals or exceeds 120 percent of the firm's 
``risk equivalent amount,'' which is the sum of the firm's market risk, 
credit risk, and basic risk.\83\ Basic Items are composed of the 
Japanese nonbank SD's balance sheet capital including: issued and 
outstanding shares; (ii) the payment for an application for new shares; 
(iii) the capital surplus; (iv) the earned surplus; (v) the negative 
valuation difference on available-for-sale securities; and (vi) the 
firm's own treasury stock.\84\ Supplemental Items include the positive 
valuation difference on available-for-sale securities and certain 
subordinated debt instruments.\85\ Subordinated debt instruments also 
must meet certain conditions to qualify as Supplemental Items under the 
Japanese Capital Rules, including containing appropriate provisions 
subordinating the rights of the lender to the payment of principal and 
interest to other creditors of the Japanese nonbank SD.\86\ The 
Japanese Capital Rules also provide that a minimum of 50 percent of a 
Japanese nonbank SD's capital adequacy amount must be composed of Basic 
Items.\87\
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    \83\ See Article 46-6-2 of the FIEA, Article 176 of the COO and 
Section IV-2-1 (Preciseness of Capital Adequacy Ratio) of the 
Supervisory Guidelines for FIBO.
    \84\ See Article 176(1)(i) through (vi) of the COO.
    \85\ See Article 176(1)(vii) of the COO.
    \86\ Article 176(2) and (3) of the COO.
    \87\ FSA Application, pp. 14-15.
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    The Japanese Capital Rules further require a Japanese nonbank SD, 
in computing its capital adequacy amount, to deduct the balance sheet 
carrying

[[Page 48101]]

value of fixed assets from its Basic Items.\88\ The deduction of the 
carrying value of fixed assets is a conservative approach to the 
computation of a Japanese nonbank SD's capital adequacy amount as it 
excludes the value of non-liquid fixed assets from the firm's total 
Basic Items. The deduction of the carrying value of fixed assets from a 
Japanese nonbank SD's Basic Items reduces the amount of regulatory 
capital that the firm may recognize in meeting its capital 
requirements, and places an emphasis on the Japanese nonbank SD 
maintaining liquid assets to meet its minimum capital requirement to 
absorb business losses and decreases in the value of firm assets, and 
to satisfy financial obligations to counterparties and creditors.\89\
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    \88\ See Article 177 of the COO for a breakdown of the fixed 
assets to be deducted from the Basic Items.
    \89\ The Japanese Capital Rules require a Japanese nonbank SD to 
deduct illiquid fixed assets from its regulatory capital to better 
ensure that the firm's regulatory capital reflects assets that may 
be more promptly liquidated at values comparable to carrying values 
to meet losses. As discussed infra, under the CFTC Capital Rules, 
fixed assets are not deducted from regulatory capital, and are 
included in the nonbank SD's risk weighted assets.
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3. Commission Analysis
    The Commission has reviewed the FSA Application and the relevant 
Japanese laws and regulations, and has preliminarily determined that 
the Japanese Capital Rules are comparable in purpose and effect to CFTC 
Capital Rules with regard to the types and characteristics of a nonbank 
SD's equity that qualifies as regulatory capital in meeting its minimum 
requirements. The Japanese Capital Rules and the CFTC Capital Rules for 
nonbank SDs both require a nonbank SD to maintain a quantity of high-
quality and permanent capital that, based on the firm's activities and 
on-balance sheet and off-balance sheet exposures, is sufficient to 
absorb losses and decreases in the value of the firm's assets without 
resulting in the firm becoming insolvent.
    The Japanese Capital Rules and the CFTC Capital Rules permit 
nonbank SDs to recognize comparable forms of equity capital and 
qualifying subordinated debt instruments toward meeting minimum capital 
requirements, with both the Japanese Capital Rules and the CFTC Capital 
Rules placing an emphasis on high quality equity capital instruments. 
In this regard, the types and characteristics of the equity instruments 
included in Basic Items under the Japanese Capital Rules are comparable 
to the types and characteristics of equity instruments comprising 
common equity tier 1 capital and additional tier 1 capital under the 
CFTC Capital Rules. Specifically, the Japanese Capital Rules' Basic 
Items and the CFTC Capital Rules' common equity tier 1 capital and 
additional tier 1 capital are comparable in that these forms of equity 
capital have similar characteristics (e.g., the equity must be in the 
form of high-quality, committed, and permanent capital) and these forms 
of capital represent contributed equity capital that generally has no 
priority to the distribution of firm assets or income with respect to 
other shareholders or creditors of the firm, which allows a nonbank SD 
to use this equity to absorb decreases in the value of firm assets and 
cover losses from business activities, including the firm's swap 
dealing activities.
    Supplemental Items under the Japanese Capital Rules are also 
comparable to tier 2 capital under the CFTC Capital Rules. 
Specifically, the qualifying conditions imposed on subordinated debt 
instruments are comparable under the Japanese Capital Rules and the 
CFTC Capital Rules and ensure that the debt has qualities that support 
its recognition by a nonbank SD as equity for capital purposes, 
including that the debt lenders have effectively subordinated their 
claims for repayment on the debt to other creditors of the nonbank SD. 
Qualifying subordinated debt under the Japanese Capital Rules and CFTC 
Capital Rules also must contain provisions limiting or restricting 
repayment of the subordinated loans if such repayments result in the 
nonbank SD's equity falling below certain defined thresholds. These 
terms and conditions provide assurances that the subordinated debt is 
appropriate to be recognized as regulatory capital available to a 
nonbank SD to meet its obligations and to absorb business losses and 
decreases in the value of firm assets.
    The Japanese Capital Rules differ from the CFTC Capital Rules, 
however, in that the Japanese Capital Rules require Japanese nonbank 
SDs to exclude the carrying value of fixed assets from the sum of the 
Basic Items in computing the capital adequacy amount. The CFTC Capital 
Rules do not require a nonbank SD to exclude fixed assets from the 
firm's common equity tier 1 capital or additional tier 1 capital. The 
deduction of the carrying value of fixed assets is a stricter capital 
standard as it imposes an obligation on Japanese nonbank SDs to meet 
minimum regulatory capital requirements with assets that are more 
liquid than fixed assets.
    Having reviewed the FSA Application and the relevant Japanese laws 
and regulations, the Commission has made a preliminary determination 
that the Japanese Capital Rules and CFTC Capital Rules impose 
comparable requirements on Japanese nonbank SDs with respect to the 
types and characteristics of equity capital that must be used to meet 
minimum regulatory capital requirements. The Commission invites public 
comment on its analysis above, including comment on the FSA Application 
and relevant Japanese laws and regulations.

C. Nonbank Swap Dealer Minimum Capital Requirement

1. CFTC Capital Rules: Nonbank SD Minimum Capital Requirement
    The CFTC Capital Rules require a nonbank SD electing the Bank-Based 
Approach to maintain regulatory capital that satisfies each of the 
following criteria: (i) an amount of common equity tier 1 capital of at 
least $20 million; (ii) an aggregate of common equity tier 1 capital, 
additional tier 1 capital, and tier 2 capital in an amount equal to or 
in excess of 8 percent of the nonbank SD's uncleared swap margin 
amount: (iii) an aggregate amount of common equity tier 1 capital, 
additional tier 1 capital, and tier 2 capital equal to or greater than 
8 percent of the nonbank SD's total risk-weighted assets, provided that 
common equity tier 1 capital comprises at least 6.5 percent of the 8 
percent; and (iv) the amount of capital required by the NFA.\90\
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    \90\ See 17 CFR 23.101(a)(1)(i). NFA has not adopted a separate 
capital requirement for a nonbank SD.
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    Prong (i) above requires each nonbank SD electing the Bank-Based 
Approach to maintain a minimum of $20 million of common equity tier 1 
capital in order to operate as a nonbank SD. The requirement that each 
nonbank SD electing the CFTC Bank-Based Approach maintain a minimum of 
$20 million of common equity tier 1 capital is also consistent with the 
minimum capital requirement for nonbank SDs electing the NLA Approach 
and the TNW Approach.\91\ The Commission adopted this minimum 
requirement as it believed that the role a nonbank SD performs in the 
financial markets by engaging in swap dealing activities warranted a 
minimum level of capital, stated as a fixed dollar amount that does not 
fluctuate with the level of the firm's

[[Page 48102]]

dealing activities, to help ensure that the firm meets its financial 
commitments to swap counterparties and creditors without the firm 
becoming insolvent.\92\
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    \91\ Nonbank SDs electing the NLA Approach are subject to a 
minimum capital requirement that includes a fixed minimum dollar 
amount of net capital of $20 million. See 17 CFR 
23.101(a)(1)(ii)(A)(1). Nonbank SDs electing the TNW Approach are 
required to maintain levels of tangible net worth that equals or 
exceeds $20 million plus the amount of the nonbank SDs' market risk 
and credit risk associated with the firms' dealing activities. See 
17 CFR 23.101(a)(2)(ii)(A).
    \92\ See, e.g., 85 FR 57492.
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    Prong (ii) above is a minimum capital requirement that is based on 
the amount of uncleared margin for swap transactions entered into by 
the nonbank SD and is computed on a counterparty by counterparty basis. 
The requirement for a nonbank SD to maintain minimum capital equal to 8 
percent of the firm's uncleared swap margin provides a capital floor 
based on a measure of the risk and volume of the swap positions, and 
the number of counterparties and the complexity of operations, of the 
nonbank SD. The intent of the minimum capital requirement based on a 
percentage of the nonbank SD's uncleared swap margin was to establish a 
minimum capital requirement that would help ensure that the nonbank SD 
meets all of its obligations as a SD to market participants, and to 
cover potential operational risk, legal risk and liquidity risk in 
addition to the risks associated with its trading portfolio.\93\
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    \93\ See, 85 FR 57462.
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    Prong (iii) above is a minimum capital requirement that is based on 
the Federal Reserve Board's capital requirements for bank holding 
companies and is consistent with the BCBS international capital 
adequacy framework for banking institutions. As noted above, a nonbank 
SD under prong (iii) must maintain an aggregate of common equity tier 1 
capital, additional tier 1 capital, and tier 2 capital in an amount 
equal to or greater than 8 percent of the nonbank SD's total risk-
weighted assets, with common equity tier 1 capital comprising at least 
6.5 percent of the 8 percent. Risk-weighted assets are a nonbank SD's 
on-balance sheet and off-balance sheet exposures, including proprietary 
swap, security-based swap, equity, and futures positions, weighted 
according to risk. The Bank-Based Approach requires each nonbank SD to 
maintain regulatory capital in an amount that equals or exceeds 8 
percent of the firm's total risk-weighted assets to help ensure that 
the nonbank SD's level of capital is sufficient to absorb decreases in 
the value of the firm's assets and unexpected losses resulting from 
business activities, including uncollateralized defaults from swap 
counterparties, without the nonbank SD becoming insolvent.
    A nonbank SD must compute its risk-weighted assets using 
standardized market risk and/or credit risk charges, unless the nonbank 
SD has been approved by the Commission or NFA to use internal 
models.\94\ For standardized market risk charges, the Commission adopts 
by reference the standardized market risk charges set forth in 
Regulation 1.17 for FCMs and SEC Rule 18a-1 for nonbank SBSDs.\95\ The 
standardized market risk charges under Regulation 1.17 and SEC Rule 
18a-1 are calculated as a percentage of the market value or notional 
value of the nonbank SD's marketable securities and derivatives 
positions, with the percentages applied to the market value or notional 
value increasing as the expected or anticipated risk of the positions 
increases.\96\ As stated above, the nonbank SD must maintain qualifying 
capital in an amount that equals or exceeds 8 percent of the firm's 
total market risk-weighted assets.\97\
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    \94\ See 17 CFR 23.101(a)(1)(i)(B) and the definition of the 
term BHC equivalent risk-weighted assets in 17 CFR 23.100.
    \95\ See paragraph (3) of the definition of the term BHC 
equivalent risk-weighted assets in 17 CFR 23.100.
    \96\ See 17 CFR 1.17(c)(5) and 17 CFR 240.18a-1(c)(1).
    \97\ See 17 CFR 23.100 (definition of BHC equivalent risk-
weighted assets). As noted, a nonbank SD is required to maintain 
qualifying capital (i.e., an aggregate of common equity tier 1 
capital, additional tier 1 capital, and tier 2 capital) in an amount 
that exceeds 8 percent of its market risk-weighted assets and 
credit-risk-weighted assets. The regulations, however, require the 
nonbank SD to effectively maintain qualifying capital in excess of 
100 percent of is market risk-weighted assets by requiring the 
nonbank SD to multiply its market-risk weighted assets by a factor 
of 12.5.
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    With respect to standardized credit risk charges for exposures from 
non-derivatives positions, a nonbank SD computes its on-balance sheet 
and off-balance sheet exposures in accordance with the standardized 
credit risk charges adopted by the Federal Reserve Board and set forth 
in Subpart D of 12 CFR 217.\98\ Standardized credit risk charges are 
computed by multiplying the amount of the exposure by defined 
counterparty credit risk factors that range from 0 percent to 150 
percent.\99\ A nonbank SD with off-balance sheet exposures is required 
to calculate a credit risk charge by multiplying each exposure by a 
credit conversion factor that ranges from 0 percent to 100 percent, 
depending on the type of exposure.\100\
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    \98\ See 23.101(a)(1)(i)(B) and paragraph (1) of the definition 
of the term BHC equivalent risk-weighted assets in 17 CFR 23.100.
    \99\ See 17 CFR 217.32. Lower credit risk factors are assigned 
to entities with lower credit risk and higher credit risk factors 
are assigned to entities with higher credit risk. For example, a 
credit risk factor of 0% is applied to exposures to the U.S. 
government, the Federal Reserve Bank, and U.S. government agencies 
(see 12 CFR 217.32(a)(1)), and a credit risk factor of 100% is 
assigned to an exposure to foreign sovereigns that are not members 
of the Organization of Economic Co-operation and Development (see 12 
CFR 217.32(a)(2)).
    \100\ See 17 CFR 217.33.
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    A nonbank SD may compute standardized credit risk charges for 
derivatives positions, including uncleared swaps and non-cleared 
security-based swaps, using either the current exposure method 
(``CEM'') or the standardized approach for measuring counterparty 
credit risk (``SA-CCR'').\101\ Both CEM and SA-CCR are non-model, 
rules-based, approaches to calculating counterparty credit risk for 
derivatives positions. Credit risk under CEM is the sum of: (i) the 
current exposure (i.e., the positive mark-to-market) of the derivatives 
contract; and (ii) the potential future exposure, which is calculated 
as the product of the notional principal amount of the derivatives 
contract multiplied by a standard credit risk conversion factor set 
forth in the rules of the Federal Reserve Board.\102\ Credit risk under 
SA-CCR is defined as the exposure at default amount of a derivatives 
contract, which is computed as the sum of: (i) the replacement costs of 
the contract (i.e., the positive mark-to market); and (ii) the 
potential future exposure of the contract multiplied by a factor of 
1.4.\103\
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    \101\ See 17 CFR 217.34. See also, Regulation 23.100 (17 CFR 
23.100) defining the term BHC risk-weighted assets, which provides 
that a nonbank SD that does not have model approval may use either 
CEM or SA-CCR to compute its exposures for over-the-counter 
derivative contracts without regard to the status of its affiliate 
entities to use CEM or SA-CCR under the Federal Reserve Board's 
capital rules.
    \102\ See 12 CFR 217.34.
    \103\ See 12 CFR 217.132(c).
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    A nonbank SD also may obtain approval from the Commission or NFA to 
use internal models to compute market risk and/or credit risk charges 
in lieu of the standardized charges. A nonbank SD seeking approval to 
use an internal model is required to submit an application to the 
Commission or NFA.\104\ The application is required to include, among 
other things, a list of categories of positions that the nonbank SD 
holds in its proprietary accounts and a brief description of the 
methods that the nonbank SD will use to calculate deductions for market 
risk and/or credit risk charges for such positions, as well as a 
description of the mathematical models used to compute market risk and 
credit risk charges.
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    \104\ See 17 CFR 23.102(c).
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    A nonbank SD approved by the Commission or NFA to use internal 
models to compute market risk is required to comply with Subpart F of 
the Federal Reserve Board's Part 217

