2015-32320

Federal Register, Volume 81 Issue 3 (Wednesday, January 6, 2016)

[Federal Register Volume 81, Number 3 (Wednesday, January 6, 2016)]

[Rules and Regulations]

[Pages 635-709]

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

[FR Doc No: 2015-32320]

[[Page 635]]

Vol. 81

Wednesday,

No. 3

January 6, 2016

Part III

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

Commodity Futures Trading Commission

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

17 CFR Parts 23 and 140

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap

Participants; Final Rule

Federal Register / Vol. 81 , No. 3 / Wednesday, January 6, 2016 /

Rules and Regulations

[[Page 636]]

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

COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 23 and 140

RIN 3038-AC97

Margin Requirements for Uncleared Swaps for Swap Dealers and

Major Swap Participants

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule and interim final rule.

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

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

``CFTC'') is adopting regulations to implement a particular provision

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

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

This provision requires the Commission to adopt initial and variation

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

participants (``MSPs''). The final rules would establish initial and

variation margin requirements for SDs and MSPs but would not require

SDs and MSPs to collect margin from non-financial end users.

The Commission is also adopting and inviting comment on an interim

final rule that will exempt certain uncleared swaps with certain

counterparties from these margin requirements. This interim final rule

implements Title III of the Terrorism Risk Insurance Program

Reauthorization Act of 2015 (``TRIPRA''), which exempts from the margin

rules for uncleared swaps certain swaps for which a counterparty

qualifies for an exemption or exception from clearing under the Dodd-

Frank Act.

DATES: The rules will become effective April 1, 2016. Comments on the

interim final rule (Sec. 23.150(b)) must be received on or before

February 5, 2016.

ADDRESSES: You may submit comments on the interim final rule by any of

the following methods:

CFTC Web site: http://comments.cftc.gov. Follow the

instructions for submitting comments through the Comments Online

process on the Web site.

Mail: Send to Christopher Kirkpatrick, Secretary of the

Commission, Commodity Futures Trading Commission, Three Lafayette

Centre, 1155 21st Street NW., Washington, DC 20581.

Hand Delivery/Courier: Same as Mail, above.

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

Follow the instructions for submitting comments.

Please submit your comments using only one of these methods.

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

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

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

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

information that may be exempt from disclosure under the Freedom of

Information Act, a petition for confidential treatment of the exempt

information may be submitted according to the procedures established in

Sec. 145.9 of the Commission's regulations.\1\

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

\1\ 17 CFR 145.9. Commission regulations referred to herein are

found at 17 CFR Chapter I.

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

The Commission reserves the right, but shall have no obligation, to

review, pre-screen, filter, redact, refuse or remove any or all of your

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

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

redacted or removed that contain comments on the merits of the

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

considered as required under the Administrative Procedure Act and other

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

Act.

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

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

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

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

Financial Risk Analyst, Division of Swap Dealer and Intermediary

Oversight, 202-418-5462, [email protected]; Francis Kuo, Special

Counsel, Division of Swap Dealer and Intermediary Oversight, 202-418-

5695, fkuo[email protected]; Paul Schlichting, Assistant General Counsel,

Office of General Counsel, 202-418-5884, [email protected]; Stephen

A. Kane, Research Economist, Office of the Chief Economist, 202-418-

5911, [email protected]; or Lihong McPhail, Research Economist, Office of

the Chief Economist, 202-418-5722, [email protected]; Commodity Futures

Trading Commission, Three Lafayette Centre, 1155 21st Street NW.,

Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. Statutory Authority

B. International Standards

C. Proposed Rules

D. Subsequent Amendment to Dodd-Frank

II. Final Rules

A. Overview

B. Products

C. Participants

D. Nature and Timing of Margin Requirements

E. Calculation of Initial Margin

F. Calculation of Variation Margin

G. Forms of Margin

H. Custodial Arrangements

I. Inter-Affiliate Trades

J. Implementation Schedule

III. Interim Final Rule

IV. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

V. Cost Benefit Considerations

Appendix A to the Preamble

Appendix B to the Preamble

I. Background

A. Statutory Authority

On July 21, 2010, President Obama signed the Dodd-Frank Act.\2\

Title VII of the Dodd-Frank Act amended the CEA \3\ to establish a

comprehensive regulatory framework designed to reduce risk, to increase

transparency, and to promote market integrity within the financial

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

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

requirements on standardized derivative products; (3) creating

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

Commission's rulemaking and enforcement authorities with respect to all

registered entities and intermediaries subject to the Commission's

oversight.

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

\2\ See Dodd-Frank Wall Street Reform and Consumer Protection

Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

\3\ 7 U.S.C. 1 et seq.

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

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

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

mandates the adoption of rules establishing margin requirements for

uncleared swaps of SDs and MSPs.\4\ Each SD and MSP for which there is

a Prudential Regulator, as defined below, must meet margin requirements

for their uncleared swaps established by the applicable Prudential

Regulator, and each SD and MSP for which there is no Prudential

Regulator must comply with the Commission's regulations governing

margin.

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

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

requirements for SDs and MSPs. The Commission proposed capital rules

in 2011. Capital Requirements for Swap Dealers and Major Swap

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

address capital requirements in a separate release.

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

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

CEA, as amended by Section 721 of the Dodd-

[[Page 637]]

Frank Act. This definition includes the Federal Reserve Board

(``FRB''); the Office of the Comptroller of the Currency (``OCC''); the

Federal Deposit Insurance Corporation (``FDIC''); the Farm Credit

Administration; and the Federal Housing Finance Agency.

The definition specifies the entities for which these agencies act

as Prudential Regulators. These consist generally of federally insured

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

Federal Home Loan Mortgage Corporation, and the Federal National

Mortgage Association. The FRB is the Prudential Regulator under section

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

certain foreign banks treated as bank holding companies, and certain

subsidiaries of these bank holding companies and foreign banks.

The FRB is not, however, the Prudential Regulator for nonbank

subsidiaries of bank holding companies, some of which are required to

be registered with the Commission as SDs or MSPs. Therefore, the

Commission is required to establish margin requirements for uncleared

swaps for all registered SDs and MSPs that are not subject to a

Prudential Regulator. These include, among others, nonbank subsidiaries

of bank holding companies, as well as certain foreign SDs and MSPs.

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

registered SD and MSP for which there is not a Prudential Regulator

shall meet such minimum capital requirements and minimum initial margin

and variation margin requirements as the Commission shall by rule or

regulation prescribe.

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

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

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

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

all swaps that are not cleared by a registered derivatives clearing

organization (``DCO'').

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

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

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

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

appropriate for the risk associated with the uncleared swaps.

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

prescribing margin requirements the Prudential Regulator and the

Commission shall permit the use of noncash collateral the Prudential

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

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

preserving the stability of the United States financial system.

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

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

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

capital requirements and minimum initial and variation margin

requirements.

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

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

and maintain comparable minimum capital and minimum initial and

variation margin requirements, including the use of noncash collateral,

for SDs and MSPs.

B. International Standards

In October 2011, the Basel Committee on Banking Supervision

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

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

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

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

standards for margin requirements for uncleared swaps. Representatives

of more than 20 regulatory authorities participated. From the United

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

of New York, and the SEC were represented.

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

comment.\5\ In addition, the group conducted a Quantitative Impact

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

quantitative impacts associated with margin requirements.\6\

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

\5\ BCBS/IOSCO, Consultative Document, Margin requirements for

non-centrally cleared derivatives (July 2012).

\6\ BCBS/IOSCO, Quantitative Impact Study, Margin requirements

for non-centrally cleared derivatives (November 2012).

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

After consideration of the comments on the proposal and the results

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

and requested comment on several specific issues.\7\ The group

considered the additional comments in finalizing the recommendations

set out in the report.

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

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

non-centrally cleared derivatives (February 2013).

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

The final report was issued in September 2013.\8\ This report (the

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

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

principles represent the minimum standards approved by BCBS and IOSCO

and their recommendations to the regulatory authorities in member

jurisdictions of these organizations.

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

\8\ BCBS/IOSCO, Margin requirements for non-centrally cleared

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

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

C. Proposed Rules

The Commission initially proposed margin requirements for SDs and

MSPs in 2011. In response to the 2013 international framework, the

Commission re-proposed margin requirements in September 2014.\9\

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

\9\ Margin Requirements for Uncleared Swaps for Swap Dealers and

Major Swap Participants, 79 FR 59898 (Oct. 3, 2014).

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

In developing the proposed rules, the Commission staff worked

closely with the staff of the Prudential Regulators.\10\ In most

respects, the proposed rules would establish a framework for margin

requirements similar to the Prudential Regulators' proposal. The

proposed rules were consistent with the 2013 international framework.

In some instances, as contemplated in the framework, the proposed rules

provided more detail than the framework. In a few other instances, the

proposed rules were stricter than the framework.

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

\10\ As required by section 4s of the CEA, the Commission staff

also has consulted with the SEC staff.

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

D. Subsequent Amendment to Dodd-Frank

On January 12, 2015, the President signed Title III of TRIPRA.

Title III amends sections 731 and 764 of the Dodd-Frank Act to exempt

certain transactions of certain commercial end users and others from

the Commission's capital and margin requirements.\11\ Specifically,

section 302 of Title III amends sections 731 and 764 of the Dodd-Frank

Act to provide that the Commission's rules on margin requirements under

those sections shall not apply to a swap in which a counterparty: (1)

Qualifies for an exception under section 2(h)(7)(A) of the Commodity

Exchange Act; (2) qualifies for an exemption issued under section

4(c)(1) of the Commodity Exchange Act for cooperative entities as

defined in such exemption, or (3) satisfies the criteria in section

2(h)(7)(D) of the Commodity Exchange Act.

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

\11\ Pub. L. 114-1, 129 Stat. 3.

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

Section 303 of TRIPRA requires that the Commission implement the

provisions of Title III, ``Business Risk Mitigation and Price

Stabilization Act of 2015,'' by promulgating an interim final rule, and

seeking public comment on the interim final rule. The Commission is

adopting Sec. 23.150(b) as part of this final rule. These exemptions

are

[[Page 638]]

transaction-based, as opposed to counterparty-based. The Commission

will be requesting comment, as required by TRIPRA. If necessary, the

Commission will amend Sec. 23.150(b) after receiving comments on the

interim final rule.

II. Final Rules

A. Overview

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

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

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

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

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

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

inter-affiliate swaps; \12\ and (x) the implementation schedule. The

Commission received 59 written comments on the proposal.\13\ They are

discussed in the applicable sections.

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

\12\ Where appropriate, the preamble uses the term affiliate to

mean a margin affiliate and the term subsidiary to mean margin

subsidiary, as they are defined in Sec. 23.151.

\13\ The written submissions from the public are available in

the comment file on www.cftc.gov. They include, but are not limited

to those listed in Appendix B. In citing these comments, the

Commission used the abbreviations set forth in the Appendix B.

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

The rules adopted herein essentially provide for the same treatment

as the rules recently adopted by the Prudential Regulators \14\ with a

few exceptions. The areas where there are differences are (i) the anti-

evasion provision in the definition of margin affiliate, (ii) the model

approval process, (iii) the calculation of variation margin and related

documentation requirements, and the (iv) treatment of inter-affiliate

trades. Each of these differences is discussed in the applicable

section below.

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

\14\ Margin and Capital Requirements for Covered Swap Entities,

80 FR 74840 (Nov. 30, 2015).

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

The Prudential Regulators also issued a provision addressing cross-

border application of their margin rule. The Commission will address

this aspect of the rule in a separate rulemaking.\15\

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

\15\ Margin Requirements for Uncleared Swaps for Swap Dealers

and Major Swap Participants, 80 FR 41376 (July 14, 2015).

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

B. Products

1. Proposal

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

Commission to establish both initial and variation margin requirements

for certain SDs and MSPs ``on all swaps that are not cleared.'' As a

result, the Commission's proposal covered swaps that are uncleared

swaps \16\ and that are executed after the applicable compliance

date.\17\

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

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

23.151.

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

Regulation 23.160.