[[Page 48103]]

regulations (``Subpart F'').\105\ Subpart F is based on models that are 
consistent with the BCBS Basel 2.5 capital framework.\106\ The 
Commission's qualitative and quantitative requirements for internal 
capital models also are comparable to the SEC's existing internal 
capital model requirements for broker-dealers in securities and 
SBSDs,\107\ which are also broadly based on the BCBS Basel 2.5 capital 
framework.
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    \105\ See paragraph (4) of the definition of BHC equivalent 
risk-weighted assets in 17 CFR 23.100.
    \106\ Compare 17 CFR 23.100 (providing for a nonbank SD that is 
approved to use internal models to calculate market and credit risk 
to calculate its RWAs using Subparts E and F of 12 CFR part 217), 
Subpart F of 12 CFR, 17 CFR 23.101(a)(1)(ii) (providing for an SD 
that elects the Net Liquid Assets Approach to calculate its net 
capital in accordance with Rule 18a-1), and 17 CFR 23.102(a), with 
Basel Committee on Banking Supervision, Revisions to the Basel II 
Market Risk Framework (2011), https://www.bis.org/publ/bcbs193.pdf 
(describing the revised internal model approach under Basel 2.5).
    \107\ The SEC internal model requirements for SBSDs are listed 
in 17 CFR 240.18a-1(d). See also SEC FOCUS Report Part II, 
Computation of Net Capital (Filer Authorized to Use Models) 
(providing for inclusion of a market risk exposure section for Basel 
2.5 firms).
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    A nonbank SD approved to use internal models to compute credit risk 
is required to perform such computation in accordance with Subpart E of 
the Federal Reserve Board's Part 217 regulations.\108\ These internal 
credit risk modeling requirements are also based on the Basel 2.5 
capital framework and the Basel 3 capital framework.
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    \108\ 12 CFR 217 Subpart E.
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    Under the Basel 2.5 capital framework, nonbank SDs have flexibility 
in developing their internal models, but must follow certain minimum 
standards. Internal market risk and credit risk models must follow a 
Value at Risk (``VaR'') structure to compute, on a daily basis, a 99th 
percentile, one-tailed confidence interval for the potential losses 
resulting from an instantaneous price shock equivalent to a 10-day 
movement in prices (unless a different time-frame is specifically 
indicated). The simulation of this price shock must be based on a 
historical observation period of minimum length of one year, but there 
is flexibility on the method used to render simulations, such as 
variance-covariance matrices, historical simulations, or Monte Carlo.
    The Commission and the Basel standards for internal models also 
have requirements on the selection of appropriate risk factors as well 
as on data quality and update frequency.\109\ One specific concern is 
that internal models must capture the non-linear price characteristics 
of options positions, including but not limited to, relevant 
volatilities at different maturities.\110\
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    \109\ See 17 CFR Appendix A to Subpart E of Part 23(i)(2)(iii), 
and Basel Committee on Banking Supervision, Revisions to the Basel 
II Market Risk Framework (2011), paragraph 718(Lxxvi)(e), available 
at: https://www.bis.org/publ/bcbs193.pdf.
    \110\ The Commission's requirement is set forth in paragraph 
(i)(2)(iv)(A) of Appendix A to Subpart E of 17 CFR part 23. See 
also, Basel Committee on Banking Supervision, Revisions to the Basel 
II Market Risk Framework (2011), paragraph 718(Lxxvi)(h), available 
at: https://www.bis.org/publ/bcbs193.pdf.
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    In addition, BCBS standards for market risk models include a series 
of additive components for risks for which the broad VaR is ill-suited 
or that may need targeted calculation. These include the calculation of 
a Stressed VaR measure (with the same specifications as the VaR, but 
calibrated to historical data from a continuous 12-month period of 
significant financial stress relevant to the firm's portfolio); a 
Specific Risk measure (which includes the effect of a specific 
instrument); an Incremental Risk measure (which addresses changes in 
the credit rating of a specific obligor which may appear as a reference 
in an asset); and a Comprehensive Risk measure (which addresses risk of 
correlation trading positions).
2. Japanese Capital Rules: Japanese Nonbank Swap Dealer Minimum Capital 
Requirements
    The Japanese Capital Rules impose bank-like capital requirements on 
a Japanese nonbank SD that, consistent with the BCBS international bank 
capital framework, require the Japanese nonbank SD to hold a sufficient 
amount of qualifying equity capital and subordinated debt to absorb 
decreases in the value of a firm assets and to cover losses from its 
business activities, including the firm's swap dealing activities, 
without the firm becoming insolvent. Specifically, the Japanese Capital 
Rules require each Japanese nonbank SD to maintain a ``capital adequacy 
amount'' that equals or exceeds 120 percent of the firm's ``risk 
equivalent amount.'' \111\ The ``capital adequacy amount'' is 
calculated as the Japanese nonbank SD's qualifying balance sheet equity 
capital in the form of Basic Items and Supplemental Items. The Japanese 
Capital Rules further require that at least 50 percent of the Japanese 
nonbank SD's capital used to meet the 120 percent minimum requirement 
must be composed of Basic Items, and any subordinated debt included in 
Supplemental Items must meet regulatory requirements designed to ensure 
that the debt is adequately subordinated to claims of other potential 
creditors of the firm.\112\
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    \111\ Article 46-6(2) of the FIEA, Article 176 of the COO and 
Section IV-2-1 (Preciseness of Capital Adequacy Ratio) of the 
Supervisory Guidelines for FIBO.
    \112\ Article 176(1)(vii) of the COO.
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    The Japanese nonbank SD's ``risk equivalent amount'' is calculated 
as the sum of the: (i) market risk equivalent amount; (ii) counterparty 
risk equivalent amount; and (iii) basic risk equivalent amount.\113\ 
Comparable to nonbank SDs under the CFTC Bank-Based Approach, the 
Japanese Capital Rules require Japanese nonbank SDs to compute market 
risk and/or credit risk using a standardized approach or, if approved 
to use internal models, market risk and/or credit risk models. The 
basic risk equivalent amount is computed as an amount equal to 25 
percent of the Japanese nonbank SD's defined annual operating expenses, 
and is intended to provide a capital cushion to cover risks that may 
accrue in the course of executing ordinary business operations, such as 
error in business transactions.\114\
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    \113\ Article 46-6(2) of the FIEA, Article 176 of the COO and 
Section IV-2-1 (Preciseness of Capital Adequacy Ratio) of the 
Supervisory Guidelines for FIBO.
    \114\ Article 178(1)(iii) of the COO and Article 16 of the 
Notice on Capital.
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    For standardized market risk charges, the Japanese Capital Rules 
require a Japanese nonbank SD to calculate a market risk equivalent 
amount to reflect possible decreases in value of the firm's financial 
positions including equity risk, interest rate risk, foreign exchange 
risk, commodity risk, crypto asset risk, and option risk.\115\ The 
market risk equivalent amount is calculated by the Japanese nonbank SD 
by multiplying specified market risk charges set forth in the Japanese 
Capital Rules by the notional or market value of the relevant assets 
and positions. A Japanese nonbank SD is further required to include the 
full value of its market risk equivalent amount in its aggregate risk 
equivalent amount, which effectively requires the Japanese nonbank SD 
to hold qualifying equity capital and subordinated debt in an amount 
that equals or exceeds 120 percent of the market risk equivalent 
amount.
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    \115\ FSA Notice No. 59 of 2007, Chapter III, Section 2, Article 
4.
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    With respect to credit risk for non-derivatives positions, the 
Japanese Capital Rules require a Japanese nonbank SD to calculate its 
standardized counterparty risk equivalent amount by multiplying its 
exposure under a given transaction by the specific risk weight 
applicable to the counterparty under the provisions of the

[[Page 48104]]

Japanese Capital Rules. In this regard, the Japanese Capital Rules 
impose risk-weights ranging from 0 percent to 25 percent on exposures 
to governmental financial institutions, non-governmental financial 
institutions, general corporations, and individuals.\116\ For certain 
exposures, credit ratings are used to determine the percentage of the 
counterparty credit risk exposure and, if no credit ratings are 
available, the Japanese nonbank SD generally applies a 25 percent risk-
weight.
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    \116\ Article 15(3) of the Notice on Capital.
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    A Japanese nonbank SD is required to include the full amount of the 
counterparty risk equivalent in its aggregate risk equivalent amount. 
Therefore, a Japanese nonbank SD is effectively required to maintain a 
capital adequacy amount that is equal to or in excess of 120 percent of 
its credit risk equivalent amount.
    With respect to credit risk for derivatives positions, the Japanese 
Capital Rules require a Japanese nonbank SD that is not approved to use 
credit risk models to calculate its exposure using the CEM, which is 
one of the standardized methods that a nonbank SD may use to calculate 
its credit risk exposure under a derivatives transaction pursuant to 
the Commission's Bank-Based Approach.\117\ Under the CEM, a Japanese 
nonbank SD calculates its exposures for over-the-counter derivatives 
using a standardized rules-based approach, and is required to hold an 
amount of qualifying capital that equals or exceeds 120 percent of the 
aggregate derivatives exposures.
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    \117\ See 17 CFR 23.101(a)(1)(i) and supra, note 78.
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    Japanese nonbank SDs may use internal models approved by the FSA to 
calculate their market risk equivalent amount and/or counterparty risk 
equivalent amount in lieu of the standardized charges. Japanese Capital 
Rules set out qualitative and quantitative requirements \118\ that 
internal models must meet in order to be approved for use. The Japanese 
Capital Rules also require Japanese nonbank SDs to satisfy qualitative 
and quantitative requirements in order to continue to use models after 
obtaining the initial approval. These qualitative and quantitative 
requirements address: the effective review and assessment of models 
during development, validation, and periodic examinations; 
identification of key assumptions and limitations; and management of 
model risk. In this regard, Japanese nonbank SDs approved to use 
internal models for capital purposes are subject to principles for 
model risk management.\119\ The principles lay out practices for 
nonbank SDs, covering model governance, model risk rating, 
documentation, testing, monitoring, independent validation, controls of 
vendor products and external resources, and internal audit. The ongoing 
monitoring includes frequent tests, such as stress testing, backtesting 
and benchmarking. The FSA periodically confirms that firms using models 
are adhering to the conditions set.
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    \118\ Article 13 of the Notice on Capital.
    \119\ Principles for Model Risk Management, Financial Services 
Agency (November 12, 2021). The principles are available at: https://www.fsa.go.jp/en/news/2021/2021112en.html.
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    The internal market risk model-based methodology contained in the 
Japanese Capital Rules is based on the Basel 2.5 standard,\120\ and 
requires a Japanese nonbank SD to use a VaR model with a 99 percent, 
one-tailed confidence level with: (i) price changes equivalent to a 10 
business-day movement in rates and prices; (ii) effective historical 
observation periods of at least one year; and (iii) at least monthly 
data set updates.\121\ The Japanese Capital Rules require a Japanese 
nonbank SD using approved internal models for market risk to calculate 
a stressed VaR, specific risk, incremental risk, and comprehensive risk 
of correlation trading.\122\
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    \120\ Compare Article 1 through 14-11 of the Notice on Capital 
with Revisions to the Basel II Market Risk Framework.
    \121\ Article 13(3)(i), (ii) and (iv) of the Notice on Capital.
    \122\ Article 13-2 and 14-9 of the Notice on Capital.
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    The Japanese Capital Rules' internal credit risk model-based 
methodology is also based on the Basel 2.5 standard. The Japanese 
Capital Rules allow for the estimation of expected exposure, as a 
measure of potential future exposure, based on VaR techniques as well, 
with adjustments to the period of risk, as appropriate to the asset and 
counterparty.\123\ Credit risk models may include internal ratings 
based on the estimation of default probabilities, consistent with the 
Basel framework and subject to the same model risk management 
guidelines.
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    \123\ FSA Notice 15.2-2.
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3. Commission Analysis
    The Commission has reviewed the FSA Application and the relevant 
Japanese laws and regulations, and has preliminarily determined that 
the Japanese Capital Rules are comparable in purpose and effect to CFTC 
Capital Rules with regard to the establishment of a nonbank SD's 
minimum capital requirement and the calculation of the nonbank SD's 
amount of regulatory capital. Although there are differences in the 
minimum capital requirements and calculation of regulatory capital 
between the Japanese Capital Rules and the CFTC Capital Rules, as 
discussed below, the Commission preliminarily believes that the 
Japanese Capital Rules and CFTC Capital Rules are designed to ensure 
the safety and soundness of a nonbank SD and, subject to the proposed 
condition discussed below, will achieve comparable outcomes by 
requiring the firm to maintain a minimum level of qualifying regulatory 
capital and subordinated debt to absorb losses from the firm's business 
activities, including its swap dealing activities, and decreases in the 
value of the firm's assets, without the nonbank SD becoming insolvent.
    The CFTC Capital Rules require a nonbank SD electing the Bank-Based 
Approach to maintain regulatory capital in an amount that meets or 
exceeds each of the following requirements: (i) $20 million of common 
equity tier 1 capital; (ii) 8 percent of the nonbank SD's uncleared 
swap margin amount; (iii) 8 percent of the nonbank SD's risk-weighted 
assets (with common equity tier 1 capital comprising at least 6.5 
percent of the 8 percent);and (iv) the amount of capital required by 
NFA.\124\ The Japanese Capital Rules require a Japanese nonbank SD to 
maintain regulatory capital in an amount equal to or in excess of 9.6 
percent of the market risk, credit risk, and operational risk of the 
firm.\125\
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    \124\ 17 CFR 23.101(a)(1)(i). NFA has not adopted additional 
capital requirements for nonbank SDs and, therefore, an analysis of 
the comparability of this element of the CFTC Capital Rules with the 
Japanese Capital Rules is not applicable.
    \125\ The Japanese Capital Rules require a Japanese nonbank SD 
to maintain a capital adequacy amount that equals or exceeds 120 
percent of its risk-weighted assets. Adjusting the Japanese Capital 
Rules approach to be consistent with the CFTC Capital Rules approach 
results in a Japanese nonbank SD having an effective minimum capital 
requirement of 9.6 percent of its risk weighted assets.
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    The Japanese Capital Rules differ from the CFTC Capital Rules in 
that the Japanese Capital Rules do not impose a capital requirement on 
Japanese nonbank SDs based on a minimum dollar amount or based on a 
percentage of the margin for uncleared swap transactions. However, the 
approach for conducting a Capital Comparability Determination is a 
principles-based, holistic approach that focuses on whether the 
applicable foreign jurisdiction's capital requirements achieve 
comparable outcomes to the corresponding CFTC requirements for nonbank 
SDs.\126\ The focus of the comparability determination is on