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

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

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

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

swaps through foreign clearing organizations that are not registered

with the Commission. The Commission believes that a clearing

organization that is not a registered DCO must meet certain basic

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

uncleared margin requirements. Accordingly, the Commission proposed to

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

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

or other exemptive relief from the Commission to clear such swaps for

U.S. persons without being registered as a DCO.

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

to exempt foreign exchange swaps and foreign exchange forwards from the

definition of swap,\18\ under the proposal the following transactions

would not be subject to the requirements: (i) Foreign exchange swaps;

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

foreign exchange transactions associated with the exchange of principal

in cross-currency swaps.

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

\18\ Determination of Foreign Exchange Swaps and Foreign

Exchange Forwards Under the Commodity Exchange Act, 77 FR 69694

(Nov. 20, 2012).

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

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

interest rate payments in one currency for principal and interest rate

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

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

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

foreign exchange transactions associated with the fixed exchange of

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

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

or swap. Accordingly, the Commission proposed to treat that portion of

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

that is consistent with the treatment of foreign exchange forwards and

swaps. This treatment of cross-currency swaps was limited to cross-

currency swaps and did not extend to any other swaps such as non-

deliverable currency forwards.

2. Comments

The Commission received several comments involving products.

Commenters expressed support for the Commission's decision to exempt

foreign exchange forwards and swaps \19\ and swaps cleared by an exempt

derivatives clearing organization from margin requirements.\20\ One

commenter asked for clarification that commodity trade options are not

subject to the margin requirements.\21\

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

\19\ See GFXD (initial margin should not apply to physically-

settled foreign exchange swaps and forwards and variation margin

should be applied via supervisory guidance or national regulation)

and CPFM.

\20\ See ISDA and Sifma (any swap cleared by a derivatives

clearing organization whether registered or not should be exempt

from margin requirements).

\21\ See BP. To the extent that any financial instrument is an

uncleared swap, it will be covered under the final rule.

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

3. Discussion

The Commission is adopting this aspect of the final regulations

substantially as proposed. The Commission is modifying the definition

of uncleared swap to eliminate the reference to no-action letters and

to require that any exemptive relief be provided by Commission order.

Under sections 4s(e), the Commission is directed to impose initial

and variation margin requirements on all swaps that are not cleared by

a registered derivatives clearing organization. The Commission is

interpreting this statutory language to mean all swaps that are not

cleared by a registered derivatives clearing organization or a

derivatives clearing organization that the Commission has exempted from

registration as provided under the CEA.

In particular, the CEA prohibits persons from engaging in a swap

that is required to be cleared unless they submit such swaps for

clearing to a derivatives clearing organization that is either

registered with the Commission as a derivatives clearing organization

or exempt from registration. Section 5b(h) of the CEA allows the

Commission to exempt, conditionally or unconditionally, a DCO from

registration for the clearing of swaps, where the DCO is subject to

``comparable, comprehensive supervision and regulation'' by the

appropriate government authorities in its home country. The Commission

has granted, by order, relief from registration to derivatives clearing

organizations pursuant to section 5b(h) \22\ and is considering whether

to

[[Page 639]]

grant relief to other derivatives clearing organizations before the

implementation date of these rules. Accordingly, the Commission is

excluding from the definition of uncleared swap, those swaps that are

cleared by a derivatives clearing organization that is either

registered with or has received an exemption by order or rule from

registration.

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

\22\ See In the Matter of the Petition of ASX Clear (Futures)

Pty Limited for Exemption from Registration as a Derivatives

Clearing Organization (Aug. 18, 2015); In the Matter of the Petition

of Japan Securities Clearing Corporation (JSCC) for Exemption from

Registration as a Derivatives Clearing Organization (Oct 26, 2015);

In the Matter of the Petition of Korea Exchange, Inc (KRX) for

Exemption from Registration as a Derivatives Clearing Organization

(Oct. 26, 2015).

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

C. Participants

1. Proposal

Section 4s(e)(3)(A)(2) states that the margin requirements must be

``appropriate to the risks associated with'' the swaps. Because

different types of counterparties can pose different levels of risk,

the proposed rules established three categories of counterparty: (i)

SDs and MSPs, (ii) financial end users,\23\ and (iii) non-financial end

users.\24\ The nature of an SD/MSP's obligations under the rules

differed depending on the nature of the counterparty.

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

\23\ This term is defined in Regulation 23.151.

\24\ This term is defined in Regulation 23.151 to include

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

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

2. Comments

Commenters generally urged the Commission to exclude certain

entities from the definition of ``financial end user.'' For example,

commenters urged the Commission to exclude foreign funds \25\ and

employee benefit plans such as pension plans,\26\ structured finance

special purpose vehicles,\27\ certain captive finance units,\28\

entities guaranteed by a foreign sovereign,\29\ small financial

institutions (such as small banks) that qualify for an exemption from

clearing,\30\ certain financial cooperatives,\31\ covered bond

issuers,\32\ and multilateral banks (e.g., International Monetary Fund

and World Bank Group).\33\ Commenters also urged the Commission to

exclude from margin requirements certain other entities that are exempt

from clearing.\34\ One commenter also supported the exclusion of

certain payment card networks and payment solution providers from the

definition of a ``financial end user.'' \35\

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

\25\ See ISDA (contending that it will be difficult for a non-

U.S. entity to determine which Investment Company Act exemption

would apply if it were organized in the U.S.).

\26\ See ABA (pension plans should not be subject to margin and

should be treated as non-financial end users); AIMA (benefit plans

should not be subject to margin and there is ambiguity involving

whether non-U.S. public and private employee benefit plans would be

financial end users); JBA (securities investment funds should be

exempt from variation margin).

\27\ See ISDA (structured finance vehicles should be excluded

because they do not pose systemic risk, have credit support

arrangements to protect counterparties, and lack ready access to

liquid collateral for initial and variation margin), JBA (securities

investment funds and securitization vehicles are not set up to

exchange variation margin and should be treated as non-financial end

users), JFMC, Sifma-AMG, SFIG, and Sifma. See also FSR (the

Commission should explore conditions to minimize risk rather than

impose variation margin). See SFIG and Sifma (requesting the

Commission to exclude structured finance vehicles from the payment

of variation margin).

\28\ See CDEU (wholly owned centralized treasury units of non-

financial end users that execute swaps on behalf of those non-

financial end users should not be treated as financial end users for

margin purposes).

\29\ See KfW and ICO (entities backed by the full faith and

credit and irrevocable guarantee of a sovereign nation should be

either within the definition of a sovereign entity or excluded from

the definition of a financial end user and hence not subject to

margin requirements). See also FMS-WM (legacy portfolio entity

backed by the full faith and credit of a sovereign government should

be included in the definition of a sovereign).

\30\ See ABA (small banks that qualify for the clearing

exemption should be excluded from margin requirements as subjecting

them to margin requirements would incentivize them to clear their

trades while imposing monitoring costs on them to ensure that they

do not have material swaps exposure).

\31\ See CFC.

\32\ See ISDA (arguing that the EU proposal has special criteria

for covered bond issuers and that covered bond issuers should be

able to use collateral arrangements other than the requirements in

the Commission's proposal).

\33\ See Sifma (the Commission should align the definition of

multilateral banks in the margin regulations to the definition in

the clearing exemption and specify that the United Nations and

International Monetary Fund are included among multilateral banks)

and MFX (MFX contends that it, as a fund, should be considered a

multilateral development bank because the U.S. government is a

shareholder through the Overseas Private Investment Corporation's

involvement in the fund, the fund poses a similar risk profile as

that of a multilateral development bank, and the fund engages in the

same types of activities as a multilateral development bank).

\34\ See W&C (initial and variation margin should not apply to

an eligible treasury affiliate as defined in Commission No-Action

Letter No. 13-22); ABA; CFC (entities that are exempt from clearing

such as exempt cooperatives should be exempt from margin

requirements); and CDEU (special purpose vehicles that are

subsidiaries of captive finance companies that are exempt from

clearing should be exempt from margin). But see AFR (cautioning

against the scope of the exemption provided to non-financial end

users in the proposal and urging the Commission to separate the

clearing and margin exemptions).

\35\ See MasterCard.

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

Commenters pointed out that the exclusion from financial end user

for a person that qualifies for the affiliate exemption from clearing

pursuant to section 2(h)(7)(D) of the Commodity Exchange Act requires

an entity to be acting as agent for an affiliate and thus would not

capture equivalent entities that act as principal for an affiliate.\36\

These commenters contended that many such entities act as principal for

an affiliate and that the Commission has issued a no-action letter

effectively exempting such entities from clearing.\37\

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

\36\ See CEWG; Sifma; W&C.

\37\ See CFTC No-Action Letter No. 13-22 (June 4, 2013).

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

With respect to employee benefit plans, commenters generally argued

that these plans should not be subject to margin requirements because

they are highly regulated, highly creditworthy, have low leverage and

are prudently managed counterparties whose swaps are used primarily for

hedging and, as such, pose little risk to their counterparties or the

broader financial system. One commenter urged the Commission to exclude

both U.S. and non-U.S. public and private employee benefit plans where

swaps are hedging risk. This commenter also contended that there may be

ambiguity whether certain pension plans are financial end users if they

are not subject to the Employee Retirement Income and Security Act of

1974 (``ERISA'') (29 U.S.C. 1002). Another commenter argued that

current market practice is not to require initial margin for pension

plans.

A number of commenters also requested that the Commission exclude

from financial end user structured finance vehicles including

securitization special purpose vehicles (``SPVs'') and covered bond

issuers. These commenters argued that imposing margin requirements on

structured finance vehicles would restrict their ability to hedge

interest rate and currency risk and potentially force these vehicles to

exit swap markets since these vehicles generally do not have ready

access to liquid collateral. These commenters contended that it is

impossible for the vast majority of these entities to exchange margin,

including variation margin, and that subjecting them to margin

requirements would severely restrict the ability of securitization

vehicles to hedge interest rate risk and currency risk.

Moreover, commenters argued that covered swap entities, as defined

below, that enter a swap may be protected by other means--e.g., a

security interest granted in the assets of a securitization SPV.

Commenters also noted that these types of entities make payments on a

monthly payment cycle using collections received on the underlying

assets during the previous month and would not be able to make daily

margin calls. These commenters argued that

[[Page 640]]

significant structural changes would be necessary for securitization

vehicles to post and collect variation margin.

These commenters urged the Commission to follow the approach of the

proposed European rules under which securitization vehicles would be

defined as non-financial entities and would not be required to exchange

initial or variation margin. Certain of these commenters also expressed

concerns about consistency with the treatment under the EU proposal.

One commenter stated that the EU proposal has special criteria for

covered bond issuers and that covered bond issuers should be able to

use collateral arrangements other than the requirements in the

Commission's proposal. Commenters similarly urged the Commission to

follow the EU margin proposal which provided a special set of criteria

for covered bond issuers and requested that the Commission develop

rules that would permit covered bond issuers to use other forms of

collateral arrangements. One commenter, however, argued that requiring

SPVs and other asset-backed security issuers to post full margin

against all swap contracts would defuse commonly used ``flip clauses''

and decrease the loss exposure of investors in asset-backed

securities.\38\

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

\38\ See William J. Harrington.

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

A few commenters urged the Commission to remove a provision in the

proposal allowing the Commission to designate entities as financial end

users due to concerns that it would allow the Commission to re-

categorize nonfinancial entities as financial end users.\39\ These

commenters argued that in order for an entity to be treated as a

financial end user, the Commission would have to provide adequate

notice and propose an amendment to the rule to address such

concerns.\40\

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

\39\ See CDEU; Joint Associations; IECA.

\40\ See CDEU.

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

Commenters also pointed out miscellaneous concerns with the

proposal. They have asked for clarification with respect to the process

for determining whether an entity is a financial end user,\41\

suggested that the change in status of a counterparty over the life of

a swap should not affect the classification of the counterparty,\42\

and urged the Commission to align its definition of ``financial end

user'' with the definition put forth by the Prudential Regulators

regarding business development companies.\43\ With respect to foreign

counterparties, a few commenters argued that the test in the proposal

concerning whether a foreign counterparty would be a financial end user

if it were organized under the laws of the U.S. or any State is

difficult to apply because it would require a covered swap entity to

analyze a foreign counterparty's business activities in light of a

broad array of U.S. regulatory requirements.\44\ Finally, a commenter

commended the Commission on its definition of financial end user.\45\

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

\41\ See CDEU.

\42\ See ISDA and Sifma.

\43\ See JBA.

\44\ See ISDA (contending that it will be difficult for a non-

U.S. entity to determine which Investment Company Act exemption

would apply if it were organized in the U.S.); see also AIMA

(arguing that there is ambiguity regarding whether non-U.S. public

and private pension plans would be treated as financial end users).

\45\ See MasterCard (the definition in the margin regulations is

commendable because it is narrower than the definition in Commission

Regulation 50.50. Entities that engage in financial activities

within the meaning of Section 4(k) of the Bank Holding Company Act

that are not a financial end user should be allowed to rely on the

end user exception).

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

3. Discussion

a. Covered Swap Entities

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

Commission to impose margin requirements on SDs and MSPs for which

there is no Prudential Regulator. These entities are defined in

proposed Sec. 23.151 as ``covered swap entities'' or ``CSEs.'' The

final rule adopts the definition as set forth in the proposal. The

final rule also includes special provisions for inter-affiliate swaps

between a CSE and its affiliates. The following sections provide a

discussion of other significant market participants and applicable

standards set forth in the final rule.

b. Financial End Users

(i) Definition

In order to provide certainty and clarity to counterparties as to

whether they would be financial end users for purposes of this final

rule, the financial end user definition provides a list of entities

that would be financial end users as well as a list of entities

excluded from the definition. In the final rule, as under the proposed

rule, the Commission is relying, to the greatest extent possible, on

the counterparty's legal status as a regulated financial entity. The

definition lists numerous entities whose business is financial in

nature.

In developing the definition, the Commission sought to provide

clarity to CSEs and their counterparties about whether particular

counterparties would be financial end users and subject to the margin

requirements of the final rule. The definition is an attempt to capture

all financial counterparties without being overly broad and capturing

commercial firms and sovereigns.

The Commission believes that this approach is consistent with the

risk-based approach of the final rule, as financial firms generally

present a higher level of risk than other types of counterparties

because their profitability and viability are more tightly linked to

the health of the financial system than other types of counterparties.

Because financial counterparties are more likely to default during a

period of financial stress, they pose greater systemic risk and risk to

the safety and soundness of the CSE.

In developing the list of financial entities, the Commission sought

to include entities that engage in financial activities that give rise

to Federal or State registration or chartering requirements, such as

deposit taking and lending, securities and swaps dealing, or investment

advisory activities.

The Commission notes that an entity or person would be classified

as a financial end user based on the nature of the activities of that

entity or person regardless of the source of the funds used to finance

such activities. For example, an entity or person would be a financial

entity if it raises money from investors, uses its own funds, or

accepts money from clients or customers to predominately engage in

investing, dealing, or trading in loans, securities, or swaps.

The list also includes asset management and securitization

entities. For example, certain investment funds as well as

securitization vehicles are covered, to the extent those entities would

qualify as private funds defined in section 202(a) of the Investment

Advisers Act of 1940, as amended (the ``Advisers Act''). In addition,

certain real estate investment companies would be included as financial

end users as entities that would be investment companies under section

3 of the Investment Company Act of 1940, as amended (the ``Investment

Company Act''), but for section 3(c)(5)(C), and certain other

securitization vehicles would be included as entities deemed not to be

investment companies pursuant to Rule 3a-7 of the Investment Company

Act.

Because Federal law largely looks to the States for the regulation

of the business of insurance, the definition of financial end user in

the final rule broadly includes entities organized as insurance

companies or supervised as such by a State insurance regulator. This

element of the final rule's definition

[[Page 641]]

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

insurance firms supervised by a foreign insurance regulator.

The Commission intends to cover, as financial end users, a broad

variety and number of nonbank lending and retail payment firms that

operate in the market. To this end, the Commission has included State-

licensed or registered credit or lending entities and money services

businesses under the final rule's provision incorporating an inclusive

list of the types of firms subject to State law. However, the

Commission recognizes that the licensing of nonbank lenders in some

states extends to commercial firms that provide credit to the firm's

customers in the ordinary course of business. Accordingly, the

Commission is excluding an entity registered or licensed solely on

account of financing the entity's direct sales of goods or services to

customers.

Under the final rule, those cooperatives that are financial

institutions,\46\ such as credit unions, Farm Credit System banks and

associations,\47\ and other financial cooperatives \48\ are financial

end users because their sole business is lending and providing other

financial services to their members, including engaging in swaps in

connection with such loans.\49\ The treatment of the uncleared swaps of

these financial cooperatives may differ under the final rule due to

TRIPRA, which became law after the proposal was issued. More

specifically, almost all swaps of the cooperatives that are financial

end users qualify for an exemption from clearing if certain conditions

are met,\50\ and therefore, these uncleared swaps also would qualify

for an exemption from margin requirements under Sec. 23.150(b) of the

final rule. Uncleared swaps of financial cooperatives that do not

qualify for an exemption would be treated as uncleared swaps of

financial end users under the final rule.

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

\46\ The Commission expects that state-chartered financial

cooperatives that provide financial services to their members, such

as lending to their members and entering into swaps in connection

with those loans, would be treated as financial end users, pursuant

to this aspect of the final rule's coverage of credit or lending

entities. However, these cooperatives could elect an exemption from

clearing under Regulation 50.51, 17 CFR 50.51, and as a result,

their uncleared swaps would also be exempt from the margin

requirements of the final rule pursuant to Regulation 23.150(b).

\47\ The preamble more fully discusses the status of Farm Credit

System institutions as financial end users and their exemptions from

clearing and the margin requirements.

\48\ The National Rural Utility Cooperative Finance Cooperation

(``CFC'') is an example of another financial cooperative. The CFC's

comment letter requested that the Commission exempt swaps entered

into by nonprofit cooperatives from the margin requirement to the

extent they that are already exempt from clearing requirements.

Regulation 23.150(b) of the final rule responds to the CFC's

concerns.

\49\ Most cooperatives are producer, consumer, or supply

cooperatives and, therefore, they are not financial end users.

However, many of these cooperatives have financing subsidiaries and

affiliates. These financing subsidiaries and affiliates would not be

financial end users under this final rule if they qualify for an

exemption under sections 2(h)(7)(C)(iii) or 2(h)(7)(D) of the CEA.

Moreover, certain swaps of these entities may be exempt pursuant to

TRIRA and Regulation 23.150(b) of the final rule.

\50\ Section 2(h)(7)(C)(ii) of the CEA authorizes the Commission

to exempt small depository institutions, small Farm Credit System

institutions, and small credit unions with total assets of $10

billion or less from the mandatory clearing requirements for swaps.

See 7 U.S.C. 2(h)(7) and 15 U.S.C. 78c-3(g). Additionally, the

Commission, pursuant to its authority under section 4(c)(1) of the

CEA, enacted 17 CFR part 50, subpart C, Sec. 50.51, which allows

cooperative financial entities, including those with total assets in

excess of $10 billion, to elect an exemption from mandatory clearing

of swaps that: (1) They enter into in connection with originating

loans for their members; or (2) hedge or mitigate commercial risk

related to loans or swaps with their members.

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

The final rule's definition of ``financial end user'' is largely

similar to the proposed definition, with a few modifications. In the

final rule, the Commission added as a financial end user a U.S.

intermediate holding company (``IHC'') established or designated for

purposes of compliance with the Board's Regulation YY (12 CFR 252.153).

Pursuant to Regulation YY, a foreign banking organization with U.S.

non-branch assets of $50 billion or more must establish a U.S. IHC and

transfer its ownership interest in the majority of its U.S.

subsidiaries to the IHC by July 1, 2016. As not all IHCs will be bank

holding companies, the Commission is explicitly identifying IHCs in the

list of financial end users to clarify that they are included. To the

extent an IHC that is not itself registered as a swap entity enters

into uncleared swaps with a CSE, the IHC would be treated as a

financial end user like other types of holding companies that are not

swap entities (e.g., bank holding companies and saving and loan holding

companies).

In response to the commenters request to align its definition of

financial end user with the Prudential Regulators' definition, the

Commission also added business development companies in subparagraph

(vi) of the definition of financial end user.

The Commission also has added three entities registered with the

Commission to the enumerated list of financial end users: floor

brokers, floor traders, and introducing brokers. As defined in section

1a(22) of the CEA, a floor broker generally provides brokering services

on an exchange to clients in purchasing or selling any future,

securities future, swap, or commodity option. As defined in section

1a(23) of the CEA, a floor trader generally purchases or sells on an

exchange solely for that person's account, any future, securities

future, swap, or commodity option. As defined in section 1a(31) of the

CEA, an introducing broker generally means any person who engages in

soliciting or in accepting orders for the purchase and sale of any

future, security future, commodity option, or swap. In addition, it

also includes anyone that is registered with the Commission as an

introducing broker.

In deciding to add these entities to the definition of financial

end user, the Commission determined that these entities' services and

activities are financial in nature and that these entities provide

services, engage in activities, or have sources of income that are

similar to financial entities already included in the definition. In

this vein, the Commission is also adding to the list of financial end

user security-based swap dealers and major security-based swap

participants. The Commission believes that by including these financial

entities in the definition of financial end user, the definition

provides additional clarity to CSEs when engaging in uncleared swaps

with these entities. As noted above, financial entities are considered

more systemic than non-financial entities and as such, the Commission

believes that these entities, whose activities, services, and sources

of income are financial in nature, should be included in the definition

of financial end user. The Commission notes, however, that if a

commercial end user falls within the definition of financial end user

under this rule because of, for example, its registration as a floor

broker or otherwise, so long as its swaps qualify for an exemption

under TRIPRA, those swaps will not be subject to the margin

requirements of these rules.

In the proposal, the Commission included in the definition of a

financial end user ``An entity that is, or holds itself out as being,

an entity or arrangement that raises money from investors primarily for

the purpose of investing in loans, securities, swaps, funds or other

assets for resale or other disposition or otherwise trading in loans,

securities, swaps, funds or other assets.'' In addition to asking

whether the definition was too broad or narrow, as noted above, the

Commission asked questions as to whether this prong of the definition

was broad enough to capture other types of pooled investment

[[Page 642]]

vehicles that should be treated as financial end users.

After reviewing all comments, the Commission is broadening section

(xi) of the definition of a ``financial end user'' to include other

types of entities and persons that primarily engage in trading,

investing, or in facilitating the trading or investing in loans,

securities, swaps, funds, or other assets. In broadening the

definition, the Commission believes that the enumerated list in the

proposal of financial end users was under-inclusive, not covering

certain entities that provide or engage in services and activities that

are financial in nature. Specifically, the Commission is concerned that

the proposed definition did not cover certain financial entities that

are not organized as pooled investment vehicles and that trade or

invest their own or client funds (e.g., high frequency trading firms)

or that provide other financial services to their clients. The

Commission's approach also addresses concerns, now or in the future,

that one or more types of financial entities might escape

classification under the specific Federal or State regulatory regimes

included in the definition of ``financial end user.''

In order to address concerns raised by commenters, the final rule

removes the provision in the definition of ``financial end user'' that

included any other entity that the Commission has determined should be

treated as a financial end user. The Commission will monitor the margin

arrangements of swap transactions of CSEs to determine if certain types

of counterparties, in fact, are financial entities that are not covered

by the definition of ``financial end user'' in the final rule. In the

event that the Commission finds that one or more types of financial

entities escape classification as financial end users under the final

rule, the Commission may consider another rulemaking that would amend

the definition of ``financial end user'' so it covers such entities.

In the proposal, the Commission stated that ``[f]inancial firms

present a higher level of risk than other types of counterparties

because the profitability and viability of financial firms is more

tightly linked to the health of the financial system than other types

of counterparties.'' \51\ Accordingly, it is crucial that the

definition of financial end user include the types of firms that engage

in the activities described above.

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

\51\ 79 FR at 57360 (September 24, 2014).