[[Page 48105]]

whether the foreign jurisdiction's capital requirements are comparable 
to the Commission's in purpose and effect, and not on whether the 
foreign jurisdiction's capital requirements are comparable in every 
aspect or contain identical elements based on a line-by-line assessment 
or comparison of the foreign jurisdiction's regulatory requirements 
with the Commission's regulatory requirements.\127\
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    \126\ 17 CFR 23.106(a)(3)(ii). See also 85 FR 57520 at 57521.
    \127\ Id.
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    Based on a principles-based assessment, the Commission 
preliminarily believes, subject to the proposed condition below, and 
further subject to its consideration of public comments to the proposed 
Capital Comparability Determination and Order, that the purpose and 
effect of the Japanese Capital Rules and the CFTC Capital Rules are 
comparable. In this connection, the Japanese Capital Rules and CFTC 
Capital rules are both designed to require a nonbank SD to maintain a 
sufficient amount of qualifying regulatory capital and subordinated 
debt to absorb losses resulting from the firm's business activities, 
and decreases in the value of firm assets, without the nonbank SD 
becoming insolvent. As discussed below, the Commission specifically 
seeks public comment on the question of whether requirements under the 
Japanese Capital Rules are comparable in purpose and effect to the 
Commission's requirement for a nonbank SD to hold regulatory capital 
equal to or greater than 8 percent of its uncleared swap margin amount.
    The Commission preliminarily believes that the Japanese Capital 
Rules and CFTC Capital Rules impose a comparable approach by requiring 
a nonbank SD to maintain qualifying equity capital and qualifying 
subordinated debt in an amount that equals or exceeds the nonbank SD's 
risk-weighted assets, which are composed of the aggregate of the firm's 
market risk and credit risk charges. The Japanese Capital Rules, 
however, require a Japanese nonbank SD to maintain a higher percentage 
of regulatory capital relative to the firm's risk-weighted assets than 
the CFTC Capital Rules require. Specifically, the Japanese Capital 
Rules require a Japanese nonbank SD to maintain regulatory capital 
equal to or greater than 9.6 percent of the firm's risk-weighted 
assets.\128\
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    \128\ As previously noted, the Japanese Capital Rules require a 
Japanese nonbank SD to maintain a capital adequacy amount that 
equals or exceeds 120 percent of its risk-weighted assets. For 
purposes of comparison of the two rules, the Japanese Capital Rules 
effectively require a Japanese nonbank SD to maintain an effective 
minimum capital ratio of 9.6 percent of the firm's risk-weighted 
assets and the CFTC Capital Rules require a nonbank SD to maintain a 
minimum capital ratio of 8 percent of the firm's risk-weighted 
assets.
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    Furthermore, the Japanese Capital Rules add operational risk to the 
market risk and credit risk charges in setting the minimum capital 
requirements whereas the CFTC Capital Rules sets operational risk as a 
separate minimum capital requirement from the market risk and credit 
risk calculation of the risk weighted assets.\129\ Specifically, as 
noted above, under the Japanese Capital Rules the basic risk equivalent 
amount is computed as an amount equal to 25 percent of the Japanese 
nonbank SD's defined annual operating expenses, and is intended to 
provide a capital cushion to cover risks that may accrue in the course 
of executing ordinary business operations, such as error in business 
transactions.\130\ In addition, the Japanese Capital Rules require a 
Japanese nonbank SD to deduct the carrying value of fixed assets from 
its Basic Items in computing its regulatory capital, which promotes a 
degree of liquidity into the Japanese nonbank SD's regulatory capital. 
The Commission preliminarily believes the inclusion of an operational 
risk charge with the market risk and credit risk charges, and the 
deduction of the carrying value of fixed assets from regulatory 
capital, will achieve a comparable outcome to the Commission's 
requirement for nonbank SDs to hold regulatory capital in excess of 8 
percent of its uncleared swap margin amount. The Commission 
specifically seeks public comment below on the comparability of this 
Commission requirement with the Japanese requirements designed to 
address operational risk.
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    \129\ In establishing the requirement that a nonbank SD must 
maintain a level of regulatory capital in excess of 8 percent of the 
uncleared swap margin amount associated with the firm's swap 
transactions, the Commission stated that the intent of the uncleared 
swap margin amount was to establish a method of developing a minimum 
amount of capital for a nonbank SD to meet all of its obligations as 
a SD to market participants, and to cover potential operational 
risk, legal risk and liquidity risk, and not just the risks of its 
trading portfolio. See, 85 FR 57462 at 57485.
    \130\ Article 178(1)(iii) of the COO and Article 16 of the 
Notice on Capital. The basic risk equivalent amount is calculated as 
25 percent of certain defined operating expenses incurred by the 
Japanese nonbank SD over a 12-month period, and includes general 
expenses, selling expenses, and financial expenses.
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    The calculation of market risk charges and credit risk charges is 
also comparable under the Japanese Capital Rules and the CFTC Capital 
Rules. Both regimes require a nonbank SD to use standardized approaches 
to compute market and credit risk, unless the firms are approved to use 
internal models. The standardized approaches follow the same structure 
that is now the common global standard: allocating assets to categories 
according to risk and assigning each a risk weight; allocating 
counterparties to categories according to risk assessments and 
assigning each a risk factor; calculating gross exposures based on the 
valuation of assets; calculating a net exposure allowing offsets 
following well defined procedures and subject to clear limitations; 
adjusting the net exposure by the market risk weights; and finally, for 
credit risk exposures, multiplying the sum of net exposures to each 
counterparty by the corresponding risk factor. After reviewing the 
standardized risk weights contained in the Japanese Capital Rules and 
the CFTC Capital Rules, the Commission preliminarily believes that the 
resulting risk charges are comparable for corresponding categories of 
instruments and credit exposures.
    Internal market risk and credit risk models under the Japanese 
Capital Rules and the CFTC Capital Rules are based on the BCBS 
framework and contain comparable quantitative and qualitative 
requirements covering the same risks, including comparable model risk 
management requirements. As both rule sets address the same types of 
risk, with similar allowed methodologies, calibrated to similar risk 
levels and under similar controls, the Commission preliminarily 
believes that these requirements are comparable, as they produce 
similar market and credit risk charges for comparable exposures. Market 
risk charges increase capital requirements, or conversely are deducted 
from available capital, in full amount. Credit risk charges increase 
capital requirements, or conversely are deducted from available 
capital, with an adjustment. This adjustment to credit risk charges is 
applied in the CFTC Capital Rules as a final multiplication of credit 
risk weights by 8 percent, while the Japanese Capital Rules apply a 
comparable adjustment directly via the counterparty risk weights. The 
Japanese Capital Rules and the CFTC Capital Rules contain comparable 
requirements for the management of model risk, which depend on a series 
of controls, including the independence of validation, ongoing 
monitoring and audit. The ongoing monitoring includes frequent tests, 
such as stress testing, backtesting and benchmarking.
    The Japanese Capital Rules differ from the CFTC Capital Rules in 
that the Japanese Capital Rules do not contain a requirement that each 
Japanese nonbank

[[Page 48106]]

SD maintain a fixed amount of regulatory capital. As noted previously, 
the requirement in the CFTC Capital Rules for a non-bank SD to maintain 
a minimum of $20 million of common equity tier 1 capital is intended to 
ensure that each nonbank SD maintains a level of capital, without 
regard to the firm's level of dealing activities, sufficient to meet 
its obligations to swap market participants given the firm's status as 
a registered SD.
    The Commission preliminarily believes that each CFTC-registered 
nonbank SD should maintain a minimum level of regulatory capital to 
help ensure that it satisfies its regulatory obligations and meets is 
financial commitments to swap counterparties and creditors without the 
firm becoming insolvent. Therefore, the Commission is proposing to 
condition the proposed Capital Comparability Determination Order to 
require each Japanese nonbank SD to maintain a minimum level of 
regulatory capital in the form of Basic Items, as defined in Article 
176 of the COO. Specifically, the proposed condition would require each 
Japanese nonbank SD to maintain at all times regulatory capital in the 
form of Basic Items in an amount denominated in yen that is equivalent 
to or greater than $20 million in U.S. dollars. The Commission is also 
proposing that a Japanese nonbank SD may convert the yen-denominated 
amount of its Basic Items to the U.S. dollar equivalent based on a 
commercially reasonable and observed exchange rate.
    Having compared the minimum capital requirements and the 
calculation of regulatory capital under the Japanese Capital Rules for 
Japanese nonbank SDs with the corresponding minimum capital 
requirements and calculation of regulatory capital under the CFTC's 
Capital Rules for nonbank SDs, the Commission preliminarily finds that, 
subject to the proposed condition discussed above, the minimum capital 
requirements and calculation of regulatory capital are comparable. The 
Commission invites public comment on its analysis above, including 
comment on the FSA Application and Japanese laws and regulations, and 
the Commission's preliminary determination that the Japanese Capital 
Rules and the CFTC Capital Rules are comparable in purpose and effect 
and achieve comparable outcomes with respect to the minimum regulatory 
capital requirements and the calculation of regulatory capital for 
nonbank SDs.
    The Commission also specifically seeks public comment on the 
question of whether the requirement under the Japanese Capital Rules 
for a Japanese nonbank SD to hold qualifying capital in an amount equal 
to 25 percent of its defined annual operating expenses is sufficiently 
comparable in purpose and effect to the CFTC's requirement for a 
nonbank SD to hold qualifying capital in amount equal to at least 8 
percent of the nonbank SD's uncleared swap margin amount.
    The Commission further requests comment on the proposed condition 
that each Japanese nonbank SD maintains a minimum level of regulatory 
capital in the form of yen-denominated Basic Items (as defined in 
Article 176 of the COO) that equals or exceeds the equivalent of $20 
million U.S. dollars. Lastly, the Commission requests comment on the 
proposed requirement that a Japanese nonbank SD determine the amount of 
yen-denominated Basic Items it holds in U.S. dollars by using a 
commercially reasonable and observed yen/U.S. dollar exchange rate.

D. Nonbank Swap Dealer Financial Reporting Requirements

1. CFTC Financial Recordkeeping and Reporting Rules for Nonbank Swap 
Dealers
    The CFTC Financial Reporting Rules impose financial recordkeeping 
and reporting requirements on nonbank SDs. In this regard, the CFTC 
Financial Reporting Rules require each nonbank SD to prepare and keep 
current ledgers or similar records summarizing each transaction 
affecting the nonbank SD's asset, liability, income, expense, and 
capital accounts.\131\ The nonbank SD's ledgers and similar records 
must be prepared in accordance with generally accepted accounting 
principles as adopted in the United States (``U.S. GAAP''), except that 
if the nonbank SD is not otherwise required to prepare financial 
statements in accordance with U.S. GAAP, the nonbank SD may prepare and 
maintain its accounting records in accordance with International 
Financial Reporting Standards (``IFRS'') issued by the International 
Accounting Standards Board.\132\
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    \131\ 17 CFR 23.105(b).
    \132\ Id.
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    The CFTC Financial Reporting Rules also require each nonbank SD to 
prepare and file with the Commission and NFA periodic unaudited and 
annual audited financial statements.\133\ A nonbank SD that elects the 
TNW Approach is required to file unaudited financial statements within 
17 business days of the close of each fiscal quarter, and its annual 
audited financial statements within 90 days of its fiscal year-
end.\134\ A nonbank SD that elects either the NLA Approach or the Bank-
Based Approach is required to file unaudited financial statements 
within 17 business days of the end of each month, and its annual 
audited financial statements within 60 days of the end of its fiscal 
year.\135\
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    \133\ 17 CFR 23.105(d) and (e).
    \134\ 17 CFR 23.105(d)(1) and (e)(1).
    \135\ Id.
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    The CFTC Financial Reporting Rules further provide that a nonbank 
SD's unaudited financial statements must include: (i) a statement of 
financial condition; (ii) a statement of income/loss; (iii) a statement 
of changes in liabilities subordinated to claims of general creditors; 
(iv) a statement of changes in ownership equity; (v) a statement 
demonstrating compliance with, and calculation of, the applicable 
regulatory minimum capital requirement; and (vi) such further material 
information necessary to make the required statements not 
misleading.\136\ The annual audited financial statements must include: 
(i) a statement of financial condition; (ii) a statement of income/
loss; (iii) a statement of cash flows; (iv) a statement of changes in 
liabilities subordinated to claims of general creditors; (v) a 
statement of changes in ownership equity; (vi) a statement 
demonstrating the calculation of, and compliance with, the applicable 
regulatory minimum capital requirement; (vii) appropriate footnote 
disclosures; and (vii) a reconciliation of any material differences 
between the annual audited financial statements and the unaudited 
financial statements prepared as of the nonbank SD's year-end 
date.\137\
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    \136\ 17 CFR 23.105(d)(2).
    \137\ 17 CFR 23.105(e)(4).
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    A nonbank SD that has obtained approval from the Commission or NFA 
to use internal capital models also must submit certain model metrics, 
such as aggregate VaR and counterparty credit risk information, each 
month to the Commission and NFA.\138\ A nonbank SD also is required to 
provide the Commission and NFA with a detailed list of financial 
positions reported at fair market value as part of its monthly 
unaudited financial statements.\139\ Each nonbank SD is also required 
to provide information to the Commission and NFA regarding its 
counterparty credit concentration for the 15 largest exposures in 
derivatives, a summary of its derivatives exposures by internal credit 
ratings, and the geographic

[[Page 48107]]