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

Many of the provisions in the financial end user definitions rely

on whether an entity's financial activities trigger Federal or State

registration or chartering requirements. In its proposal, the

Commission included in the definition of ``financial end user'' any

entity that would be a financial end user if it were organized under

the laws of the United States or any State. A few commenters argued

that the proposed test is difficult to apply because it would require a

CSE to analyze a foreign counterparty's business activities in light of

a broad array of U.S. regulatory requirements.

The Commission has not modified this provision in the final rule.

The Commission acknowledges that the test imposes a greater incremental

burden in classifying foreign counterparties than it does in

identifying U.S. financial end users. The burdens associated with

classifying counterparties as financial or non-financial has been a

recurring theme during the rulemaking. To reduce the burden, in this

instance, the Commission believes that CSEs may rely on good faith

representations from their counterparties as to whether they are

financial end users under the final rule. The Commission believes the

approach in the final rule captures the kinds of entities whose

profitability and viability are most tightly linked to the health of

the financial system.

In this respect, the Commission's financial end user definition is

broad by design. Exclusion from the financial end user definition for

any enterprise engaged extensively in financial and market activities

should, as a practical matter, be the exception rather than the rule.

The Commission believes it is appropriate to require a CSE that seeks

to exclude a foreign financial enterprise from the rule's margin

requirements to ascertain the basis for that exclusion under the same

laws that apply to U.S. entities.

The Commission has included in the final rule not only an entity

that is or would be a financial end user but also an entity that is or

would be a swap entity, if it were organized under the laws of the

United States or any State. Since a financial end user is defined as

``a counterparty that is not a swap entity,'' the purpose of this

addition is to make clear that an entity that is not a registered swap

entity in the U.S. but acts as a swap entity in a foreign jurisdiction

would be treated as a financial end user under the final rule.

As noted above, the Commission believes that financial firms

present a higher level of risk than other types of counterparties

because the profitability and viability of financial firms is more

tightly linked to the health of the financial system than other types

of counterparties. Accordingly, the Commission has adopted a definition

of financial end user that includes the types of firms that engage in

the activities described above.

The final rule, like the proposal, excludes certain types of

counterparties from the definition of financial end user. The

definition of financial entities \52\ excludes the government of any

country, central banks, multilateral development banks,\53\ the Bank

for International Settlements, captive finance companies,\54\ and agent

affiliates.\55\ The exclusion for sovereign entities, multilateral

development banks and the Bank for International Settlements is

consistent with the 2013 international framework and the definition of

the Prudential Regulators.\56\

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

\52\ Regulation 23.151.

\53\ Some commenters requested additional clarity that certain

entities would be included as multilateral development banks. See

SIFMA; MFX. The definition in the final rule includes an enumerated

list of entities in addition to any other entity that provides

financing for national or regional development in which the U.S.

government is a shareholder or contributing member or which the

relevant Agency determines poses comparable credit risk. Entities

that meet this part of the definition would be treated as

multilateral development banks for purposes of the final rule.

\54\ A captive finance company is an entity that is excluded

from the definition of financial entity under section

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

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

whose primary business is providing financing, and uses derivatives

for the purpose of hedging underlying commercial risks related to

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

which arise from financing that facilitates the purchase or lease of

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

company or another subsidiary of the parent company.''

\55\ An agent affiliate is an entity that is an affiliate of a

person that qualifies for an exception from the requirement to

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

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

under subparagraph (A) (including affiliate entities predominantly

engaged in providing financing for the purchase of the merchandise

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

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

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

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

entity.''

\56\ As discussed below, captive finance companies and agent

affiliates are excluded by TRIPRA from the definition of financial

entity.

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

The Commission believes that this approach is appropriate as these

entities generally pose less systemic risk to the financial system as

their activities generally have a different purpose in the financial

system leading to a lower risk profile in addition to posing less

counterparty risk to a swap entity. Thus, the Commission believes that

application of the margin requirements that would apply for financial

end users to swaps with these counterparties is

[[Page 643]]

not necessary to achieve the objectives of this rule.

The Commission notes that States would not be excluded from the

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

includes only central governments. This does not mean, however, that

States are categorically classified as financial end users. Whether a

State or particular part of a State (e.g., counties, municipalities,

special administrative districts, agencies, instrumentalities, or

corporations) would be a financial end user depends on whether that

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

end user. For example, a State entity that is a ``governmental plan''

under ERISA would meet the definition of financial end user.

As noted above, commenters requested that the Commission exclude a

number of other entities from the definition of financial end user

including small banks that qualify for an exception from clearing,\57\

certain financial cooperatives,\58\ pension plans,\59\ structured

finance vehicles,\60\ and covered bond issuers.\61\ Depository

institutions, financial cooperatives, employee benefit plans,

structured finance vehicles, and covered bond issuers are financial end

users for purposes of the final rule. The interim final rule addresses

the comments raised regarding the uncleared swaps of small banks and

certain financial cooperatives by providing an exemption for such swaps

that qualify for an exemption from clearing. The uncleared swaps of

small banks or financial cooperatives that do not qualify for the

exemptive treatment would be treated as swaps of financial end users

under the final rule.

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

\57\ See ABA.

\58\ See CFC.

\59\ See ABA; AIMA. These commenters generally argued that

pension plans should not be subject to margin requirements because

they are highly regulated, highly creditworthy, have low leveraged

and are prudently managed counterparties whose swaps are used

primarily for hedging and, as such, pose little risk to their

counterparties or the broader financial system.

\60\ See FSR; ISDA; JBA; JFMC; SIFMA AMG; SFIG. Commenters

argued that imposing margin requirements on structured finance

vehicles would restrict their ability to hedge interest rate and

currency risk and potentially force these vehicles to exit swaps

markets since these vehicles generally do not have ready access to

liquid collateral. Certain of these commenters also expressed

concerns about consistency with the treatment under the EU proposal.

\61\ See ISDA (arguing that the EU proposal has special criteria

for covered bond issuers and that covered bond issuers should be

able to use collateral arrangements other than the requirements in

the Commission's proposal).

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

The Commission has not modified the definition of financial end

user to exclude pension plans, structured finance vehicles, or covered

bonds issuers.

Congress explicitly listed an employee benefit plan as defined in

paragraph (3) and (32) of section 3 of the ERISA in the definition of

``financial entity'' in the Dodd-Frank Act, meaning that a pension plan

would not benefit from an exclusion from clearing even if the pension

plan used swaps to hedge or mitigate commercial risk. The Commission

believes that, similarly, when a pension plan enters into an uncleared

swap with a CSE, the pension plan should be treated as a financial end

user and subject to the requirements of the final rule.

The definition of employee benefit plan in the final rule is the

same as in the proposal and is defined by reference to paragraphs (3)

and (32) of the ERISA. Paragraph (3) provides that the term ``employee

benefit plan'' or ``plan'' means an employee welfare benefit plan or an

employee pension benefit plan or a plan which is both an employee

welfare benefit plan and an employee pension benefit plan. Paragraph

(32) describes certain governmental plans. In response to concerns

raised by commenters, the Commission believes that these broad

definitions would cover all pension plans regardless of whether the

pension plan is subject to the ERISA. In addition, non-U.S. employee

benefit plans would be included as an entity that would be a financial

end user, if it were organized under the laws of the United States or

any State thereof.

The Commission believes that all of these entities should qualify

as financial end users; their financial and market activities comprise

the same range of activities as the other entities encompassed by the

final rule's definition of financial end user. The Commission notes

that the increase in the size of positions necessary to constitute

material swaps exposure in the final rule should address some of the

concerns raised by these commenters with respect to the applicability

of initial margin requirements.

(ii) Small Banks

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

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

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

material swaps exposure. However, TRIPRA also excluded certain swaps

with small banks from the margin requirements of this rule. In

particular, section 2(h)(7)(A) of the Commodity Exchange Act excepts

from clearing any swap where one of the counterparties is not a

financial entity, is using the swap to hedge or mitigate commercial

risk, and notifies the Commission how it generally meets its financial

obligations associated with entering into uncleared swaps.\62\ As

authorized by the Dodd-Frank Act, the Commission has excluded

depository institutions, Farm Credit System Institutions, and credit

unions with total assets of $10 billion or less, from the definition of

``financial entity,'' thereby permitting those institutions to avail

themselves of the clearing exception for end users.\63\ Uncleared swaps

with those entities would be eligible for the TRIPRA exemption in the

Commission's margin rules, provided they meet other requirements for

the clearing exception. As a consequence of TRIPRA, if a small bank

with total assets of $10 billion or less enters into a swap with a CSE

that meets the requirements of the exception from clearing, that swap

will not be subject to the margin requirements of these rules.

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

\62\ A ``financial entity'' is defined to mean (i) a swap

dealer; (ii) a security-based swap dealer; (iii) a major swap

participant; (iv) a major security-based swap participant; (v) a

commodity pool; (vi) a private fund as defined in section 202(a) of

the Investment Advisers Act of 1940; (vii) an employee benefit plan

as defined in sections 3(3) and 3(32) of the Employment Retirement

Income Security Act of 1974; (viii) a person predominantly engaged

in activities that are in the business of banking, or in activities

that are financial in nature, as defined in section 4(k) of the Bank

Holding Company Act of 1956. See 7 U.S.C. 2(h)(7)(C)(i).

\63\ See 7 U.S.C. 2(h)(7)(C)(ii) and 77 FR 42560 (July 19,

2012); 77 FR 20536 (April 5, 2012).

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

When a bank with total assets greater than $10 billion enters into

a swap with a CSE, the CSE will be required to post and collect initial

margin pursuant to the rule only if the bank had a material swaps

exposure and is not otherwise exempt.\64\ The final rule requires a CSE

to exchange daily variation margin with a bank with total assets above

$10 billion, regardless of whether the bank has material swaps

exposure. However, the CSE will only be required to collect variation

margin from a bank when the amount of both initial margin and variation

margin required to be collected exceeds the minimum transfer amount of

$500,000.

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

\64\ The final rule defines material swaps exposure as an

average daily aggregate notional amount of uncleared swaps,

uncleared security-based swaps, foreign exchange forwards and

foreign exchange swaps with all counterparties for June, July, and

August of the previous calendar year that exceeds $8 billion, where

such amount is calculated only for business days.

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

[[Page 644]]

(iii) Multilateral Development Banks

The proposed definition of the term ``multilateral development

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

provides financing for national or regional development in which the

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

Commission determines poses comparable credit risk.''

As described above, the final rule excludes from the definition of

financial end user a ``sovereign entity'' defined to mean a central

government (including the U.S. government) or an agency, department, or

central bank of a central government. An entity guaranteed by a

sovereign entity is not explicitly excluded from the definition of

financial end user in the final rule, unless that entity qualifies as a

central government agency, department, or central bank. The existence

of a government guarantee does not in and of itself exclude the entity

from the definition of financial end user.

(iv) Material Swaps Exposure

The Commission proposed a ``material swaps exposure'' level of $3

billion. This threshold is lower than the guidelines contained in WGMR

and also in the EU's consultation paper. The Commission proposed a

lower threshold based on data it analyzed concerning the required

margin on cleared swaps.

A number of commenters argued that the Commission should raise the

level of material swaps exposure to the threshold of [euro]8 billion

set out in the 2013 international framework to be consistent with the

EU and Japanese proposals.\65\ A commenter suggested that adopting

different exposure levels may result in the failure of an international

framework.\66\ Commenters suggested that the Commission conduct further

studies on the uncleared swaps markets before adopting a threshold.\67\

Some commenters expressed the view that the international

implementation of material swaps exposure threshold treats the

threshold more as a scope provision, to define the group of financial

firms in the swaps market whose activities rise to a level appropriate

to the exchange of initial margin as a policy matter.\68\

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

\65\ See ABA; AIMA; CEWG, CPFM; CCMR; FHLB; FSR; GPC; IFM, ISDA;

ICI; IIB; JBA; MFA: Sifma AMG; Sifma; Shell TRM; NERA; and Vanguard.

By contrast, one commenter suggested reducing the threshold below $3

billion. CME. Another commenter expressed concerns that entities

below $3 billion could have considerable exposures. AFR. One

commenter cautioned against the aggressive use of thresholds to

manage liquidity. Barnard.

\66\ See JBA (financial institutions will abide by different

rules depending on their counterparties' jurisdiction).; see also

MFA (competitive discrepancies may result).

\67\ See IFM; Sifma; ABA. See also ISDA (Commission's

calculations assume that a covered swap counterparty has all its

swaps with one party).

\68\ For example, one commenter acknowledged data described by

the Commission in the proposed rule indicating that bilateral

initial margin exposures between one CSE and a financial end user

could exceed $50 million for a portfolio with a gross notional value

well below the USD-equivalent of the international [euro]8 billion

threshold. But the commenter urged the Commission to shift its focus

from the $65 million amount, as a bilateral constraint, and

recognize that a financial end user will often use multiple dealers.

Accordingly, the commenter urged the Commission to treat the

material swaps exposure threshold as a focus on a financial end

user's multilateral exposures with all its dealers, which provides

the rationale for the higher international threshold.

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

Commenters representing public interest groups and CCPs expressed

policy concerns about whether the $3 billion threshold was conservative

enough, focusing on the collective systemic risk posed by all smaller

counterparties in the aggregate. Other commenters representing CSEs and

financial end users expressed concerns about the additional initial

margin they would be required to exchange compared to foreign firms,

and the associated competitive impacts.

Commenters also commented on the method for calculating material

swaps exposure. A few commenters suggested that a daily aggregate

notional measure was burdensome and the Commission should use a month-

end notional amount like the EU proposal and consistent with the

international framework.\69\ Commenters urged the Commission to make

clear that inter-affiliate swaps would not be included for purposes of

determining the material swaps exposure.\70\ Certain of these

commenters also argued that the proposal could require an entity to

double-count inter-affiliate swaps in assessing material swaps

exposure.

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

\69\ See JBA; Sifma.

\70\ See ABA; CEWG; CDEU; FSR; GPC; ICI; ISDA: Sifma AMG; Sifma;

Shell TRM; Vanguard.

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

Commenters also argued that certain other swaps should not be

counted for purposes of the material swaps exposure calculation. A few

commenters argued that foreign exchange swaps and foreign exchange

forwards that are exempt from the definition of swap by Treasury

determination should not be included for purposes of determining

material swaps exposure.\71\ Other commenters argued that hedging

positions should not be counted toward material swaps exposure.\72\ A

commenter argued that the material swaps exposure calculation should

not include swaps of all affiliates of a financial end user.\73\

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

\71\ See ICI; ABA; ISDA; GPC; Sifma; Sifma AMG; Vanguard. The

final rule defines ``foreign exchange forward and foreign exchange

swap'' to mean any foreign exchange forward, as that term is defined

in section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)),

and foreign exchange swap, as that term is defined in section 1a(25)

of the Commodity Exchange Act (7 U.S.C. 1a(25)). See Regulation

23.151.

\72\ See GPC; CFC.

\73\ See CDEU (many non-financial end users have financial end

users as affiliates, and certain of their swaps should be excluded).

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

A few commenters urged the Commission to make clear that a CSE may

rely on representations of its counterparties in assessing whether it

is transacting with a financial end user with material swaps

exposure.\74\ One commenter urged the Commission to clarify what

happens when a financial end user counterparty that had a material

swaps exposure falls below the threshold.\75\

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

\74\ See ABA; FHLB: IFM; ISDA; BP; Shell TRM; CEWG; see also

GPC; SIFMA.

\75\ See FHLB.

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

The final rule increases the level of the aggregate notional amount

of transactions that gives rise to material swaps exposure to $8

billion. The material swaps exposure threshold of $8 billion in the

final rule is broadly consistent with the [euro]8 billion established

by the 2013 international framework and the EU and Japanese proposals.

In the proposal, the Commission had calibrated the proposed $3 billion

threshold to the size of a potential swap portfolio between a CSE and a

financial end user for which the initial margin amount would often

exceed the proposed initial margin threshold amount of $65 million,

reducing the burden of calculating initial margin amounts for smaller

portfolios.

The material swaps exposure threshold of $8 billion in the final

rule has been calibrated relative to the [euro]8 billion established by

the 2013 international framework in the manner described below. At this

time, the Commission believes the better course is to calibrate the

final rule's material swaps exposure threshold to the higher 2013

international framework amount, in recognition of each financial end

user's overall potential future swaps exposure to the market rather

than its potential future exposure to one dealer. In this regard, the

Commission notes that variation margin will still be exchanged without

any threshold, and further that the $8 billion threshold may warrant

further discussion among international regulators in future years, if

implementation of the threshold proves to create concerns about market

coverage for initial margin.

In the final rule, ``material swaps exposure'' for an entity means

that an

[[Page 645]]

entity and its affiliates have an average daily aggregate notional

amount of uncleared swaps, uncleared security-based swaps, foreign

exchange forwards, and foreign exchange swaps with all counterparties

for June, July, and August of the previous calendar year that exceeds

$8 billion, where such amount is calculated only for business days.\76\

The final rule's definition also provides that an entity shall count

the average daily aggregate notional amount of an uncleared swap, an

uncleared security-based swap, a foreign exchange forward or a foreign

exchange swap between the entity and an affiliate only one time. In

addition, as discussed below, the calculation does not include a swap

or security-based swap that is exempt pursuant to TRIPRA.

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

\76\ The final rule also includes a new definition of ``business

day'' that means any day other than a Saturday, Sunday, or legal

holiday. This definition is described further below.

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

The time period for measuring material swaps exposure is June, July

and August of the previous calendar year under the final rule, the same

period as under the proposal. The Commission believes that using the

average daily aggregate notional amount \77\ during June, July, and

August of the previous year, instead of a single as-of date, is

appropriate to gather a more comprehensive assessment of the financial

end user's participation in the swaps market, and to address the

possibility that a market participant might ``window dress'' its

exposure on an as-of date such as year-end, in order to avoid the

Commissions' margin requirements. Material swaps exposure would be

calculated based on the previous year. For example, for the period

January 1, 2017 through December 31, 2017, an entity would determine

whether it had a material swaps exposure with reference to June, July,

and August of 2016.\78\

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

\77\ A few commenters suggested that a daily aggregate notional

measure was burdensome and that the Commission should use a month-

end notional amount like the EU proposal and consistent with the

international framework. JBA; SIFMA. The Commission has maintained

the daily aggregate notional amount.

\78\ As a specific example of the calculation for material swaps

exposure, consider a financial end user (together with its

affiliates) with a portfolio consisting of two uncleared swaps

(e.g., an equity swap, an interest rate swap) and one uncleared

security-based credit swap. Suppose that the notional value of each

swap is exactly $10 billion on each business day of June, July, and

August of 2016. Furthermore, suppose that a foreign exchange forward

is added to the entity's portfolio at the end of the day on July 31,

2016, and that its notional value is $10 billion on every business

day of August 2016. On each business day of June and July 2016, the

aggregate notional amount of uncleared swaps, security-based swaps

and foreign exchange forwards and swaps is $30 billion. Beginning on

June 1, 2016, the aggregate notional amount of uncleared swaps,

security-based swaps and foreign exchange forwards and swaps is $40

billion. The daily average aggregate notional value for June, July,

August 2016 is then (22 x $30 billion + 23 x $30 billion + 21 x $40

billion)/(22 + 20 + 23) = $33.5 billion, in which case this entity

would be considered to have a material swaps exposure for every date

in 2017.

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

The definition of material swaps exposure also contains a number of

other changes from the proposed definition. Commenters urged the

Commission to make clear that inter-affiliate swaps would not be

included for purposes of determining the material swaps exposure.\79\

Certain of these commenters also argued that the proposal could require

an entity to double-count inter-affiliate swaps in assessing material

swaps exposure.

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

\79\ See ABA; WGCEF; FSR; GPC; ICI; ISDA: SIFMA AMG; SIFMA;

Vanguard.

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

In order to address concerns about double counting affiliate swaps,

the final rule provides that an entity shall count the average daily

aggregate notional amount of an uncleared swap, an uncleared security-

based swap, a foreign exchange forward or a foreign exchange swap

between the entity and an affiliate only one time.\80\ The Commission

also believes that the revised definition of affiliate in the final

rule (described below) should help mitigate some of the concerns raised

by commenters about the inclusion of an affiliate's swaps in

determining material swaps exposure.\81\

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

\80\ The Commission made a similar change to the definition of

``initial margin threshold amount'' as described in Regulation

23.151.

\81\ For example, the revised definition of ``affiliate''

generally would not treat investment funds that share an investment

adviser or investment manager as affiliates.

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

The final rule's definition of material swaps exposure also states

that for purposes of this calculation, an entity shall not count a swap

that is exempt pursuant to Sec. 23.150(b).\82\ This change is

consistent with the statutory exemptions provided by Congress in TRIPRA

2015 and ensures that exempt swaps do not count toward determining

whether an entity has material swaps exposure.

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

\82\ The Commission made a similar change to the definition of

``initial margin threshold amount'' as described in Regulation

23.151.

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

As the material swaps exposure is designed to measure the overall

derivatives exposure of an entity, the final rule's calculation of

material swaps exposure continues to include foreign exchange swaps and

foreign exchange forwards as well as swaps used to hedge. The final

rule also does not make a distinction between uncleared swaps entered

into prior to and after the effective dates for mandatory clearing. The

Commission believes that the increase in the level of the material

swaps exposure to $8 billion in the final rule should address many of

the concerns raised by commenters about the inclusion of particular

categories of swaps. Moreover, the material swaps exposure threshold is

intended to identify entities that engage in significant derivatives

activity in order to determine whether their swaps activity should be

subject to initial margin requirements under the final rule.

The Commission believes the final rule's approach is appropriate in

assessing a swap counterparty's overall size and risk exposure and

providing for a simple and transparent measurement of exposure that

presents only a modest operational burden. This approach also is

intended to achieve consistency with other jurisdictions based on the

2013 international framework which sets a threshold based on overall

gross notional non-centrally cleared derivatives activity.\83\

Moreover, given that the Commission is viewing the final rule's

material swaps exposure as an indicator of a financial end user's

overall exposure in the market and revising the threshold upward to $8

billion, the Commission believes the inclusiveness of the calculation

adopted in the final rule is appropriate.

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

\83\ One commenter urged the Commission to conform with the 2013

international framework where material swaps exposure is based on

derivatives (not swaps). See ICI. Another commenter urged the

Commission to exclude registered swap dealers from the material

swaps exposure calculation as this could cause affiliates of the

swap dealer to exceed the material swaps exposure threshold. See

FSR. The final rule does not exclude registered swap dealers from

the material swaps exposure threshold. The Commission believes that

financial affiliates of a registered swap dealer should be treated

as having a material swaps exposure based on their level of risk.

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

Although the final rule does not explicitly provide how a CSE

should determine if a financial end user counterparty has material

swaps exposure, the Commission believes that it would be reasonable for

a CSE to rely on good-faith representations of its counterparty in

making such assessments.

One commenter urged the Commission to clarify what happens when a

financial end user counterparty that had a material swaps exposure

falls below the threshold. Because the material swaps exposure

determination applies to a financial end user for an entire calendar

year, depending on whether the financial end user exceeded the

threshold during the third calendar quarter of the previous year, it is

possible for a CSE to have a portfolio of swaps with a financial end

user whose

[[Page 646]]

status under the material swaps exposure test changes from time to

time. New Sec. 23.161(c) of the final rule addresses this concern and

explains what happens upon a change in counterparty status.

For example, if a financial end user is moving below the threshold

for the upcoming calendar year, the CSE is not obligated under the

final rule to exchange initial margin with that end user during that

calendar year, either for new swaps entered into that year or existing

swaps from a prior year. Any margin that had been previously collected

while the counterparty had a material swaps exposure would not be

required under the final rule for as long as the counterparty did not

have a material swaps exposure. In addition, a CSE's swaps with a

financial end user without material swaps exposure would continue to be

subject to the variation margin requirements of the final rule.