distribution of derivatives exposures for the 10 largest 
countries.\140\
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    \138\ 17 CFR 23.105(k) and (l) and Appendix B to Subpart E of 
Part 23.
    \139\ 17 CFR 23.105(l) and Appendix B to Subpart E of Part 23.
    \140\ 17 CFR 23.105(l) in Schedules 2, 3, and 4, respectively.
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    The CFTC Financial Reporting Rules also require a nonbank SD to 
attach to each unaudited and audited financial report an oath or 
affirmation that to the best knowledge and belief of the individual 
making the affirmation the information contained in the financial 
report is true and correct.\141\ The individual making the oath or 
affirmation must be a duly authorized officer if the nonbank SD is a 
corporation, or one of the persons specified in the regulation for 
business organizations that are not corporations.\142\
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    \141\ 17 CFR 23.105(f).
    \142\ Id.
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    The CFTC Financial Reporting Rules further require a nonbank SD to 
make certain financial information publicly available by posting the 
information on its public website.\143\ Specifically, a nonbank SD must 
post on its website a statement of financial condition and a statement 
detailing the amount of the nonbank SD's regulatory capital and the 
minimum regulatory capital requirement based on its audited financial 
statements and based on its unaudited financial statements that are as 
of a date that is six months after the nonbank SD's audited financial 
statements.\144\ Such public disclosure is required to be made within 
10 business days of the filing of the audited financial statements with 
the Commission, and within 30 calendar days of the filing of the 
unaudited financial statements required with the Commission.\145\ A 
nonbank SD also must obtain written approval from NFA to change the 
date of its fiscal year-end for financial reporting.\146\
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    \143\ 17 CFR 23.105(i).
    \144\ Id.
    \145\ Id.
    \146\ 17 CFR 23.105(g).
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    The CFTC Financial Reporting Rules also require a nonbank SD to 
provide the Commission and NFA with information regarding the 
custodianship of margin for uncleared swap transactions (``Margin 
Report'').\147\ The Margin Report must contain: (i) the name and 
address of each custodian holding initial margin or variation margin 
that is required for uncleared swaps subject to the CFTC margin rules 
(``uncleared margin rules''), on behalf of the nonbank SD or its swap 
counterparties; (ii) the amount of initial and variation margin 
required by the uncleared margin rules held by each custodian on behalf 
of the nonbank SD and on behalf its swap counterparties; and (iii) the 
aggregate amount of initial margin that the nonbank SD is required to 
collect from, or post with, swap counterparties for uncleared swap 
transactions subject to the uncleared margin rules.\148\ The Commission 
requires this information in order to monitor the use of custodians by 
nonbank SDs and their swap counterparties. Such information assists the 
Commission in monitoring the safety and soundness of a nonbank SD by 
monitoring whether the firm is current with its swap counterparties 
with respect to the posting and collecting of margin required by the 
uncleared margin rules. By requiring the nonbank SD to report the 
required amount of margin to be posted and collected, and the amount of 
margin that is actually posted and collected, the Commission could 
identify potential issues with the margin practices and compliance by 
nonbank SDs that may hinder the ability of the firm to meet its 
obligations to market participants. The Margin Report also allows the 
Commission to identify custodians used by nonbank SDs and their 
counterparties, which may permit the Commission to assess potential 
market issues, including a concentration of custodial services by a 
limited number of banks.
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    \147\ 17 CFR 23.105(m).
    \148\ Id.
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2. Japanese Nonbank Swap Dealer Financial Reporting Requirements
    The Japanese Financial Reporting Rules impose financial reporting 
requirements on FIBOs, including Japanese nonbank SDs. Specifically, 
the Japanese Financial Reporting Rules require each of the Japanese 
nonbank SDs to submit monthly monitoring survey reports (``Monthly 
Monitoring Reports'') to the FSA.\149\ The Monthly Monitoring Reports 
are required to report on the Japanese nonbank SD's balance sheet, 
profit and loss statement, capital adequacy ratio, market risk, 
counterparty risk and liquidity risk.\150\ The Monthly Monitoring 
Reports are typically submitted by the Japanese nonbank SDs within 2-3 
weeks of the end of each month.\151\
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    \149\ See II-1-4 (General Supervisory Processes) of the 
Supervisory Guidelines for FIBO, which directs the FSA (and other 
supervisors) as part of its offsite monitoring to require FIBOs 
(including the Japanese nonbank SDs) to submit a monitoring survey 
report regarding the following matters: capital adequacy ratio, 
status of business operations and accounting (including a balance 
sheet and profit and loss statement), status of segregated 
management of customer assets, market risk, counterparty risk, 
operational risk, and liquidity risk. The FSA has, pursuant to 
Article 56-2(1) of the FIEA, ordered the Japanese nonbank SDs to 
submit monthly monitoring reports to the FSA.
    \150\ Id.
    \151\ There are various types of reports which are required of 
the Japanese nonbank SDs under ``Reporting orders'' issued by the 
FSA in accordance with Article 56-2(1) of the FIEA. Some reports are 
required to be submitted on monthly basis, whereas other reports are 
required to be submitted on a quarterly basis, semi-annual basis, or 
annual basis. In terms of the filing due dates of those reports, the 
FSA typically does not set a specific deadline and instead requests 
all reports to be submitted ``without delay.'' In case of monthly 
reports, the normal practice is for firms to submit such reports 
within 2 to 3 weeks from the prior month-end.
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    Each Japanese nonbank SD is also required to submit a business 
report to the Commissioner of the FSA within three months of the end of 
the firm's fiscal year (``Annual Business Report'').\152\ The Annual 
Business Report must include a balance sheet, profit and loss 
statement, statement of changes in shareholders' equity, balance of 
subordinated debt and statement of capital adequacy ratio.\153\
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    \152\ Article 46-3(1) of the FIEA and Article 172 of the COO.
    \153\ Appended Forms No.12 of the COO.
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    Furthermore, each Japanese nonbank SD is required to prepare 
financial statements and business reports every business year pursuant 
to the Japanese Companies Act (Act No. 86 of 2005). The financial 
statements include a balance sheet, profit and loss statement, and 
statement of changes in shareholders' equity, and are required to be 
audited by an accounting auditor (``Annual Audited Financial 
Report'').\154\ The Annual Audited Financial Report must be submitted 
to and approved by the shareholders' meeting within 3 months of the 
Japanese nonbank SD's fiscal year-end.\155\
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    \154\ Article 328(1) and (2) and Article 435(2) and 436(2)(i) of 
the Companies Act, and Article 59 of Rules of Corporate Accounting 
(Ordinance of the Ministry of Justice No. 13 of 2006). The audit 
requirement applies to a ``Large Company,'' which is defined by 
Article 2(vi) of the Companies Act as a stock company that satisfies 
any of the following requirements: (a) that the amount of stated 
capital in the balance sheet as of the end of the firm's most recent 
business year is JPY 500 million or more; or (b) that the total sum 
of the liabilities section of the balance sheet as of the end of the 
firm's most recent business year is JPY 20 billion or more. The FSA 
has represented that each of the Japanese nonbank SDs is a Large 
Company under the Companies Act, and is subject to the audit 
requirement for its financial statements. See FSA Application p. 18.
    \155\ Id.
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3. Commission Analysis
    The Commission has reviewed the FSA Application and the relevant 
Japanese laws and regulations, and has preliminarily determined that 
the financial reporting requirements of the Japanese Financial 
Reporting Rules, subject to the conditions specified

[[Page 48108]]

below, are comparable to CFTC Financial Reporting Rules in purpose and 
effect as they are intended to provide the FSA and Commission, 
respectively, with financial information to monitor and assess the 
financial condition of nonbank SDs and their ongoing ability to absorb 
decreases in the value of firm assets and to cover losses from business 
activities, including swap dealing activities, without the firm 
becoming insolvent.
    The Japanese Financial Reporting Rules require Japanese nonbank SDs 
to file financial reports with the FSA that are comparable with respect 
to the content of the financial reporting and the frequency of the 
submission of the financial reports with the requirements for nonbank 
SDs under the CFTC Financial Reporting Rules. In this regard, the 
Japanese Financial Reporting Rules require Japanese nonbank SDs to 
prepare and submit reports that include statements of financial 
condition, statements of profit and loss, and statements of capital 
adequacy that are comparable to the statements required of nonbank SDs 
under Regulation 23.105 of the CFTC Financial Reporting Rules. 
Accordingly, the Commission has preliminarily determined that a 
Japanese nonbank SD may comply with the financial reporting 
requirements contained in Commission Regulation 23.105 by complying 
with the corresponding Japanese Financial Reporting Rules, subject to 
the conditions set forth below.\156\
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    \156\ A Japanese nonbank SD that qualifies and elects to seek 
substituted compliance with Japanese Capital Rules must also seek 
substituted compliance with the Japanese Financial Reporting Rules.
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    Such substituted compliance is proposed to be conditioned upon a 
Japanese nonbank SD providing the Commission and NFA with copies of its 
Monthly Monitoring Report and Annual Business Report filed with the FSA 
pursuant to Article 56-2(1) and Article 46-3(1), respectively, of the 
FIEA. It is proposed that a Japanese nonbank SD also must provide the 
Commission and NFA with a copy of its Annual Audited Financial Report 
that is required to be prepared pursuant to Article 453(2) of the 
Companies Act. The Monthly Monitoring Report, Annual Business Report, 
and Annual Audited Financial Report must be translated into the English 
language.\157\ The Monthly Monitoring Report and the Annual Business 
Report must have balances converted from yen to U.S. dollars. The 
Commission, however, recognizes that the requirement to translate 
accounts denominated in yen to U.S. dollars on the audited financial 
statements may impact the opinion provided by the public accountant. 
The Commission is therefore proposing to accept the Annual Audited 
Financial Report denominated in yen, provided that the report is 
translated into the English language.
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    \157\ The translation of audited financial statements into the 
English language is not required to be subject to the audit of the 
public accountants. The Monthly Monitoring Report and Annual 
Business Report must convert balances into U.S. dollars. A Japanese 
nonbank SD must report the exchange rate that it used to convert 
balances from yen to U.S. dollars to the Commission and NFA as part 
of the financial reporting.
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    The Commission also is proposing to condition the Capital 
Comparability Determination Order below on the Japanese nonbank SD 
filing (i) its Annual Business Report with the Commission and NFA 
within 15 business days of the earlier of the date the report is filed 
with the FSA or the date that the report is required to be filed with 
the FSA; (ii) its Annual Audited Financial Statement with the 
Commission and NFA within 15 business days of the approval of the 
report at the Japanese nonbank SD's shareholder meeting; and (iii) its 
Monthly Monitoring Report within 15 business days of the earlier of the 
date the report is filed with the FSA or 35 calendar days after the 
month-end reporting date.\158\ The Commission preliminarily believes 
that these proposed filing dates provide sufficient time for the 
respective reports to be translated into the English language and 
balances converted from yen to U.S. dollars, where applicable.
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    \158\ As previously noted, the FSA does not set a specific 
filing date for Monthly Monitoring Reports, electing to instead 
require firms to file such reports ``without delay.'' The Commission 
proposes to establish a due that that is no later than 35 calendar 
days from the reporting date in order to set a definitive filing 
date that also provides Japanese nonbank SDs with sufficient time to 
translate the reports into English and convert balances to U.S. 
dollars.
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    The filing of English language financial reports by a Japanese 
nonbank SD with the Commission and NFA is necessary as financial 
reporting is a critical and central component of the Commission's and 
NFA's ability to assess the safety and soundness of registered nonbank 
SDs as required under Section 4s(e) of the CEA. Although the Commission 
is proposing to permit Japanese nonbank SDs to comply with the form and 
content requirements for the financial reports set forth in the 
Japanese Financial Reporting Rules, the receipt of English language 
financial reports that have balances converted to U.S. dollars (with 
the exception of the Annual Audited Financial Report) is necessary for 
the Commission to effectively monitor the ongoing financial condition 
of all nonbank SDs, including Japanese nonbank SDs, to help ensure 
their safety and soundness and ability to meet their financial 
obligations to customers, counterparties, and general market 
participants.
    The Commission preliminarily believes that its proposed approach of 
requiring Japanese nonbank SDs to provide the Commission and NFA with 
copies of the Monthly Monitoring Reports, Annual Business Reports, and 
Annual Audited Financial Reports that the firms currently file with the 
FSA or otherwise prepare strikes an appropriate balance of ensuring 
that the Commission and NFA receive the financial reporting necessary 
for the effective monitoring of the financial condition of the nonbank 
SDs, while also recognizing the appropriateness of providing 
substituted compliance based on the existing FSA financial reporting 
requirements and regulatory structure.
    The Commission is also proposing to condition the Capital 
Comparability Determination Order on Japanese nonbank SDs filing the 
aggregate securities, commodities, and swap positions information set 
forth in Schedule 1 of Appendix B to Subpart E of Part 23 on a monthly 
basis with the Commission and NFA.\159\ Schedule 1 provides the 
Commission and NFA with detailed information regarding the financial 
positions that a nonbank SD holds as of the end of each month, 
including the firm's swaps positions, which will allow the Commission 
and NFA to monitor the types of investments and other activities that 
the firm engages in and will enhance the Commission's and NFA's ability 
to monitor the safety and soundness of the firm.
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    \159\ Schedule 1 of Appendix B to Subpart E of Part 23 includes 
a nonbank SD's holding of U.S. Treasury securities, U.S. government 
agency debt securities, foreign debt and equity securities, money 
market instruments, corporate obligations, spot commodities, and 
cleared and uncleared swaps, security-based swaps, and mixed swaps 
in addition to other position information.
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    The Commission is also proposing to condition the Capital 
Comparability Determination Order on a Japanese nonbank SD submitting 
with each Monthly Monitoring Report, Annual Business Report, and Annual 
Audited Financial Report, as well as the applicable Schedule 1, a 
statement by an authorized representative or representatives of the 
Japanese nonbank SD that to the best knowledge and belief of the 
person(s) the information contained in the respective report is true

[[Page 48109]]

and correct, including the translation of the report into the English 
language and conversion of balances in the reports to U.S. dollars. The 
statement by the authorized representative or representatives of the 
Japanese nonbank SD is in lieu of the oath or affirmation required of 
nonbank SDs under Regulation 23.105(f),\160\ and is intended to ensure 
that reports filed with the Commission and NFA are prepared and 
submitted by firm personnel with knowledge of the financial reporting 
of the firm who can attest to the accuracy of the reporting and 
translation.
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    \160\ 17 CFR 23.105(f).
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    The Commission is further proposing to condition the Capital 
Comparability Determination Order on a Japanese nonbank SD filing the 
Margin Report specified in Regulation 23.105(m) with the Commission and 
NFA. The Margin Report contains: (i) the name and address of each 
custodian holding initial margin or variation margin required by the 
uncleared margin rules on behalf of the nonbank SD or its swap 
counterparties; (ii) the amount of initial and variation margin 
required by the uncleared margin rules held by each custodian on behalf 
of the nonbank SD and on behalf its swap counterparties; and (iii) the 
aggregate amount of initial margin required by the uncleared margin 
rules that the nonbank SD is required to collect from, or post to, swap 
counterparties for uncleared swap transactions.\161\
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    \161\ 17 CFR 23.105(m).
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    The Commission believes that receiving this margin information from 
Japanese nonbank SDs will assist in the Commission's assessment of the 
safety and soundness of the Japanese nonbank SDs. Specifically, the 
Margin Report will provide the Commission with information regarding a 
Japanese nonbank SD's swap book, the extent to which it has 
uncollateralized exposures to counterparties or has not met its 
financial obligations to counterparties. This information, along with 
the list of custodians holding both the firm's and counterparties' 
swaps collateral, will assist the Commission in assessing and 
monitoring potential financial impacts to the nonbank SD resulting from 
defaults on its swap transactions. The Commission is further proposing 
to require a Japanese nonbank SD to file its Margin Report at the same 
time that the Japanese nonbank SD files its Monthly Monitoring Report, 
and to require the Margin Report to be prepared in the English language 
with balances reported in U.S. dollars.
    The Commission is not proposing to require a Japanese nonbank SD 
that has been approved by FSA to use capital models to file the monthly 
model metric information contained in Regulation 23.105(k) with the 
Commission or NFA.\162\ Regulation 23.105(k) requires a nonbank SD that 
has obtained approval from the Commission or NFA to use internal 
capital models to submit to the Commission and NFA each month 
information regarding its risk exposures, including VaR and credit risk 
exposure information when applicable. The model metrics are intended to 
provide the Commission and NFA with information that would assist with 
the ongoing oversight and assessment of internal market risk and credit 
risk models that have been approved for use by a nonbank SD. The 
Commission preliminarily believes, however, that the receipt by the 
Commission and NFA of model metrics set forth in Regulation 23.105(k) 
from Japanese nonbank SDs is not necessary as the initial approval and 
the ongoing assessment of the performance of a Japanese nonbank SD's 
models will be performed by the FSA as part of its oversight function.
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    \162\ 17 CFR 23.105(k).
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    The Commission also is proposing not to require a Japanese nonbank 
SD to file the monthly counterparty credit exposure information 
specified in Regulation 23.105(l) and Schedules 2, 3, and 4 of Appendix 
B to Subpart E of Part 23 with the Commission or NFA. Regulation 
23.105(l) requires each nonbank SD to provide information to the 
Commission and NFA regarding its counterparty credit concentration for 
the 15 largest exposures in derivatives, a summary of its derivatives 
exposures by internal credit ratings, and the geographic distribution 
of derivatives exposures for the 10 largest countries in Schedules 2, 
3, and 4, respectively. The Commission preliminarily believes that, 
under a substituted compliance regime, the FSA is best positioned to 
monitor a Japanese nonbank SD's credit exposures, which may be 
comprised of credit exposures to primarily other Japanese 
counterparties, as part of the FSA's overall monitoring of the 
financial condition of the firm.
    Furthermore, the Commission, in making the preliminary 
determination to not require a Japanese nonbank SD to file the model 
metrics and counterparty exposures required by Regulations 23.105(k) 
and (l), respectively, recognizes that NFA's current risk monitoring 
program requires each bank SD and each nonbank SD, including each 
Japanese nonbank SD, to file risk metrics addressing market risk and 
credit risk with NFA on a monthly basis. This information includes: (i) 
monthly VaR for interest rates, credit, foreign exchange, equities, 
commodities, and total VaR; (ii) total stressed VaR; (iii) interest 
rate, credit spread, foreign exchange market, and commodity 
sensitivities; (iv) total swaps current exposure both before and after 
offsetting against collateral held by the firm; and (v) a list of the 
15 largest swaps counterparty current exposures.\163\ While there are 
differences between the information filed with the NFA and the 
information required under Regulations 23.105(k) and (l), the NFA risk 
metrics provide a level of information that allows NFA to identify SDs 
that may pose heightened risk and to allocate appropriate NFA 
regulatory oversight resources. The Commission preliminarily believes 
that the proposed financial reporting set forth as conditions in the 
proposed Capital Comparability Determination Order, and the risk metric 
and counterparty exposure information required to be reported by 
nonbank SDs (including Japanese nonbank SDs) under NFA rules, provide 
the appropriate balance of recognizing the comparability of the 
Japanese Financial Reporting Rules to the CFTC Financial Reporting 
Rules while also ensuring that the Commission and NFA receive 
sufficient data to monitor and assess the overall financial condition 
of nonbank Japanese SDs.
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    \163\ See NFA Financial Requirements, Section 17--Swap Dealer 
and Major Swap Participant Reporting Requirements, and Notice to 
Members--Monthly Risk Data Reporting for Swap Dealers (May 30, 
2017).
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    The Commission invites public comment on its analysis above, 
including comment on the FSA Application and relevant Japanese 
Financial Reporting Rules. The Commission also invites comment on the 
proposed conditions listed above. The Commission recognizes that while 
the Monthly Monitoring Reports, Annual Business Reports, and Annual 
Audited Financial Reports contain financial information regarding a 
Japanese nonbank SD that is comparable to the financial information 
required of nonbank SDs under Regulation 23.105 (such as statements of 
financial condition, statements of income, and statements demonstrating 
compliance with capital requirements), the reports also contain 
financial information that exceeds the requirements of regulation 
23.105 (such as information regarding the holding of customer funds 
under Japanese laws). The Commission requests comment on the scope of 
the financial information that Japanese nonbank SDs should be required 
to file