If a financial end user is moving above the threshold for the

upcoming calendar year, the treatment of the existing swaps and the new

swaps is the same as described for swaps before and after the rule's

compliance implementation date. As described in more detail below, the

parties have the option to document the old and new swaps as separate

portfolios for netting purposes under an eligible master netting

agreement, and exchange initial margin only for the new portfolio of

swaps entered into during the new calendar year after the financial end

user triggered the material swaps exposure threshold determination.

(v) Margin Affiliates and Margin Subsidiaries

The proposal defined an ``affiliate'' as any company that controls,

is controlled by, or is under common control with another company.\84\

The proposal defined the control of another company generally as the

ownership or power to vote 25% or more of any class of voting

securities of another entity; or the ownership of 25% or more of the

total equity in any entity; or the power to elect a majority of the

directors or trustees of an entity. An entity would be a subsidiary of

another entity if it were controlled by that other entity.

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

\84\ The Commission notes that under the proposal the Commission

used the terms affiliate and subsidiary; however in its final rule,

it is using the term ``margin affiliate'' and ``margin subsidiary''.

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

Commenters raised a number of concerns with the proposal's

definitions of ``affiliate,'' ``subsidiary'' and ``control.'' While one

commenter expressed support for the proposal's definition of

control,\85\ the vast majority of commenters argued for a modified

definition of control that did not use the 25 percent threshold.\86\

One commenter suggested that these terms should be defined by reference

to whether an affiliate or subsidiary is consolidated under accounting

standards.\87\ A number of these commenters urged the Commission to use

a majority ownership test (51 percent or more) for determining

control.\88\ Certain commenters expressed concern about the cross-

border application of these definitions.\89\

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

\85\ See Better Markets.

\86\ See ACLI; FSR; CEWG; the GPC; IIB; ISDA; JBA; MFA; Sifma

AMG; Sifma; Vanguard. (One commenter argued that the definitions of

affiliate and control should not include relationships with or

through the U.S. government and its representatives. See Freddie.)

\87\ See ISDA.

\88\ See ACLI; Commercial Energy Working Group; IIB; JBA; IFM;

SIFMA AMG; SIFMA; TIAA-CREF; Vanguard. For example, one commenter

argued that applying the initial margin threshold would be difficult

with a 25 percent control test and it would be hard to agree on

allocation of the threshold among the parties. ACLI.

\89\ See CCMR; IIB; SIFMA AMG. For example, one commenter argued

that a 50 percent ownership threshold would conform to the EU

Proposal. See IIB.

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

Commenters also expressed particular concerns about the application

of these definitions in the proposal to investment funds, including

during the seeding period. A number of commenters urged the Commission

to use the same criteria as the 2013 international framework as the

basis for determining whether or not an investment fund is an affiliate

of a fund sponsor.\90\ Commenters also argued that seed capital

contributed by a fund sponsor should not be viewed as control even if

the ownership by the fund sponsor exceeds 25 percent.\91\ One

commenter, for example, suggested that passive investors should be

excluded even where they own more than 51 percent of the ownership

interests.\92\ A few commenters also suggested that registered funds

may treat each separately managed ``sleeve'' of the fund as a separate

registered fund.\93\

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

\90\ See AIMA; CCMR; ICI; SIFMA AMG; Vanguard; MFA. The 2013

international framework states that investment funds that are

managed by an investment adviser are considered distinct entities

that are treated separately when applying the threshold as long as

the funds are distinct legal entities that are not collateralized by

or otherwise guaranteed or supported by other investment funds or

the investment adviser in the event of fund insolvency or

bankruptcy. One commenter suggested an investment fund separateness

to determine whether an investment fund is a separate legal entity.

This commenter also urged the Commission to incorporate the concept

of ``effective control'' as developed by the Financial Accounting

Standards Board (``FASB'') to cover variable interest entities and

special purpose entities. See Better Markets.

\91\ See ACLI; Sifma; Sifma AMG. One commenter also urged the

Commission to clarify that independently controlled accounts are

separate counterparties. See Sifma.

\92\ See Sifma AMG.

\93\ See ICI; Sifma AMG.

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

Commenters also expressed particular concerns about how the

definitions applied to pension funds. One commenter argued that the

sponsor of a pension should not be an affiliate of the pension fund by

virtue of appointing trustees or directors of the pension fund.\94\

This commenter urged that pension plans should not be deemed to have

any affiliates other than those entities to whom a CSE counterparty has

recourse for relevant pension trades. Other commenters argued that

pension plans should be exempted from the definition of affiliate which

could conflict with fiduciary obligations under ERISA.\95\

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

\94\ See GPC (arguing this could foreclose pension plans from

using third-party custodians).

\95\ See FSR (arguing that how a swap entity allocates its

initial margin threshold to the ERISA plan must be done in a way not

to violate the fiduciary duty to the pension plan and that would

requirement input from the Department of Labor).

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

The term affiliate is used in the definition of initial margin

threshold amount which means a credit exposure of $50 million that is

applicable to uncleared swaps between a CSE and its affiliates with a

counterparty and its affiliates. The inclusion of affiliates in this

definition is meant to make clear that the initial margin threshold

amount applies to an entity and its affiliates.

Similarly, the term ``affiliate'' is also used in the definition of

``material swaps exposure,'' as material swaps exposure takes into

account the exposures of an entity and its affiliates. The term

``affiliate'' is also used for determining the compliance date for a

CSE and its counterparty in Sec. 23.161.

Using financial accounting as the trigger for affiliation, rather

than a legal control test, should address many of the concerns raised

by commenters. In addition, the Commission believes that this approach

reflects a more accurate method for discerning whether an entity has

control over another entity. Although consolidation tests under any

other accounting standard that the entity may use must also be applied

on a case-by-case basis, like the proposed rule's ``control'' test, the

analysis has already been performed for companies that prepare their

financial statements in accordance with relevant standards. For

companies that do not prepare these statements, the Commission believes

that industry participants are more familiar with the relevant

accounting

[[Page 647]]

standards and tests, and they will be less burdensome to apply.\96\

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

\96\ The Commission is deleting the definition of the term

``subsidiary.'' This term is no longer used in this set of rules.

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

Additionally, the accounting consolidation analysis typically

results in a positive outcome (consolidation) at a higher level of an

affiliation relationship than the 25 percent voting interest standard

of the legal control test. This is responsive to commenters' concerns

that the proposed definitions were over-inclusive.

Because there are circumstances where an entity holds a majority

ownership interest and would not consolidate, the Prudential Regulators

have reserved the right to include any other entity as an affiliate or

subsidiary based on a conclusion that either company provides

significant support to, or is materially subject to the risks or losses

of, the other company. This provision is meant to leave discretion to

the Prudential Regulators in order to avoid evasion. The Commission has

determined not to include this provision at this time.

The Commission believes that the modifications to the definition of

affiliate will address many of the concerns raised by commenters,

including with respect to investment and pension funds. Investment

funds generally are not consolidated with the asset manager other than

during the seeding period or other periods in which the manager holds

an outsized portion of the fund's interests although this may depend on

the facts and circumstances. The Commission believes that during these

periods, when an entity may own up to 100 percent of the ownership

interest of an investment fund, the investment fund should be treated

as an affiliate.

This approach to investment funds is similar to that in the 2013

international framework. The Commission acknowledges that some

accounting standards, such as the GAAP and IFRS variable interest

standards, sometimes require consolidation between a sponsor or manager

and a special purpose entity created for asset management,

securitization, or similar purposes, under circumstances in which the

manager does not hold interests comparable to a majority equity or

voting control share. On balance, the Commission believes it is

appropriate to treat these consolidated entities as affiliates of their

sponsors or managers. They are structured with legal separation to

address the concerns of passive investors, but the manager retains such

levels of influence and exposure as to indicate its status is beyond

that of another minority or passive investor.

In the case of pension funds that are associated with a non-

financial end user, the Commission believes that consolidation of the

pension fund with its parent would be the exception to the rule under

applicable accounting standards. Even if consolidation is applicable

for some pension funds, the parent would, as a general matter, be

exempt from the rule under TRIPRA and would not be included in the

threshold amount calculations.

(vi) Treasury Affiliates Acting as Principal

The Commission has issued no-action letters providing relief with

respect to certain Treasury affiliates acting as principal from the

clearing requirement provided that certain conditions are met.\97\ Some

commenters urged the Commission to provide similar treatment here.\98\

The Commission has determined that similar treatment is appropriate.

The Commission has included in the definition of financial end user a

provision stating that the term shall not include an eligible treasury

affiliate that the Commission has exempted by rule. The Commission will

act to implement this approach by rule in a separate procedure.

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

\97\ See CFTC No-Action Letter No. 13-22 (June 4, 2013); CFTC

No-Action Letter No. 14-144 (Nov. 26, 2014).

\98\ See W&C (initial and variation margin should not apply to

an eligible treasury affiliate as defined in Commission No-Action

Letter No. 13-22).

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

The Prudential Regulators final rules do not include this

provision. The Prudential Regulators have stated, however, that if the

CFTC acted to exclude these entities by rule, the entities would be

excluded from the Prudential Regulators' rule.\99\

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

\99\ 80 FR 74840 at 74856.

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

c. Non-Financial End Users

(i) Proposal

Non-financial end users under the proposal included any entity that

was not an SD, an MSP, or a financial end user. The proposal did not

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

Commission believes that such entities, which generally are using swaps

to hedge commercial risk, pose less risk to CSEs than financial

entities.

To ensure the safety and soundness of CSEs, the proposal required a

CSE (i) to enter into certain documentation with all counterparties to

provide clarity about the parties' respective rights and obligations

and (ii) to calculate hypothetical initial and variation margin amounts

each day for positions held by non-financial entities that have

material swaps exposure to the covered counterparty.\100\ That is, the

CSE would be required to calculate what the margin amounts would be if

the counterparty were another SD or MSP and compare them to any actual

margin requirements for the positions.\101\ These calculations would

serve as risk management tools to assist the CSE in measuring its

exposure and to assist the Commission in conducting oversight of the

CSE.

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

\100\ Proposed Regulations 23.154(a)(6) and 23.155(a)(3).

\101\ This is consistent with the requirement set forth in

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

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

uncleared swaps.

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

(ii) Comments

Many commenters supported the Commission's decision not to impose

margin requirements on non-financial end users.\102\ One commenter

raised concerns about certain uncleared matched commodity swaps that

economically offset each other and that are used to hedge municipal

prepayment transactions for the supply of long-term natural gas or

electricity (municipal prepayment transactions as described

earlier).\103\ However, two commenters expressed concerns with this

decision.\104\ These concerns ranged from fears that large market

players (such as the type of entities that once included Enron, among

others) would be able to participate in the markets on an unmargined

basis to disappointment that the Commission did not at least include a

requirement for a specific internal exposure limit for commercial

counterparties.

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

\102\ See ABA; ETA; CDEU (asking the Commission to make explicit

in the rule text the exclusion for non-financial end users from the

margin requirements); COPE.

\103\ This commenter contended that each side of this matched

pair of swaps could be subject to different margin treatment that

could make these transactions prohibitively expensive. In

particular, according to this commenter, the first or ``front-end''

swap in this matched pair would be between a non-financial end user

(typically a government gas supply agency) and a swap entity, while

the second swap or ``back-end'' swap generally would be between a

swap entity and a prepaid gas supplier that is a swap entity or

other financial entity.

\104\ See Public Citizen (opposed the exemption, citing that

non-financial end users are not exempt by statute); AFR (suggesting

that the Commission should separate clearing and margin exemptions

while expressing concerns regarding the scope of this exemption).

AFR further argued that margin should be required where the volume

of swaps could present risks to the financial system or to

affiliated entities deemed to be systemically important.

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

Many commenters opposed the documentation requirement in the

proposal, citing administrative burdens on the parties and noting that

non-

[[Page 648]]

financial end users currently use other forms of documentation.\105\

Other commenters asked the Commission for clarification with respect to

aspects of the documentation requirement.\106\

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

\105\ See ISDA; Joint Associations; CDEU; Freddie; COPE; ABA;

ETA; BP; Shell TRM.