[[Page 48110]]

with the Commission and NFA. Should the Commission limit the financial 
information required of Japanese nonbank SDs to the types of financial 
information required of nonbank SDs under regulation 23.105?
    The Commission also invites comment on its proposal not to require 
Japanese nonbank SDs to submit to the Commission and NFA the 
information set forth in Regulations 23.105(k) and (l). Are there 
specific elements of the data required under Regulations 23.105(k) and 
(l) that the Commission should require of Japanese nonbank SDs for 
purposes of monitoring model performance?
    The Commission requests comment on the proposed filing dates for 
the reports and information specified above. Specifically, do the 
proposed filing dates provide sufficient time for Japanese nonbank SDs 
to prepare the reports, translate the reports into English, and, where 
required, convert balances into U.S. dollars? If not, what period of 
time should the Commission consider imposing on one or more of the 
reports?
    The Commission also specifically requests comment regarding the 
setting of compliance dates for the reporting conditions that the 
proposed Capital Comparability Determination Order would impose on 
Japanese nonbank SDs. In this connection, if the Commission were to 
require Japanese nonbank SDs to file the Margin Report as set forth in 
the proposed Order below, how much time would Japanese nonbank SDs need 
to develop new systems or processes to capture information that is 
required? Would Japanese nonbank SDs need a period of time to develop 
any systems or processes to meet any other reporting conditions in the 
proposed Capital Comparability Determination Order? If so, what would 
be an appropriate amount of time for a Japanese nonbank SD to develop 
and implement such systems or processes?

E. Notice Requirements

1. CFTC Nonbank SD Notice Reporting Requirements
    The CFTC Financial Reporting Rules require nonbank SDs to provide 
the Commission and NFA with written notice of certain defined 
events.\164\ The notice provisions are intended to provide the 
Commission and NFA with an opportunity to assess whether the 
information contained in the written notices indicates the existence of 
actual or potential financial and/or operational issues at a nonbank 
SD, and, when necessary, allows the Commission and NFA to engage the 
nonbank SD in an effort to minimize potential adverse impacts on swap 
counterparties and the larger swaps market. The notice provisions are 
part of the Commission's overall program for helping to ensure the 
safety and soundness of nonbank SDs and the swaps markets in general.
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    \164\ 17 CFR 23.105(c).
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    The CFTC Financial Reporting Rules require a nonbank SD to provide 
written notice within specified timeframes if the firm is: (i) 
undercapitalized; (ii) fails to maintain capital at a level that is in 
excess of 120 percent of its minimum capital requirement; or (iii) 
fails to maintain current books and records.\165\ A nonbank SD is also 
required to provide written notice if the firm experiences a 30 percent 
or more decrease in excess regulatory capital from its most recent 
financial report filed with the Commission.\166\ A nonbank SD also is 
required to provide notice if the firm fails to post or collect initial 
margin for uncleared swap and non-cleared security-based swap 
transactions or exchange variation margin for uncleared swap or non-
cleared security-based swap transactions as required by the 
Commission's uncleared swaps margin rules or the SEC's non-cleared 
security-based swaps margin rules, respectively, if the aggregate is 
equal to or greater than: (i) 25 percent of the nonbank SD's required 
capital under Regulation 23.101 calculated for a single counterparty or 
group of counterparties that are under common ownership or control; or 
(ii) 50 percent of the nonbank SD's required capital under Regulation 
23.101 calculated for all of the firm's counterparties.\167\
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    \165\ 17 CFR 23.105(c)(1), (2), and (3).
    \166\ 17 CFR 23.105(c)(4).
    \167\ 17 CFR 23.105(c)(7).
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    The CFTC Financial Reporting Rules further require a nonbank SD to 
provide advance notice of an intention to withdraw capital by an equity 
holder that would exceed 30 percent of the firm's excess regulatory 
capital.\168\ Finally, a nonbank SD that is dually-registered with the 
SEC as an SBSD or major security-based swap participant (``MSBSP'') 
must file a copy of any notice with the Commission and NFA that the 
SBSD or MSBSP is required to file with the SEC under SEC Rule 18a-8 (17 
CFR 240.18a-8).\169\ SEC Rule 18a-8 requires SBSDs and MSBSPs to 
provide written notice to the SEC for comparable reporting events as 
the CFTC Capital Rules in Regulation 23.105(c), including if a SBSD or 
MSBSP is undercapitalized or fails to maintain current books and 
records.
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    \168\ 17 CFR 23.105(c)(5).
    \169\ 17 CFR 23.105(c)(6).
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2. Japanese Nonbank Swap Dealer Notice Requirements
    The FSA maintains a system of notice reporting requirements 
(``Early Warning System'') that is designed to provide the FSA with 
notice of, and an opportunity to react to, potential financial and/or 
operational issues with a Japanese nonbank SD prior to the firm falling 
below the FSA's minimum capital requirements. Specifically, each 
Japanese nonbank SD is required to submit an immediate notification to 
the FSA if its capital adequacy ratio falls below 140 percent.\170\ The 
Japanese nonbank SD's notification submitted to the FSA must be 
accompanied by a Plan Regarding Specific Voluntary Measures to Be Taken 
in Order to Maintain the Capital Adequacy Ratio, which is expected to 
include concrete measures that the firm will take to maintain a capital 
adequacy ratio above 140 percent.\171\ The FSA also has the authority 
to examine the future outlook on the Japanese nonbank SD's capital 
adequacy ratio through hearings and to urge the firm to make voluntary 
improvement efforts. \172\
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    \170\ The notification is required to be filed pursuant to 
Article 179 of the COO. As noted in section C.2 above, each Japanese 
nonbank SD is required to maintain a minimum capital adequacy ratio 
of 120 percent.
    \171\ Id.
    \172\ IV-2-2 (Supervisory Response to Cases of Financial 
Instruments Business Operators' Capital Adequacy Ratio Falling Below 
Prescribed Level) (1) of the Supervisory Guidelines for FIBO.
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    A Japanese nonbank SD also must submit an immediate notification 
and a Plan Regarding Specific Voluntary Measures to Be Taken in Order 
to Improve the Capital Adequacy Ratio (the ``Plan'') to the FSA if the 
firm's capital adequacy ratio falls below the minimum capital adequacy 
ratio of 120 percent.\173\ The FSA reviews the Plan and, when 
necessary, identifies the specific method by which a Japanese nonbank 
SD must bring its capital adequacy ratio back above the prescribed 
minimum level and the estimated date of the recovery. In situations 
where the Japanese nonbank SD fails to maintain the minimum level of 
regulatory capital, the FSA will also examine other aspects of the 
firm's operations, including the status of segregated management of 
customer assets and fund-raising. If the FSA finds it to be necessary 
and appropriate in the public interest or for the protection of 
investors, the Commissioner of the FSA may order a change of business

[[Page 48111]]

methods, order assets to be deposited, or issue orders with respect to 
matters that are otherwise necessary from a supervisory 
perspective.\174\
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    \173\ Article 179 of the COO.
    \174\ Article 53(1) of the FIEA. IV-2-2 (Supervisory Response to 
Cases of Financial Instruments Business Operators' Capital Adequacy 
Ratio Falling Below Prescribed Level) (3) of the Supervisory 
Guidelines for FIBO indicates four examples of the order: (i) To 
draft and implement measures (including the drafting of specifics 
and the implementation schedule) to bring the capital adequacy ratio 
back above the legally prescribed level and maintain the ratio above 
that level on a permanent basis; (ii) To implement measures to 
ensure the protection of investors in preparation for an unexpected 
event, through appropriate management of securities and cash and 
careful management of fund-raising; (iii) To avoid activities that 
could lead to wasteful use of corporate assets; and (iv) To compile 
the projections of the balance sheet and fund-raising status on a 
daily basis and the projection of the capital adequacy ratio in ways 
to reflect the specific measures to be implemented, in order to 
bring the capital adequacy ratio back above the legally prescribed 
level.
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    If a Japanese nonbank SD's capital adequacy ratio falls below 100 
percent, the Commissioner of the FSA may order the suspension of all or 
part of the firm's business activities for a period not to exceed three 
months if the FSA deems such action to be necessary and appropriate for 
the public interest or for the protection of investors.\175\ If the 
Japanese nonbank SDs capital adequacy ratio does not exceed 100 
percent, and the FSA determines that the firm's capital adequacy ratio 
status is not likely to recover, the Commissioner of the FSA may 
rescind the registration of the firm.\176\
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    \175\ Article 53(2) of the FIEA.
    \176\ Article 53(3) of the FIEA.
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    In addition to the above measures, the FSA may order a Japanese 
nonbank SD to change its business methods or to otherwise take measures 
that are necessary for improving its business operations or the state 
of its assets if the FSA finds such action necessary and appropriate in 
the public interest or for the protection of investors.\177\ Finally, 
the Prime Minister of Japan may rescind the registration of a Japanese 
nonbank SD, or order the suspension of all or a part of its business 
activities for a period of no longer than six months, if the Japanese 
nonbank SD violates a disposition by a government agency,\178\ or is 
likely to become insolvent due to the state of its business and 
assets.\179\
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    \177\ Article 51 of the FIEA.
    \178\ Article 52(1)(vii) of the FIEA.
    \179\ Article 52(1)(viii) of the FIEA.
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3. Commission Analysis
    The Commission has reviewed the FSA Application and the relevant 
Japanese laws and regulations, and has preliminarily determined that 
the Japanese Financial Reporting Rules related to notice provisions, 
subject to the conditions specified below, are comparable to the notice 
provisions of the CFTC Financial Reporting Rules in purpose and effect 
as each regulator's requirements are intended to provide the FSA and 
Commission with prompt notice of potential or actual financial or 
operational issues at a nonbank SD that may impact its ability to 
continue to meet its financial obligations to swap counterparties and 
other creditors, or otherwise impair its safety and soundness. The 
Commission is therefore proposing to issue a Capital Comparability 
Determination Order providing that a Japanese nonbank SD may comply 
with the notice provisions required under Japanese laws and regulations 
in lieu of certain notice provisions required of nonbank SDs under 
Regulation 23.105(c), subject to the conditions set forth below.
    The Japanese Financial Reporting Rules require a Japanese nonbank 
SD to provide notice to the FSA if the firm experiences a reduction of 
its regulatory capital that exceeds certain predefined limits 
(``Japanese Early Warning Notices''). As noted above, pursuant to the 
Japanese Early Warning Notices, a Japanese nonbank SD is required to 
provide the FSA with notices if its regulatory capital falls below: (i) 
140 percent; or (ii) 120 percent of its minimum capital requirement. 
The Japanese Early Warning Notices are also required to contain 
information regarding actions that the Japanese nonbank SD will take to 
ensure that the firm is properly capitalized.
    The Commission has preliminarily determined that these Japanese 
Early Warning Notices achieve comparable outcomes to CFTC notice 
provisions contained in Regulation 23.105(c)(1) and (2) that require a 
nonbank SD to provide notice to the Commission and to NFA if a nonbank 
SD fails to meet its minimum capital requirement or if the firm's 
regulatory capital falls below 120 percent of its minimum capital 
requirement. These notice provisions set forth in the Japanese 
Financial Reporting Rules and the CFTC Financial Reporting Rules are 
further comparable in purpose and effect in that the provisions are 
intended to alert the FSA and Commission/NFA, respectively, of 
potential financial or operational issues that could have an adverse 
impact on the safety and soundness of a nonbank SD, including the 
nonbank SD's ability to meet its financial obligations to customers, 
counterparties, creditors, and general market participants. The notices 
are also intended to provide an opportunity for the applicable 
regulator to monitor a nonbank SD's financial condition and operations 
to ensure that the firm takes appropriate actions to maintain, or to 
regain, compliance with its minimum capital requirements.
    The Japanese Financial Reporting Rules differ from the CFTC 
Financial Reporting Rules in certain respects. Specifically, unlike the 
CFTC Financial Reporting Rules, the Japanese Financial Reporting Rules 
do not contain explicit requirements for a Japanese nonbank SD to 
notify the FSA if the firm fails to maintain current books and records, 
experiences a decrease in capital over levels previously reported, or 
fails to collect or post initial margin or variation margin for 
uncleared swap transactions with swap counterparties that exceed 
certain threshold levels.\180\ The Japanese Financial Reporting Rules 
also do not require a Japanese nonbank SD to provide the FSA with 
advance notice of capital withdrawals initiated by equity holders that 
exceed defined amounts or percentages of the firm's excess regulatory 
capital.\181\
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    \180\ See 17 CFR 23.105(c)(3), (4), and (7).
    \181\ See 17 CFR 23.105(c)(5), which requires a nonbank SD to 
provide written notice to the Commission and NFA two business days 
prior to the withdrawal of capital by action of the equity holders 
if the amount of the withdrawal exceeds 30 percent of the nonbank 
SD's excess regulatory capital.
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    The Commission is proposing to condition the Capital Comparability 
Determination Order on a Japanese nonbank SD providing the Commission 
and NFA with notice if the firm fails to make or to keep current books 
and records required by the FSA. For avoidance of doubt, in this 
context the Commission believes that books and records would include 
current ledgers or other similar records which show or summarize, with 
appropriate references to supporting documents, each transaction 
affecting the Japanese nonbank SD's asset, liability, income, expense 
and capital accounts in accordance with the accounting principles 
accepted by the FSA.\182\ The Commission preliminarily believes that 
the maintenance of current books and records is a fundamental and 
essential component of operating as a registered nonbank SD and that 
the failure to comply with such a requirement may indicate an inability 
of the firm to promptly and accurately record transactions and to 
ensure compliance with regulatory requirements, including regulatory 
capital requirements. Therefore, the proposed Order below is 
conditioned on a Japanese nonbank SD providing the Commission and NFA 
with a written notice within 24 hours if