\106\ See Sifma (seeking assurance that (i) a CSE would not

violate its obligations to maintain sufficient margin if it releases

margin to a counterparty at the conclusion of a dispute resolution

mechanism consistent with the U.S. implementation of Basel and the

Commission is not requiring the parties to lock in dispositive

valuation methods; and (ii) if a non-bank swap entity and a non-

financial end user have not agreed to exchange margin, the parties

will not need to modify their trading documentation to address

matters specified in the proposal such as valuation methodologies

and data sources); JBA (seeks clarification on the level of

documentation required to ``allow the counterparty and regulators to

calculate a reasonable approximation of the margin requirement

independently); FHLB (arguing that documentation requirement with

respect to dispute resolution are inadequate).

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

The majority of commenters opposed the hypothetical margin

calculation requirement for non-financial end users.\107\ Commenters

generally noted the extra burdens this requirement may place on CSEs

and the non-financial end user, who must monitor their swaps exposures

to determine if they exceed the material swaps exposure threshold. Only

one commenter expressed support for this requirement.\108\

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

\107\ See ISDA; Sifma; Joint Associations; JBA; FSR; ETA; NGCA/

NCSA; CDEU; COPE; BP; Shell TRM; CEWG.

\108\ See AFR.

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

(iii) Discussion

In response to the comments, the Commission has removed the

hypothetical margin calculation and documentation requirements

concerning non-financial end users. Although the Commission continues

to believe that its documentation and hypothetical margin calculation

requirements would promote the financial soundness of CSEs, the

Commission recognizes the additional administrative burdens that its

proposed requirements could impose on CSEs and on non-financial end

users. The Commission has other requirements that should address the

monitoring of risk exposures for these entities.\109\

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

\109\ See e.g., Sec. 23.600 of the CFTC's regulations.

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

Moreover, under the interim final rule discussed below, certain

transactions with certain financial counterparties are exempt from the

Commission's margin requirements. Section 23.150 of the final rule

implements the exemptions enacted in Title III of TRIPRA, which

excludes these swaps from the statutory directive issued to the

Commission by section 4s of the CEA to impose margin requirements for

all uncleared swaps.

The Commission is implementing the transaction based (as opposed to

counterparty based) TRIPRA exemptions in Sec. 23.150(b) of the final

rule. With respect to municipal prepayment transactions, the Commission

notes that CSEs that are parties to these and other types of matched or

offsetting swap transactions would need to evaluate each swap to

determine whether the requirements of the final rule apply. Under the

final rule, it is possible that one swap may be exempt from the

requirements of the rule while an offsetting swap is subject to the

final rule's requirements as these requirements are set on a risk basis

as required under the statute.

A commenter also contended that the rule would cause counterparties

to matched commodity swaps to face increased costs to the extent that

the rules apply a capital charge to a CSE in connection with these

matched swaps. The Commission notes that capital requirements of CSEs

are outside the scope of this rulemaking and therefore is not

addressing the capital implications of Municipal Prepayment

Transactions at this time.

D. Nature and Timing of Margin Requirements

1. Initial Margin

a. Proposal

Subject to thresholds discussed below, the proposal required each

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

each covered counterparty on or before the business day after execution

\110\ for every swap with that counterparty.\111\ The proposal required

the CSEs to continue to post and to collect initial margin until the

swap is terminated or expires.\112\

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

\110\ Commission Regulation 23.200(e) defines execution to mean,

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

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

that legally binds the counterparties to such terms under applicable

law.'' 17 CFR 23.200(e).

\111\ Proposed Sec. Sec. 23.152(a) and 23.153(d).

\112\ Proposed Sec. 23.152(b).

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

Recognizing the greater risk that SDs, MSPs, and financial end

users pose to the financial system, the Commission proposed to require

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

with, one another. SDs and MSPs also would be required to collect

initial margin from, and post initial margin to, financial end user

counterparties that have exceeded the material swaps exposure

threshold. SDs and MSPs would be required to collect variation margin

from, and post variation margin to, each other and all financial end

user counterparties.

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

deemed to have violated its obligation to collect initial or variation

margin if it took certain steps to collect margin from its counterparty

in the event the counterparty failed to post.\113\ Specifically, if a

counterparty failed to pay the required initial margin to the CSE, the

CSE would be required to make the necessary efforts to attempt to

collect the initial margin, including the timely initiation and

continued pursuit of formal dispute resolution mechanisms,\114\ or

otherwise demonstrate upon request to the satisfaction of the

Commission that it has made appropriate efforts to collect the required

initial margin or commenced termination of the swap.

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

\113\ Proposed Sec. 23.152(c).

\114\ See Sec. 23.504(b)(4) of the CFTC's regulations.

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

b. Comments

Commenters generally expressed support for two-way initial and

variation margin.\115\ One commenter suggested that CSEs should not be

required to post margin but only to collect margin.\116\ Another

commenter further supported allowing more time to raise the required

initial margin if an increase is mandated as a result of model

recalibration.\117\

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

\115\ See Barnard; ICI; MFA; Public Citizen; AFR; CME; GPC.

\116\ See JBA.

\117\ See CCMR.

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

All commenters that addressed the Commission's proposed timing

requirement for initial margin collection opposed it.\118\ The basis

for these objections included the fact that the settlement and delivery

periods for many types of eligible margin securities are longer than

the time allowed for margin collection under the proposed rule; the

potential inability of financial end users to arrange for collateral

transfers under the proposed rule's timeframes; and the difficulties

encountered where the parties are in distant time zones.\119\

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

\118\ See JFMC; Joint Associations; JBA; Sifma; Sifma-AMG; ISDA;

ETA; Shell TRM; BP; GPC; and NGSA/NGCA.

\119\ See ISDA; Sifma; JFMC; and JBA.

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

Other concerns included the fact that valuations are typically

determined after market close and that the proposed rule did not

include time for portfolio reconciliation and dispute resolution. A

commenter suggested that, since financial end users would be required

to exchange margin with a CSE in amounts determined by the CSE's

models, the final rule should allow for a dispute resolution process

acceptable to both the CSE and its counterparty. Commenters proposed a

number of alternatives, including moving to a T+2

[[Page 649]]

basis; \120\ requiring prompt margin calls no later than a T+1 or T+2

basis with margin transfer occurring one or two days thereafter or

according to the standard settlement cycle for the type of collateral;

requiring margin collection and settlement weekly; or simply requiring

margin collection on a prompt or reasonable basis.

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

\120\ See ISDA.

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

One commenter asked for clarification that the Commission would not

require the calculation and collection of margin more than once a

day.\121\

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

\121\ See MFA.

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

c. Discussion

(i) Two-Way Margin

Consistent with the proposal, the final rule requires a CSE to

collect initial margin when it engages in an uncleared swap with

another swap entity. Because all swap entities will be subject to a

Prudential Regulator or Commission margin rule that requires them to

collect initial margin on their uncleared swaps, the final rule will

result in a collect-and-post system for all uncleared swaps between

swap entities.

When a CSE engages in an uncleared swap with a financial end user

with material swaps exposure,\122\ the final rule will require the CSE

to collect and post initial margin with respect to the uncleared swap.

Under the final rule, a CSE transacting with a financial end user with

material swaps exposure must (i) calculate its initial margin

collection amount using an approved internal model or the standardized

look-up table, (ii) collect an amount of initial margin that is at

least as large as the initial margin collection amount less any

permitted initial margin threshold amount (which is discussed in more

detail below), and (iii) post at least as much initial margin to the

financial end user with material swaps exposure as the CSE would be

required to collect if it were in the place of the financial end user

with material swaps exposure.

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

\122\ The calculation of ``material swaps exposure'' is

addressed in more detail in the discussion of the definitions above.

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

The Commission is not adopting a ``collect only'' approach for

financial end user counterparties recommended by a number of financial

industry commenters. The posting requirement under the final rule is

one way in which the Commission seeks to reduce overall risk to the

financial system, by providing initial margin to non-dealer swap market

counterparties that are interconnected participants in the financial

markets (i.e., financial end users that have material swap

exposure).\123\ Commenters representing public interest groups and

asset managers supported this aspect of the Commission's approach,

stating that it not only would better protect financial end users from

concerns about failure of a CSE, but also would act as a discipline on

CSEs by requiring them to post margin reflecting the risk of their

swaps business.

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

\123\ Some of these commenters contrasted the Commission's 2014

proposed approach with those of European and Japanese regulators. In

the United States, many financial end users operate outside of the

jurisdiction of the Commission to impose margin requirements. Thus,

unlike the proposed Japanese and European requirements, which would

cover a broader array of financial entities, a collect-only regime

in the United States would be applicable only to CSEs and thus could

leave a large number of financial entities with significant

unmargined potential future exposures to their swap dealers.

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

The final rule permits a CSE to select from two methods (the

standardized look-up table or the internal margin model) for

calculating its initial margin requirements as described in more detail

in the paragraphs that follow. In all cases, the initial margin amount

required under the final rule is a minimum requirement; CSEs are not

precluded from collecting additional initial margin (whether by

contract or subsequent agreement with the counterparty) in such forms

and amounts as the CSE believes is appropriate.

The provisions of the final rule requiring a CSE to collect initial

margin amounts calculated under the standardized approach or an

internal model apply only with respect to counterparties that are

financial end users with material swaps exposure or swap entities.\124\

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

\124\ The same is true with respect to the final rule's

requirements for eligible collateral and custody of initial margin

collected by a CSE.

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

(ii) Timing

The final rule establishes the timing under which a CSE must comply

with the initial margin requirements set out in Sec. Sec. 23.154 and

155. Under Sec. 23.152 of the final rule, a CSE, on each business day,

must comply with the initial margin requirements for a period beginning

on or before the business day following the day of execution of the

swap and ending on the date the uncleared swap is terminated or

expires. ``Business day'' is defined in Sec. 23.151 to mean any day

other than a Saturday, Sunday, or legal holiday. \125\

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

\125\ A ``business day'' under the final rule is not limited by

or tied to typical business hours. A swap dealer seeking to post or

collect margin may make the transfer during a ``business day'' but

at a time which is before or after typical business hours.

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

In practice, each CSE typically will have a portfolio of swaps with

a specific counterparty, and the CSE will collect and post initial

margin for that portfolio with that counterparty on a rolling basis.

The final rule requires the CSE to collect and post initial margin each

business day for its portfolio of swaps with that counterparty, based

on the initial margin amount calculated for that portfolio by the CSE

on the previous business day.\126\

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

\126\ Of course, if the initial margin amounts have not changed,

or the change to the posting or collecting amount (combined with

changes in the variation margin amount, as applicable) is less than

the minimum transfer amount specified in Sec. 23.151, no posting or

collection will be required.

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

As the CSE and its counterparty enter into new swaps, adding them

to the portfolio, these new swaps need to be incorporated into the

CSE's calculation of initial margin amounts to be posted and collected

on this daily cycle. When a CSE and its counterparty are located in the

same or adjacent time zones, this is a straightforward process.

However, when the CSE is located in a distant time zone from the

counterparty, or the two parties observe different sets of legal

holidays, this can be less straightforward.

The Commission added new provisions to the final rule to

accommodate practical considerations that arise in these

circumstances.\127\ The final rule requires the CSE to post and collect

initial margin on or before the end of the business day after the ``day

of execution,'' as defined in Sec. 23.151 of the rule. The ``day of

execution'' is determined with reference to the point in time at which

the parties enter into the uncleared swap.

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

\127\ The approach is patterned on principles incorporated in

the Commission's rulemaking on clearing execution, with differences

the Commission believes are appropriate in consideration of the

bilateral nature of uncleared swap margin and the non-standardized

terms of uncleared swaps. See Clearing Requirement Determination

Under Section 2(h) of the CEA, 77 FR 74,284 (Dec. 13, 2012),

available at: http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2012-29211a.pdf.

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

When the location of the CSE is in a different time zone than the

location of the counterparty, the ``day of execution'' definition

provides three special accommodations for the difference. These

accommodations are made in recognition of the fact that each of the two

parties to the swap will, as a practical necessity, observe its own

``business day'' in transmitting instructions to the third-party

custodian.