[[Page 48112]]

the firm fails to maintain on a current basis the books and records 
required by the FSA.
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    \182\ For comparison, see 17 CFR 23.105(b), which similarly 
defines the term `Current books and records' as used in the context 
of Commission's requirements.
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    The Commission is also proposing to condition the Capital 
Comparability Determination Order on a Japanese nonbank SD providing 
the Commission and NFA with a written notice within 24 hours of the 
firm filing a notice with the FSA pursuant to Article 179(3) of the COO 
that the firm's regulatory capital has fallen below 140 percent of its 
minimum requirement. It is proposed that a Japanese nonbank SD also 
must provide the Commission and NFA with written notice within 24 hours 
of filing a notice with the FSA that the firm's regulatory capital has 
fallen below 120 percent of its minimum requirement.
    The requirement for a nonbank SD to file notice with the Commission 
and NFA of a decrease of excess regulatory capital below defined levels 
is a central component of the Commission's and NFA's oversight program 
for nonbank SDs.\183\ Therefore, the Commission preliminarily believes 
that it is necessary for the Commission and NFA to receive notice from 
a Japanese nonbank SD that the firm has filed a regulatory notice with 
the FSA that its capital level has decreased below 140 percent or 120 
percent of its minimum regulatory capital requirement. The notice must 
be filed by the Japanese nonbank SD within 24 hours of the filing of 
the notice with the FSA, and the Commission expects that, upon the 
receipt of a notice, Commission staff and NFA staff will engage with 
staff of the FSA to obtain an understanding of the facts that led to 
the filing of the notice and will discuss with the FSA its plan for any 
ongoing monitoring of the Japanese nonbank SD. Therefore, the 
Commission's proposal would not require the Japanese nonbank SD to file 
copies of its recovery plan that is filed with the FSA with the 
Commission or NFA. To the extent the Commission needs further 
information from the Japanese nonbank SD, the Commission expects to 
request such information as part of its assessment of the notice and 
its discussions with the FSA.
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    \183\ See Regulation 23.105(c)(4) which requires a nonbank SD to 
file notice with the Commission and NFA if it experiences a decrease 
in excess capital of 30 percent or more from the excess capital 
reported in its last financial filing with the Commission.
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    The proposed Capital Comparability Determination Order also 
requires a Japanese nonbank SD to file notice with the Commission and 
NFA if: (i) a single counterparty, or group of counterparties under 
common ownership or control, fails to post required initial margin or 
pay required variation margin on uncleared swap and non-cleared 
security-based swap positions that, in the aggregate, exceeds 25 
percent of the Japanese nonbank SD's minimum capital requirement; (ii) 
counterparties fail to post required initial margin or pay required 
variation margin to the Japanese nonbank SD for uncleared swap and non-
cleared security-based swap positions that, in the aggregate, exceed 50 
percent of the Japanese nonbank SD's minimum capital requirement; (iii) 
a Japanese nonbank SD fails to post required initial margin or pay 
required variation margin for uncleared swap and non-cleared security-
based swap positions to a single counterparty or group of 
counterparties under common ownership and control that, in the 
aggregate, exceeds 25 percent of the Japanese nonbank SD's minimum 
capital requirement; and (iv) a Japanese nonbank SD fails to post 
required initial margin or pay required variation margin to 
counterparties for uncleared swap and non-cleared security-based swap 
positions that, in the aggregate, exceeds 50 percent of the Japanese 
nonbank SD's minimum capital requirement. The Commission is proposing 
to require this notice so that, in the event that such a notice is 
filed, it and NFA may commence communication with the Japanese nonbank 
SD and the FSA in order to obtain an understanding of the facts that 
led to the failure to exchange material amounts of initial margin or 
variation margin in accordance with the applicable margin rules, and to 
assess whether there is a concern regarding the financial condition of 
the firm that may impair its ability to meet its financial obligations 
to customers, counterparties, creditors, and general market 
participants, or otherwise adversely impact the firm's safety and 
soundness.
    The proposed Capital Comparability Determination Order does not 
require a Japanese nonbank SD to file notices with the Commission 
concerning withdrawals of capital or changes in capital levels as such 
information will be reflected in the financial statement reporting 
filed with the Commission and NFA as conditions of the order, and 
because the Japanese nonbank SD's capital levels are monitored by the 
FSA, which the Commission preliminarily believes renders the separate 
reporting to the Commission superfluous.
    The proposed Capital Comparability Determination Order requires a 
Japanese nonbank SD to file any notices required under the Order with 
the Commission and NFA in English and, where applicable, with any 
balances reported in U.S. dollars. Each notice required by the proposed 
Capital Comparability Determination Order must be filed in accordance 
with instructions issued by the Commission or NFA.
    The Commission invites public comment on its analysis above, 
including comment on the FSA Application and relevant Japanese 
Financial Reporting Rules. The Commission also invites comment on the 
proposed conditions to the Capital Comparability Determination Order 
that are listed above.
    The Commission requests comment on the timeframes set forth in the 
proposed conditions for Japanese nonbank SDs to file notices with the 
Commission and NFA. In this regard, the proposed conditions would 
require Japanese nonbank SDs to file certain written notices with the 
Commission within 24 hours of the occurrence of a reportable event or 
of being alerted to a reportable event by the FSA. These notices would 
have to be translated into English prior to being filed with the 
Commission and NFA. The Commission request comment on the issues 
Japanese nonbank SDs may face meeting the filing requirements given 
time-zone difference and translation issues. The Commission also 
requests specific comment regarding the setting of compliance dates for 
the notice reporting conditions that the proposed Capital Comparability 
Determination Order would impose on Japanese nonbank SDs.

F. Supervision and Enforcement

1. Commission and NFA Supervision and Enforcement of Nonbank SDs
    The Commission and NFA conduct ongoing supervision of nonbank SDs 
to assess their compliance with the CEA, Commission regulations, and 
NFA rules by reviewing financial reports, notices, risk exposure 
reports, and other filings that nonbank SDs are required to file with 
the Commission and NFA. The Commission and NFA also conduct periodic 
examinations as part of their supervision of nonbank SDs, including 
routine onsite examinations of nonbank SDs' books, records, and 
operations to ensure compliance with CFTC and NFA requirements.\184\
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    \184\ Section 17(p)(2) of the CEA (7 U.S.C. 21(p)(2)) requires 
NFA as a registered futures association to establish minimum capital 
and financial requirements for nonbank SDs and to implement a 
program to audit and enforce compliance with such requirements. 
Section 17(p)(2) further provides that NFA's capital and financial 
requirements may not be less stringent than the capital and 
financial requirements imposed by the Commission.
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    As noted in section D.1 above, financial reports filed by a nonbank 
SD provide the Commission and NFA with information necessary to ensure 
the

[[Page 48113]]

firm's compliance with minimum capital requirements and to assess the 
firm's overall safety and soundness and its ability to meet its 
financial obligations to customers, counterparties, creditors, and 
general market participants. A nonbank SD is also required to provide 
written notice to the Commission and NFA if certain defined events 
occur, including that the firm is undercapitalized or maintains a level 
of capital that is less than 120 percent of the firm's minimum capital 
requirements.\185\ The notice provisions, as stated in section E.1 
above, are intended to provide the Commission and NFA with information 
of potential issues at a nonbank SD that may impact the firm's ability 
to maintain compliance with the CEA and Commission regulations. The 
Commission and NFA also have the authority to require a nonbank SD to 
provide any additional financial and/or operational information on a 
daily basis or at such other times as the Commission or NFA may specify 
to monitor the safety and soundness of the firm.\186\
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    \185\ See 17 CFR 23.105(c).
    \186\ See 17 CFR 23.105(h).
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    The Commission also has authority to take disciplinary actions 
against a nonbank SD for failing to comply with the CEA and Commission 
regulations. Section 4b-1(a) of the CEA provides the Commission with 
exclusive authority to enforce the capital requirements imposed on 
nonbank SDs adopted under Section 4s(e) of the CEA.
2. FSA Supervision and Enforcement of Japanese Nonbank SDs
    The FSA has supervision, audit, and investigation authority with 
respect to Japanese nonbank SDs, including the authority to require 
such firms to provide all necessary information for FSA to carry out 
its supervisory responsibilities.\187\ Specifically, the FSA has the 
authority to require Japanese nonbank SDs to submit documents to the 
FSA and to conduct onsite inspections at the business offices of the 
Japanese nonbank SDs.\188\
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    \187\ FSA Application, p. 16.
    \188\ Article 56-2 of the FIEA.
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    The FSA also monitors the capital adequacy ratios of Japanese 
nonbank SDs through supervisory measures on an ongoing basis. The 
monitoring includes a system of notice requirements, discussed in 
section E.2 above, that obligate Japanese nonbank SDs to provide notice 
to the FSA if certain triggering conditions are met. The FSA also has a 
variety of measures in place to address actual cases of a Japanese 
nonbank SD's failure to maintain its required level of minimum capital. 
Specifically, a Japanese nonbank SD is required to submit a 
notification and an action plan to the FSA if the Japanese nonbank SD's 
capital adequacy ratio falls below 120 percent.\189\ The FSA will 
review the plan and, when necessary, identify the specific method by 
which the Japanese nonbank SD is required to bring its capital adequacy 
ratio back above the prescribed minimum level. The FSA also may order a 
Japanese nonbank SD to change its business methods, order assets to be 
deposited, or issue orders with respect to matters that are otherwise 
necessary from a supervisory perspective, if the FSA finds it in the 
public interest or for the protection of customers to take such 
actions.\190\ Furthermore, a Japanese nonbank SD may have all or parts 
of its business suspended for a period of no more than six months or 
have its registration revoked if the firm violates certain laws or 
regulations in connection with the financial instruments business or 
services,\191\ or if the firm is likely to become insolvent.\192\ 
Finally, a Japanese nonbank SD is subject to fines and other possible 
actions if it fails to submit documents that are required by law to be 
filed with the FSA.\193\
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    \189\ Article 53(2) of the FIEA.
    \190\ Id.
    \191\ Article 52(1)(vii) of the FIEA.
    \192\ Article 52(1)(viii) of the FIEA.
    \193\ Article 198-6 of the FIEA.
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3. Commission Analysis
    The Commission has a long history of regulatory cooperation with 
the FSA. In this connection, the Commission and FSA entered into a 
Memorandum of Cooperation (``MOC'') with regard to the cooperation and 
the exchange of information in the supervision and oversight of 
regulated entities that operate on a cross-border basis in both the 
U.S. and Japan (``Cross-Border Covered Entities''), including nonbank 
SDs registered with the Commission and FIBOs registered with the 
FSA.\194\ Pursuant to the MOC, the Commission and FSA expressed an 
intent to consult regularly, as appropriate, regarding: (i) general 
supervisory issues, including regulatory, oversight, or other related 
developments; (ii) issues relevant to the operations, activities, and 
regulation of Cross-Border Covered Entities; and (iii) any other areas 
of mutual supervisory interest, and to meet periodically to discuss 
their respective functions and regulatory oversight programs.\195\ The 
MOC further provides for the Commission and FSA to inform each other of 
certain events, including any material events that could adversely 
impact the financial or operational stability of a Cross-Border Covered 
Entity, and provides a procedure for the Commission or FSA to conduct 
on-site examinations in, respectively, Japan or the U.S.\196\ Pursuant 
to the terms of the MOC, the Commission intends to communicate and 
consult with the FSA regarding the supervision of the financial and 
operational condition of Japanese nonbank SDs.
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    \194\ Memorandum of Cooperation Related to the Supervision of 
Cross-Border Covered Entities (Mar. 10, 2014). See the Commission's 
website at https://www.cftc.gov/International/MemorandaofUnderstanding/index.htm.
    \195\ MOC, paragraphs 19 and 26.
    \196\ MOC, paragraphs 22 and 29. Event-triggered notification in 
paragraph 22 of the MOC includes any known adverse material change 
in the ownership, operating environment, operations, financial 
resources, management, or systems and controls of a Cross-Border 
Covered Entity, and the failure of a Cross-Border Covered Entity to 
satisfy any of its requirements for continued authorization or 
registration where that failure could have a material adverse effect 
in the jurisdiction of Commission or FSA.
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    In addition, as discussed above, as part of FSA's ongoing 
prudential regulation and supervision of FSA regulated entities, it is 
able to take all measures necessary to ensure that FSA's capital, 
financial and reporting rules are implemented.\197\ Thus, the 
Commission preliminarily finds that FSA has the necessary powers and 
ability to supervise and enforce Japanese nonbank SDs' compliance with 
Japanese capital adequacy and financial reporting requirements.\198\
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    \197\ FSA Application, pp 19-20.
    \198\ In addition, both the Commission and the FSA are 
signatories to the IOSCO Multilateral Memorandum of Understanding 
Concerning Consultation and Cooperation and the Exchange of 
Information (revised May 2012), which covers primarily information 
sharing in the context of enforcement matters.
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    The Commission invites public comment on its analysis above, 
including comment on the FSA Application and relevant Japanese laws and 
regulations.

IV. Proposed Capital Comparability Determination Order

A. Commission's Proposed Comparability Determination

    The Commission's preliminary view, based on the FSA's Application 
and the Commission's review of applicable Japanese laws and 
regulations, is that the Japanese Capital Rules and the Japanese 
Financial Reporting Rules, subject to the conditions set forth in the 
proposed Capital Comparability Determination Order below, achieve 
comparable outcomes and are comparable in purpose and effect to the

[[Page 48114]]

CFTC Capital Rules and CFTC Financial Reporting Rules. In reaching this 
preliminary conclusion, the Commission recognizes that there are 
certain differences between the Japanese Capital Rules and CFTC Capital 
Rules and certain differences between the Japanese Financial Reporting 
Rules and the CFTC Financial Reporting Rules. The proposed Capital 
Comparability Determination Order is subject to proposed conditions 
that are preliminarily deemed necessary to promote consistency in 
regulatory outcomes, or to reflect the scope of substituted compliance 
that would be available notwithstanding certain differences. In the 
Commission's preliminary view, the differences between the two rule 
sets would not be inconsistent with providing a substituted compliance 
framework for Japanese nonbank SDs subject to the conditions specified 
in the proposed Order below.
    Furthermore, the proposed Capital Comparability Determination Order 
is limited to the comparison of the Japanese Capital Rules to the Bank-
Based Approach under the CFTC Capital Rules. As noted previously, the 
FSA has not requested, and the Commission has not performed, a 
comparison of the Japanese Capital Rules to the Commission's NAL 
Approach or TNW Approach.

B. Proposed Capital Comparability Determination Order

    The Commission invites comments on all aspects of the FSA 
Application, relevant Japanese laws and regulations, the Commission's 
preliminary views expressed above, the question of whether requirements 
under the Japanese Capital Rules are comparable in purpose and effect 
to the Commission's requirement for a nonbank SD to hold regulatory 
capital equal to or greater than 8 percent of its uncleared swap margin 
amount, and the Commission's proposed Capital Comparability 
Determination Order, including the proposed conditions included in the 
proposed Order, set forth below.

Proposed Order Providing Conditional Capital Comparability 
Determination for Japanese Nonbank Swap Dealers

    It is hereby determined and ordered, pursuant to Commodity Futures 
Trading Commission (``CFTC'' or ``Commission'') Regulation 23.106 (17 
CFR 23.106) under the Commodity Exchange Act (``CEA'') (7 U.S.C. 1 et 
seq.) that a swap dealer (``SD'') organized and domiciled in Japan and 
subject to the Commission's capital and financial reporting 
requirements under Sections 4s(e) and (f) of the CEA (7 U.S.C. 6s(e) 
and (f)) may satisfy the capital requirements under Section 4s(e) of 
the CEA and CFTC Regulation 23.101(a)(1)(i) (17 CFR 23.101(a)(1)(i)) 
(``CFTC Capital Rules''), and the financial reporting rules under 
Section 4s(f) of the CEA and Commission Regulation 23.105 (17 CFR 
23.105) (``CFTC Financial Reporting Rules''), by complying with certain 
specified Japanese laws and regulations cited below and otherwise 
complying with the following conditions, as amended or superseded from 
time to time:
    (1) The SD is not subject to regulation by a prudential regulator 
defined in section 1a(39) of the CEA (7 U.S.C. 1a(39));
    (2) The SD is organized under the laws of Japan and is domiciled in 
Japan (a ``Japanese nonbank SD'');
    (3) The Japanese nonbank SD is registered as a Type I Financial 
Instruments Business Operator (``FIBO'') with the Japan Financial 
Services Agency;
    (4) The Japanese nonbank SD is subject to and complies with: 
Articles 28(1), 29, 46-3, 46-6(2), 52(1), 53(1) through (3), 56-2, and 
198-6 of the Financial Instruments and Exchange Act (Act No. 25 of 
1948); Section II-1-4 (General Supervisory Processes), Section IV-2-1 
(Preciseness of Capital Adequacy Ratio), and Section IV-2-2 
(Supervisory Response to Cases of Financial Instruments Business 
Operators' Capital Adequacy Ratio Falling Below Prescribed Level) of 
the Comprehensive Guidelines for Supervision of Financial Instruments 
Business Operators; Articles 172, 176, 177(8), 178(1), 179(3), and 
Appended Forms No. 12 of the Cabinet Office Order on Financial 
Instruments Business (Cabinet Office Order No. 52 of 2007); Articles 1 
through 17 of the Financial Services Agency Notice No. 59 of 2007; 
Articles 2(vi), 328(1) and (2), 435(2), and 436(2)(i) of the Japanese 
Companies Act (Act No. 86 of 2005); and Article 59 of the Rules of 
Corporate Accounting (Ordinance of the Ministry of Justice No. 13 of 
2006) (collectively, the ``Japanese Capital Rules and Japanese 
Financial Reporting Rules'');
    (5) The Japanese nonbank SD maintains at all times an amount of 
regulatory capital in the form of Basic Items, as defined in Article 
176 of the Cabinet Office Order No. 52 of 2007, equal to or in excess 
of the equivalent of $20 million in United States dollars (``U.S. 
dollars''). The Japanese nonbank SD shall use a commercially reasonable 
and observed yen/U.S. dollar exchange rate to convert the value of the 
yen-denominated Basic Items to U.S. dollars;
    (6) The Japanese nonbank SD has filed with the Commission a notice 
stating its intention to comply with the applicable Japanese Capital 
Rules and Japanese Financial Reporting Rules in lieu of the CFTC 
Capital Rules and the CFTC Financial Reporting Rules. The notice of 
intent must include the Japanese nonbank SD's representation that the 
firm is organized and domiciled in Japan; is a registered FIBO; and is 
subject to, and complies with, the Japanese Capital Rules and Japanese 
Financial Reporting Rules. The Japanese nonbank SD may not rely on this 
Capital Comparability Determination Order until it receives 
confirmation from Commission staff, acting pursuant to authority 
delegated by the Commission, that the Japanese nonbank SD may comply 
with the applicable Japanese Capital Rules and Japanese Financial 
Reporting Rules in lieu of the CFTC Capital Rules and CFTC Financial 
Reporting Rules. Each notice filed pursuant to this condition must be 
prepared in the English language and submitted to the Commission via 
email to the following address: [email protected];
    (7) The Japanese nonbank SD prepares and keeps current ledgers and 
other similar records in accordance with accounting principles required 
by the Financial Services Agency;
    (8) The Japanese nonbank SD files with the Commission and with the 
National Futures Association (``NFA'') a copy of its Monthly Monitoring 
Report that is required to be filed with the Financial Services Agency 
pursuant to Article 56-2(1) of the Financial Instruments and Exchange 
Act. The Monthly Monitoring Report must be translated into the English 
language and balances must be converted to U.S. dollars. The Monthly 
Monitoring Report must be filed with the Commission and NFA within 15 
business days of the date the Monthly Monitoring Report is filed with 
the Financial Services Agency or 35 days after the month-end reporting 
date, whichever is earlier;
    (9) The Japanese nonbank SD files with the Commission and with NFA 
a copy of its Annual Business Report that is required to be filed with 
the Financial Services Agency in accordance with Article 46-3(1) of the 
Financial Instruments and Exchange Act and Article 172 of the Cabinet 
Office Order on Financial Instruments Business. The Annual Business 
Report must be translated into the English language and balances must 
be converted to U.S. dollars. The Annual Business Report must be filed 
with the Commission and

[[Page 48115]]

NFA within 15 business days of the earlier of the date the Annual 
Business Report is filed with the Financial Services Agency or the date 
that the Annual Business Report is required to be filed with the 
Financial Services Agency.
    (10) The Japanese nonbank SD files with the Commission and with NFA 
a copy of its Annual Audited Financial Report that is required to be 
prepared pursuant to Article 435(2) of the Japanese Companies Act (Act 
No. 86 of 2005). The Annual Audited Financial Report must be translated 
into the English language and balances may be reported in yen. The 
Annual Audited Financial Report must be filed with the Commission and 
NFA within 15 business days of approval of the report at the 
shareholders' meeting of the Japanese nonbank SD;
    (11) The Japanese nonbank SD files Schedule 1 of Appendix B to 
Subpart E of Part 23 of the CFTC's regulations (17 CFR 23 Subpart E--
Appendix B) with the Commission and NFA on a monthly basis. Schedule 1 
must be prepared in the English language with balances reported in U.S. 
dollars and must be filed with the Commission and NFA with the Japanese 
nonbank SD's Monthly Monitoring Report;
    (12) The Japanese nonbank SD submits with each Monthly Monitoring 
Report, Schedule 1, Margin Report, Annual Business Report, and Annual 
Audited Financial Report a statement by an authorized representative or 
representatives of the Japanese nonbank SD that to the best knowledge 
and belief of the representative or representatives the information 
contained in the report, including as applicable the translation of the 
report into the English language and conversion of balances in the 
report to U.S. dollars, is true and correct. The statement must be 
prepared in the English language;
    (13) The Japanese nonbank SD files a margin report containing the 
information specified in CFTC Regulation 23.105(m) (17 CFR 23.105(m)) 
with the Commission and with NFA on a monthly basis. The margin report 
must be prepared in the English language with balances reported in U.S. 
dollars and must be filed with the Commission and NFA with the Japanese 
nonbank SD's Monthly Monitoring Report;
    (14) The Japanese nonbank SD files a notice with the Commission and 
NFA within 24 hours of being informed by the Financial Services Agency 
that the firm is not in compliance with any component of the Japanese 
Capital Rules or Japanese Financial Reporting Rules. The notice must be 
prepared in the English language;
    (15) The Japanese nonbank SD files a notice within 24 hours with 
the Commission and NFA if it fails to maintain regulatory capital in 
the form of Basic Items, as defined in Article 176 of the Cabinet 
Office Order No. 52 of 2007, equal to or in excess of the U.S. dollar 
equivalent of $20 million using a commercially reasonable and observed 
yen/U.S. dollar exchange rate. The notice must be prepared in the 
English language;
    (16) The Japanese nonbank SD provides the Commission and NFA with 
notice within 24 hours of filing a notice with the Financial Services 
Agency pursuant to Article 179 of the Cabinet Office Order on Financial 
Instruments Business that the firm's capital adequacy ratio has fallen 
below the early warning level of 140 percent. The notice filed with the 
Commission and NFA must be prepared in the English language;
    (17) The Japanese nonbank SD provides the Commission and NFA with 
notice within 24 hours of filing a notice with the Financial Services 
Agency pursuant to Article 179 of the Cabinet Office Order on Financial 
Instruments Business that the firm's capital adequacy ratio has fallen 
below 120 percent. The notice filed with the Commission and NFA must be 
prepared in the English language;
    (18) The Japanese nonbank SD files a notice with the Commission and 
NFA within 24 hours if it fails to make or keep current the financial 
books and records required by the Financial Services Agency. The notice 
must be prepared in the English language;
    (19) The Japanese nonbank SD files a notice with the Commission and 
NFA within 24 hours of the occurrence of any of the following: (i) a 
single counterparty, or group of counterparties under common ownership 
or control, fails to post required initial margin or pay required 
variation margin on uncleared swap and non-cleared security-based swap 
positions that, in the aggregate, exceeds 25 percent of the Japanese 
nonbank SD's minimum capital requirement; (ii) counterparties fail to 
post required initial margin or pay required variation margin to the 
Japanese nonbank SD for uncleared swap and non-cleared security-based 
swap positions that, in the aggregate, exceeds 50 percent of the 
Japanese nonbank SD's minimum capital requirement; (iii) the Japanese 
nonbank SD fails to post required initial margin or pay required 
variation margin for uncleared swap and non-cleared security-based swap 
positions to a single counterparty or group of counterparties under 
common ownership and control that, in the aggregate, exceeds 25 percent 
of the Japanese nonbank SD's minimum capital requirement; or (iv) the 
Japanese nonbank SD fails to post required initial margin or pay 
required variation margin to counterparties for uncleared swap and non-
cleared security-based swap positions that, in the aggregate, exceeds 
50 percent of the Japanese nonbank SD's minimum capital requirement. 
The notice must be prepared in the English language;
    (20) The Japanese nonbank SD files a notice with the Commission and 
NFA of a change in its fiscal year-end approved or permitted to go into 
effect by the Financial Services Agency. The notice required by this 
paragraph will satisfy the requirement for a nonbank SD to obtain the 
approval of NFA for a change in fiscal year-end under CFTC Regulation 
23.105(g) (17 CFR 23.105(g)). The notice of change in fiscal year-end 
must be prepared in the English language and filed with the Commission 
and NFA at least 15 business days prior to the effective date of the 
Japanese nonbank SD's change in fiscal year-end;
    (21) The Financial Services Agency notifies the Commission of any 
material changes to the information submitted in its application, 
including, but not limited to, material changes to the Japanese Capital 
Rules or Japanese Financial Reporting Rules imposed on Japanese nonbank 
SDs, the Financial Services Agency's supervisory authority or 
supervisory regime over Japanese nonbank SDs, and proposed or final 
material changes to the Japanese Capital Rules or Japanese Financial 
Reporting Rules as they apply to Japanese nonbank SDs; and
    (22) Unless otherwise noted in the conditions above, the reports, 
notices, and other statements required to be filed by the Japanese 
nonbank SD with the Commission and NFA pursuant to the conditions of 
this Capital Comparability Determination Order must be submitted 
electronically to the Commission and NFA in accordance with 
instructions provided by the Commission or NFA.

    Issued in Washington, DC, on July 29, 2022, by the Commission.
Robert Sidman,
Deputy Secretary of the Commission.

    Note: The following appendices will not appear in the Code of 
Federal Regulations.


[[Page 48116]]

Appendices to Notice of Proposed Order and Request for Comment on an 
Application for a Capital Comparability Determination From the 
Financial Services Agency of Japan--Commission Voting Summary, 
Chairman's Statement, and Commissioners' Statements

Appendix 1--Commission Voting Summary

    On this matter, Chairman Behnam and Commissioners Johnson, 
Goldsmith Romero, and Mersinger voted in the affirmative. 
Commissioner Pham voted to concur. No Commissioner voted in the 
negative.

Appendix 2--Statement of Support of Chairman Rostin Behnam

    As CFTC provisionally-registered swap dealers (SDs) operate and 
manage risk globally, the Commission's supervisory framework must 
acknowledge the realities of multi-jurisdictional operations. I 
support the Commission's proposed order and request for comment on 
its preliminary determination that nonbank \1\ swap dealers (SDs) 
organized and domiciled in Japan are subject to, and comply with, 
capital and financial reporting requirements in Japan that are 
comparable to certain capital and financial reporting requirements 
under the Commodity Exchange Act and the Commission's regulations 
(Capital Comparability Determination), subject to certain 
conditions.
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    \1\ The Commission has capital jurisdiction over registered SDs 
that are not subject to the regulation of a U.S. banking regulator 
(i.e., nonbank SDs). 7 U.S.C. 6s(e)(1).
---------------------------------------------------------------------------

    Today's preliminary Capital Comparability Determination is the 
first such order proposed by the Commission since adopting its 
regulatory substituted compliance framework for non-U.S. domiciled 
nonbank SDs in July 2020.\2\ The Commission is proposing this order 
in response to an application submitted by the Financial Services 
Agency of Japan (FSA), which has direct supervisory authority over 
the three Japanese nonbank SDs that are provisionally-registered 
with the Commission.
---------------------------------------------------------------------------

    \2\ See 85 FR 57462, 57520 (Sept. 15, 2020). Regulation 23.106 
also sets forth the Commission's substituted compliance requirements 
for major swap participants; however, there are not any registered 
with the Commission.
---------------------------------------------------------------------------

    The Commission's principles-based approach to the proposed 
determination focuses on whether the FSA's capital and financial 
reporting requirements achieve comparable outcomes to the 
corresponding CFTC requirements.\3\ Specifically, the Commission has 
also considered the scope and objectives of FSA's capital adequacy 
and financial reporting requirements; the ability of FSA to 
supervise and enforce compliance with its capital and financial 
reporting requirements; and other facts or circumstances the 
Commission has deemed relevant for this application.
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    \3\ 17 CFR 23.106(a)(3)(ii). See also 85 FR 57462 at 57521.
---------------------------------------------------------------------------

    Throughout its analysis, the Commission recognized that 
jurisdictions may adopt unique approaches to achieving comparable 
outcomes, and the Commission has focused on how the FSA's capital 
and financial reporting requirements are comparable to its own in 
purpose and effect, rather than whether each are comparable in every 
particular aspect or contain identical elements. In this regard, the 
approach was not a line-by-line assessment or comparison of FSA's 
regulatory requirements with the Commission's requirements.\4\
---------------------------------------------------------------------------

    \4\ See 85 FR 57462, 57521.
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    Consistent with the Commission's authority to issue a Capital 
Comparability Determination with terms and conditions it deems 
appropriate, today's proposed order contains 22 conditions. These 
conditions aim to ensure that the proposed order, if finalized, 
would only apply to Japanese nonbank SDs that are eligible for 
substituted compliance and that these Japanese nonbank SDs comply 
with FSA's capital and financial reporting requirements as well as 
certain additional capital, margin, position, financial reporting, 
required recordkeeping, and regulatory notice requirements.
    If the Commission, upon consideration of the comments received, 
determines to issue a favorable comparability determination, an 
eligible Japanese nonbank SD would be required to file a notice of 
its intent to comply with FSA's capital adequacy and financial 
reporting rules in lieu of the Commission's requirements.\5\ The 
Commission (or the Market Participants Division through delegated 
authority) would then be obligated to confirm to the Japanese 
nonbank SD that it may comply with the foreign jurisdiction's rules 
as well as any conditions that would be adopted as part of the final 
determination, and that, by doing so, it would be deemed to be in 
compliance with the Commission's corresponding capital adequacy and 
financial reporting requirements.
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    \5\ See 17 CFR 23.106(a)(4).
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    I believe it is important to note that today's proposed Capital 
Comparability Determination, if finalized, would not compromise the 
Commission's capital and financial reporting requirements. Instead, 
it recognizes the global nature of the swap markets with dually-
registered SDs that operate in multiple jurisdictions that mandate 
prudent capital and financial reporting requirements. A capital and 
financial reporting comparability determination order of this kind 
is not a compromise or deference to a foreign regulatory authority. 
The Commission would retain its enforcement authority and 
examinations authority as well as obtain all financial and event 
specific reporting to maintain direct oversight of nonbank SDs 
located in Japan.
    While the CFTC and the FSA have a pre-existing memorandum of 
understanding (MOU) in place, it is important to note that an MOU or 
a similar agreement is not necessary for the Commission and the 
National Futures Association to monitor these firms' compliance with 
the conditions of a capital comparability determination.
    I look forward to the public's submission of comments and 
feedback on this proposed determination and order.
    I wish to again thank the hardworking staff in the Market 
Participants Division for all of their efforts towards bringing us 
here today.

Appendix 3--Statement of Support of Commissioner Kristin N. Johnson

    I support the Commission's issuance of the proposed capital 
comparability order for comment (Proposed Order). I commend staff's 
hard work on this matter and their meticulous review of the capital 
and financial reporting requirements in Japan, as well as their 
outstanding cooperation with the Financial Services Agency of Japan 
(JFSA). I also appreciate the JFSA's sustained and meaningful 
engagement of Commission staff during the entirety of the review 
process.
    The Commission's capital and financial reporting requirements 
are critical to ensuring the safety and soundness of our regulated 
swap dealers.\1\ Ensuring necessary levels of capital, as well as 
accurate and timely reporting about financial conditions, helps to 
protect swap dealers and the broader financial markets ecosystem 
from shocks, thereby ensuring resiliency.
---------------------------------------------------------------------------

    \1\ See 7 U.S.C. 6s(e); 17 CFR subpart E.
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    Prior to the adoption of the CFTC's final rules regarding swap 
dealer capital which published in the Federal Register on September 
15, 2020,\2\ with a compliance date of October 6, 2021,\3\ the 
Commission had issued interpretive guidance allowing for substituted 
compliance determinations to be made with respect to other 
components of the Commission's swap dealer requirements. Under that 
guidance, the Commission has issued comparability determinations 
relating to market participants operating in several jurisdictions 
including the EU, Australia, Canada, Hong Kong, Switzerland, and, 
notably, Japan.\4\ The Proposed Order before the Commission is, 
however, the first capital comparability determination.
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    \2\ See Capital Requirements of Swap Dealers and Major Swap 
Participants, 85 FR 57462 (Sept. 15, 2020) (CFTC Capital Rules).
    \3\ Id. at 57462.
    \4\ The Commission has issued comparability determinations for 
certain entity-level requirements (Australia, Canada, EU, Hong Kong, 
Japan, Switzerland), certain transaction-level requirements (EU, 
Japan), and margin requirements for uncleared swaps (EU, Japan). See 
CFTC, Comparability Determinations for Substituted Compliance 
Purposes, https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm.
---------------------------------------------------------------------------

    When the Commission initially issued interpretive guidance, many 
jurisdictions had not yet implemented swaps reforms addressing risk 
management failures that precipitated the 2008 financial crisis. 
Today, many jurisdictions have made great strides to adopt effective 
regulatory regimes, mitigating the systemic risks that previously 
pervaded global markets. The current procedure for regulatory 
capital and financial reporting requirements set forth in regulation 
23.106 permits foreign nonbank swap dealers, a trade association on 
behalf of one or more foreign nonbank swap dealers, or a foreign 
regulatory authority with jurisdiction over a foreign nonbank swap 
dealer (as the JFSA has done) to file an application for substituted 
compliance. The Proposed Order, if

[[Page 48117]]

approved, will allow registered nonbank swap dealers organized and 
domiciled in Japan to satisfy certain capital and financial 
reporting requirements under the Commodity Exchange Act \5\ by being 
subject to and complying with comparable capital and financial 
reporting requirements under Japanese laws and regulations.
---------------------------------------------------------------------------

    \5\ 7 U.S.C. 1 et seq.
---------------------------------------------------------------------------

    I support acknowledging market participants' compliance with the 
regulations of foreign jurisdictions when the requirements lead to 
an outcome that is comparable to the outcome of complying with the 
CFTC's corresponding requirements. Substituted compliance must not, 
however, be confused with deference. To the contrary, the swap 
dealers that qualify for substituted compliance under regulation 
23.106 must be Commission registrants. The Proposed Order, if 
approved, would continue to ensure that relevant Japan-based swap 
dealers are subject to the Commission's examination and enforcement 
authority over the firms.
    Capital requirements play a critical role in fostering the 
safety and soundness of financial markets. As indicated in the 
Commodity Exchange Act, capital requirements protect market 
participants against risks such as counterparty default.\6\ Robust 
capital requirements enable individual market participants to absorb 
losses, meet their obligations, and successfully navigate challenges 
that may threaten their integrity or trigger systemic risk concerns. 
As a result, the Commission must be measured in applying its 
framework for capital comparability determinations. I look forward 
to reviewing the public comments on this proposed determination.
---------------------------------------------------------------------------

    \6\ 7 U.S.C. 6s(e).
---------------------------------------------------------------------------

Appendix 4--Statement of Support of Commissioner Christy Goldsmith 
Romero

    I support the Commission's efforts for strong capital 
requirements and financial reporting to help ensure the safety and 
soundness of swap dealers whose activities could affect U.S. 
markets, including through this proposed Capital Comparability 
Determination for Japan. The proposal promotes financial stability, 
and the benefits of global harmonization with a like-minded 
regulator for the global swaps markets. Thank you to the staff for 
their hard work, and for their thoughtful engagement with me and my 
office on changes to improve the proposal.

The 2008 Financial Crisis and TARP Capital Injections

    A key cause of the financial crisis was the failure of bank 
regulators to require financial institutions to have high quality 
capital in a sufficient amount to serve as a buffer against risk. 
This included the lack of capital requirements that would ensure 
that financial institutions that were swap dealers, and other major 
participants in swaps markets, had adequate capital to absorb 
losses. The devastating result of this undercapitalization swept 
rapidly through the highly interconnected financial system. The 
default or margin failure of one counterparty triggered another, and 
then another--which led to a short-term liquidity crisis. Risk and 
losses also cascaded from subsidiaries and affiliates to bank parent 
companies and/or bank holding companies, including across borders.
    The financial contagion was not limited to major players in the 
markets. The entire economy suffered, with Main Street bearing the 
consequences of Wall Street. The federal government made 
unprecedented capital injections of hundreds of billions of taxpayer 
dollars into more than 700 financial institutions through the 
Troubled Asset Relief Program (``TARP''). For the last decade, I 
served as the Special Inspector General for TARP (``SIGTARP''), 
providing oversight over TARP programs. I have testified before 
Congress and reported publicly on lessons learned from inadequate 
capital requirements pre-crisis, and the need for strong levels of 
high-quality capital to lower systemic risk in the financial system.

The Dodd Frank Act's Capital Requirements for Swap Dealers

    Swap dealer capital requirements are one of the most critical 
reforms in the Dodd-Frank Act for derivatives markets. These reforms 
led the CFTC to allow nonbank swap dealers to use a capital 
framework similar to what prudential banking regulators apply to 
banks.\1\
---------------------------------------------------------------------------

    \1\ This bank-based approach is consistent with the Basel 
Committee on Banking Supervision's international framework for bank 
capital requirements.
---------------------------------------------------------------------------

    Capital protects the solvency of the swap dealer from unexpected 
losses such as counterparty defaults and margin collateral failures. 
Capital requirements are aimed at ensuring a swap dealer has the 
ability to absorb losses and they prevent market disruption by 
helping to ensure that swap dealers continue to perform their 
critical function to provide liquidity and market making. Capital 
along with margin requirements for uncleared swaps reduces the 
potential for contagion, thereby lowering systemic risk in the 
financial system, and promoting financial stability.

The CFTC's First Substituted Compliance Determination for Capital 
Requirements

    The global nature of the financial crisis also highlighted the 
need for the CFTC to coordinate with foreign regulators as swap 
activities in a foreign jurisdiction may have an impact here in the 
United States. For example, risk of a foreign subsidiary can flow to 
their U.S. parent company.
    The CFTC's ``substituted compliance'' framework leverages a 
second regulator, a like-minded foreign regulator that has rules, 
supervision and enforcement that are comparable in purpose and 
effect to the CFTC's. Under this global harmonization, the CFTC 
would allow a non-U.S. entity to be deemed in compliance with CFTC 
requirements if the non-U.S. entity complied with the foreign 
regulator's comparable rules.
    I am mindful that this proposal is the first of its kind--the 
first substituted compliance determination for the CFTC's capital 
rules. Therefore, we should proceed carefully, as we are 
establishing precedent.
    The proposal today is for nonbank swap dealers that are 
domiciled in Japan, where we have a Memorandum of Cooperation and a 
long history of cooperation with the Japanese Financial Services 
Agency.\2\ Currently, this proposal would apply to Japanese 
affiliates of Bank of America, Morgan Stanley and Goldman Sachs--
three systemically important institutions and three of the largest 
TARP recipients having collectively received $60 billion in TARP 
capital injections. Therefore, it is vital that the CFTC ensures 
that these swap dealers have adequate amounts of high-quality 
capital. Public comment will be helpful on whether the CFTC is 
correct in its preliminary determinations of comparability.
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    \2\ As noted in the proposal, in making a Capital Comparability 
Determination the Commission may consider any facts or circumstances 
it deems relevant, including whether the relevant foreign regulatory 
authority has a memorandum of understanding or similar arrangement 
with the Commission that would facilitate supervisory cooperation. 
See 17 CFR 23.106(a)(3)(iv).
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    I highlight, and express my appreciation for, the involvement of 
the Japanese Financial Services Agency in this process. CFTC staff's 
engagement with our regulatory counterparts in Japan has helped to 
ensure the accuracy of the staff's assessment of Japanese capital 
and financial reporting requirements, along with supervisory and 
enforcement programs.\3\
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    \3\ The Commission may consider all relevant factors in making a 
Capital Comparability Determination, including the ability of the 
relevant foreign regulatory authority to supervise and enforce 
compliance with the foreign jurisdiction's capital adequacy and 
financial reporting requirements. See 17 CFR 23.106(a)(3)(iii). The 
proposal also makes a preliminary determination that the Japanese 
financial reporting rules are conditionally comparable in purpose 
and effect with the CFTC's financial reporting rules.
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    Substituted compliance does not require an all or nothing 
determination. The CFTC may continue to require compliance with 
certain of its rules, and impose any terms or conditions that it 
deems appropriate.\4\
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    \4\ See 17 CFR 23.106(a)(5).
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    The CFTC proposes to continue to require that Japanese nonbank 
swap dealers comply with the CFTC's $20 million capital requirement, 
as Japan has no minimum requirement.\5\ I strongly support retaining 
the $20 million capital requirement. However, the CFTC is not 
requiring compliance with our requirement that the $20 million be in 
the form of common equity tier 1 capital--one of the strongest forms 
of capital. Instead, the proposal would allow the $20 million 
requirement to be satisfied with types of capital defined in a 
category called ``Basic Items'' under Japanese regulation. I look 
forward to commenters' response on whether allowing the $20 million 
capital requirement to be satisfied with this category of ``Basic 
Items'' is comparable in purpose and effect to the CFTC's 
requirement that only common equity tier 1 capital be included in 
the $20 million.
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    \5\ Japanese capital requirements are consistent with Basel bank 
capital standards, similar to the CFTC.
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    Japan also does not have a minimum requirement for capital that 
is tied to the

[[Page 48118]]

margin for uncleared swaps entered into by the nonbank swap dealer. 
The CFTC requires an aggregate of common equity tier 1 capital, 
additional tier 1 capital and tier 2 capital equal to or greater 
than 8 percent of the nonbank swap dealer's uncleared swap margin 
amount. I look forward to commenters' response on the question as to 
whether Japan's capital requirement in an amount equal to 25% of 
operating expenses is comparable in purpose and effect to the CFTC's 
capital requirement equal to 8% of the uncleared swap margin amount.
    It is a priority for me to ensure that the CFTC guards against 
complacency with post-crisis reforms, particularly after market 
stresses from the pandemic and geopolitical events. We should 
remember that our capital rules serve as critical pillars of Dodd-
Frank reforms to help ensure the safety and soundness of financial 
institutions, and to protect the market from serious risks and 
contagion. The CFTC has a duty to ensure that our comparability 
assessment is sound, and that the foreign regulator is like-minded 
in not only rules but in their approach, supervision and 
enforcement. Substituted compliance must leave U.S. markets and our 
economy at no greater risk than full compliance with our rules.

Appendix 5--Concurring Statement of Commissioner Caroline D. Pham

    I respectfully concur with the notice of proposed order and 
request for comment on an application for a capital comparability 
determination submitted by the Financial Services Agency (FSA) of 
Japan.
    First, I want to recognize the staff's work as each of my fellow 
Commissioners has done because this is not easy--not only for this 
rulemaking, but also, generally speaking, swap dealer oversight is 
an incredibly complex regulatory regime. I also appreciate your 
commitment to providing substituted compliance.
    In addition, in my past work in Japan and with their financial 
sector, I have enjoyed working with the FSA for many years, and I 
appreciate their thoughtful and robust oversight of their regulated 
firms. I also want to say that my thoughts and heart are with the 
people of Japan regarding the tragic loss of Prime Minister Shinzo 
Abe.
    As I mentioned in my opening statement, the CFTC should take an 
outcomes-based approach to substituted compliance that appropriately 
balances and recognizes the nature of cross-border regulation of 
global markets and firms, and that preserves access for U.S. persons 
to other markets.\1\ I appreciate the Chairman's remarks and I 
welcome comments, particularly on operational issues with additional 
reporting requirements given the time difference, language 
translation, conversion to USD, local governance and regulatory 
requirements, and differences in financial reporting.
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    \1\ See Statement of Dissent by Commissioner Scott D. O'Malia on 
Comparability Determinations for Australia, Canada, the European 
Union, Hong Kong, Japan, and Switzerland: Certain Entity and 
Transaction-Level Requirements (Dec. 20, 2013).
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    I urge a pragmatic approach with sufficient time to implement 
conditions before any compliance date, and I appreciate the thought 
that the staff have been putting into that. I speak from my past 
experience as a global head of swap dealer compliance who had to 
implement global regulatory reforms. I'll also note that in a 
crisis, such as during the early days of the COVID-19 pandemic, 
there was timely and effective engagement between and amongst CFTC 
registrants and U.S. regulators. I have been on many calls and 
spoken to many regulators all over the world, not only during COVID-
19, but also during times of market disruption or potentially 
material events.
    There is a difference between a phone call and a formal written 
notice, and that's just one example of the conditions in this 
proposal. So, I appreciate receiving comments on this and any other 
operational issues and the careful consideration by the staff and 
the Commission of how to take a practical approach to achieving 
appropriate oversight and mitigation of risk to the United States 
and to our markets.

[FR Doc. 2022-16684 Filed 8-5-22; 8:45 am]
BILLING CODE 6351-01-P