First, if at the time the parties enter into the swap, it is a

different calendar day at the location of each party, the day of

execution is deemed to be the later of the two calendar days. For

example, if a CSE located in New York enters into

[[Page 650]]

a swap at 3:30 p.m. on Monday with a counterparty located in Japan, in

the Japanese counterparty's location, it is 4:30 a.m. on Tuesday, and

the day of execution (for both parties) will be deemed to be Tuesday.

Second, if an uncleared swap is entered into between 4:00 p.m. and

midnight in the location of a party, then such uncleared swap shall be

deemed to have been entered into on the immediately succeeding day that

is a business day for both parties, and both parties shall determine

the day of execution with reference to that business day. For example,

if a CSE located in New York enters into a swap at noon on Friday with

a counterparty located in the U.K., and in the U.K. counterparty's

location, it is 5:00 p.m. on Friday, then the U.K. counterparty will be

deemed to enter into the swap the following Monday. Or, if a CSE

located in New York enters into a swap at noon on Friday with a

counterparty located in Japan, and in the Japanese counterparty's

location, it is 1:00 a.m. on Saturday, then the Japanese counterparty

will be deemed to enter into the swap the following Monday. In both

examples, the day of execution (for both parties) will be Monday.

Third, if the day of execution determined under the foregoing rules

is not a business day for both parties, the day of execution shall be

deemed to be the immediately succeeding day that is a business day for

both parties. For example, this addresses the outcome arising from an

uncleared swap entered into by a CSE in New York at noon on Friday with

a counterparty in Japan, where it would be 1:00 a.m. on Saturday. Under

the first provision, the later calendar day would be deemed the day of

execution, which would be Saturday. Accordingly, this third provision

would operate to move the deemed day of execution to the next business

day for both parties, i.e. Monday. As a further example under the same

circumstances, except that the Monday was a legal holiday in New York,

the day of execution would then be deemed to be Tuesday for both

parties.

Section 23.152 consistently requires the CSE to begin posting and

collecting initial margin reflecting that swap no later than the end of

the business day following that day of execution and thereafter collect

and post on a daily basis. The Commission believes the final rule

should provide adequate time for the CSE to include the new swap in the

regular initial margin cycle, under which the CSE calculates the

initial margin posting and collection requirements each business day

for a portfolio of swaps with a counterparty, and under which the

independent custodian(s) for both parties must hold segregated eligible

margin collateral in those amounts by the end of the next business day,

pursuant to the respective instruction of the parties. The CSE is

required to continue including the swap in its determination of the

initial margin posting and collection requirements for that portfolio

until the date the swap expires or is terminated.

The Commission has made limited adjustments to the final rule to

accommodate operational concerns created by differences in time zones

and legal holidays between the counterparties, but otherwise has

retained the proposed approach. The Commission recognizes that the

final rule requires initial margin to be posted and collected so

quickly that CSE and their counterparties may be required to take

precautionary steps. These could include (i) pre-positioning eligible

margin collateral at the custodian, (ii) using readily-transferrable

forms of eligible collateral, such as cash, or (iii) initially

supplying readily-transferrable forms of eligible collateral and

subsequently arranging to substitute other eligible margin collateral

after the initial margin collateral has been delivered to the custodian

and the minimum margin requirements have been satisfied.

The Commission also recognizes that the final rule will require

portfolio reconciliation and dispute resolution to be performed after

initial margin has been collected, as adjustments to the original

margin call, rather than before. While the Commission recognizes the

incremental regulatory burden created by the final rule's timing

requirement, the Commission believes the additional delay that would be

introduced by the commenters' alternatives would reduce the overall

effectiveness of the margin requirements, as any further timing delay

will result in an increased margin period of risk, which is not

accounted for in calculating the initial margin amount.\128\

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

\128\ For example, if the Commission provided T+3 as the

required timing for the posting of margin, the initial margin

model's margin period of risk of 10 days, would only end up being 7

days, as the initial margin amount would not be available for

another 3 days after its calculation (i.e., 10 days (margin period

of risk)--3 days (T+3 posting requirement) = 7 days).

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

Under Sec. 23.152 of the final rule, a CSE shall not be deemed to

have violated its obligation to collect or post initial or variation

margin from or to a counterparty if: (1) The counterparty has refused

or otherwise failed to provide or accept the required margin to or from

the CSE; and (2) the CSE has (i) made the necessary efforts to collect

or to post the required margin, or has otherwise demonstrated upon

request to the satisfaction of the Commission that it has made

appropriate efforts to collect the required margin, or (ii) commenced

termination of the uncleared swap with the counterparty promptly

following the applicable cure period and notification requirements.

Under the final rule, disputes that may arise between a CSE and its

counterparty should be handled pursuant to the terms of the relevant

contract or agreement and in the normal course of business. A CSE would

not be deemed to have violated its obligation to collect or post

initial or variation margin from or to a counterparty if the

counterparty is acting in accordance with agreed-upon practices to

settle a disputed trade.

2. Netting Arrangements

a. Proposal

The proposal would permit netting of initial margin across swaps

and variation margin across swaps, but would not permit the netting of

initial and variation margin.\129\ Any netting would have to be done

pursuant to an eligible master netting agreement (``ENMA'').\130\ The

agreement would create a single legal obligation for all individual

transactions covered by the agreement upon an event of default. It

would specify the rights and obligations of the parties under various

circumstances.\131\

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

\129\ Proposed Sec. Sec. 23.152(c) and 23.153(c).

\130\ Proposed Sec. 23.151, definition of ``eligible master

netting agreement.''

\131\ Id.

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

The proposed rule provided that if uncleared swaps entered into

prior to the applicable compliance date were included in the EMNA,

those swaps would be subject to the margin requirements.\132\ Under the

proposal, a CSE would need to establish a new EMNA to cover swaps

entered into after the compliance date in order to exclude pre-

compliance date swaps.

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

\132\ The netting provisions in the proposal were in Sec.

23.153(c).

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

b. Comments

A number of commenters argued that, in order to allow close-out

netting and contain costs, the final rule should not require new master

agreements to separate pre- and post-compliance date swaps, and that

parties should be permitted to use credit support annexes that are part

of the EMNA instead of new master agreements to distinguish

[[Page 651]]

pre-and post-compliance date swaps.\133\ One party also asked the

Commission for confirmation that the requirement to separately margin

pre- and post-effective date swaps applies only to initial and not

variation margin.\134\ Another party argued that ISDA should publish

and standardize a credit support annex that would conform to the

requirements of the margin regulations and parties should be allowed to

use such credit support annex alongside other existing credit support

annexes among the parties.\135\

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

\133\ See TIAA-CREF; CPFM; ICI; Sifma; ISDA; Sifma-AMG; ABA;

JBA; CS; AIMA; MFA; FSR; Freddie; ACLI; and FHLB. One commenter also

requested clarification that the use of an EMNA does not prevent use

of a master-master netting agreement. The final rule requires that

any uncleared swaps that are netted for purposes of calculating the

margin requirements under the final rule are subject to an EMNA that

meets the definition in Sec. 23.151 of the final rule regardless of

whether or not there is a master-master agreement.

\134\ See ICI.

\135\ See Freddie.

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

c. Discussion

The final rule permits a CSE to calculate initial margin (using an

initial margin model) or variation margin on an aggregate net basis

across uncleared swap transactions that are executed under an

EMNA.\136\ Although the proposal provided that the margin requirements

would not apply to uncleared swaps entered into before the rule's

compliance dates, as a general rule, the proposal provided that if an

EMNA covered uncleared swaps that were entered into before the

applicable compliance date, those uncleared swaps would be subject to

the requirements of the rule and must be included in the aggregate

netting portfolio for purposes of calculating the required margin.

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

\136\ Initial margin and variation margin amounts may not be

netted against each other under the final rule. In addition, initial

margin netting is only for the purposes of calculating the

collection amount or post amount under an approved initial margin

model, which may not be netted against each other.

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

As discussed by several commenters, the Commission recognizes that

CSEs and their counterparties may wish to separate netting portfolios

under a single EMNA. Accordingly, the final rule provides that an EMNA

may identify one or more separate netting portfolios that independently

meet the requirement for close-out netting \137\ and to which, under

the terms of the EMNA, the collection and posting of margin applies on

an aggregate net basis separate from and exclusive of any other

uncleared swaps covered by the agreement. (These separate netting

portfolios are commonly covered by separate credit support annexes to

the EMNA.)

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

\137\ See Sec. 23.151 (paragraph 1 of the EMNA definition).

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

This rule facilitates the ability of the parties to document two

separate netting sets, one for uncleared swaps that are subject to the

final rule and one for swaps that are not subject to the margin

requirements. A netting portfolio that contains only uncleared swaps

entered into before the applicable compliance date is not subject to

the requirements of the final rule. The rule does not prohibit the

parties from including one or more pre-compliance-date swaps in the

netting portfolio of uncleared swaps subject to the margin rule, but

they will thereby become subject to the final rule's margin

requirement, as part of the netting portfolio. Similarly, any netting

portfolio that contains any uncleared swap entered into after the

applicable compliance date will subject the entire netting portfolio to

the requirements of the final rule.

The netting provisions of the final rule also address the

implications of status changes for counterparties. As discussed above,

the final rule imposes a requirement to exchange initial margin only

with respect to financial end users whose swap portfolios exceed the

material swap exposure threshold. This means that a CSE may accumulate

a portfolio of swaps with a financial end user below the threshold,

subject to a variation margin requirement, and later if the financial

end user crosses the threshold, only new swaps entered into after the

change in the financial end user's status will be subject to both

initial and variation margin requirements. To address this possibility,

the final rule extends the treatment of separate netting portfolios

under a single ENMA beyond pre-compliance-date swaps to include

separate netting portfolios for swaps entered into before and after a

financial end user's change into a higher risk status.\138\

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

\138\ As discussed earlier, the change in status might also

occur as a counterparty moves in or out of financial end user status

entirely. The final rule extends the separate netting portfolio

treatment to all status changes equally.

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

The netting provisions in the final rule are modified from the

proposal in order to provide clarifications to address implementation

concerns raised by commenters. The proposed rule provided that if

uncleared swaps entered into prior to the applicable compliance date

were included in the EMNA, those swaps would be subject to the margin

requirements.\139\ Under the proposal, a CSE would need to establish a

new EMNA to cover swaps entered into after the compliance date in order

to exclude pre-compliance date swaps.

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

\139\ The netting provisions in the proposal were in Sec.

23.153.

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

The final rule addresses the commenters' concerns regarding close-

out netting and preserves close-out netting by allowing an EMNA to

identify one or more separate netting portfolios to which the

requirements of the final rule apply on an aggregate net basis. Thus,

under the final rule, pre-compliance date swaps in the same EMNA as

post-compliance date swaps would be subject to the requirements of the

final rule unless they are treated under the EMNA as separately

identified netting portfolio.

The Commission believes it would be inconsistent with the purposes

and objectives of the rule to permit a CSE to net a counterparty's

uncleared swap obligations to the CSE in determining margin collection

amounts, unless the CSE can conclude on a well-founded basis that the

netting provisions of the agreement can be enforced against the

counterparty (as required in accordance with the final rule's

definition of the EMNA).

The Commission will address commenters' concerns regarding the lack

of availability of netting in foreign jurisdictions in its application

of the margin rule on cross-border transaction final rule.

The Commission does not believe that it would be appropriate for

margin requirements for uncleared swaps to be offset by netting other

products or exposures across markets against other products that may

present different concerns about safety and soundness or financial

stability, or that are not subject to similar associated margin

requirements. Such treatment appears inconsistent with the purposes of

the Dodd-Frank Act.

E. Calculation of Initial Margin

1. Overview

a. Proposal

Under the proposed rules, a CSE could calculate initial margin

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

method.\140\ The required amount of initial margin would be the amount

computed pursuant to either an internal model or the table minus an

initial margin threshold amount of $65 million.\141\ In the proposal,

the initial margin threshold was calculated on a consolidated basis

(i.e. including all of the entity's affiliates). This amount

[[Page 652]]

could not be less than zero.\142\ The initial margin specified under

the proposal would be a minimum requirement, and the parties would have

been free to require more initial margin. To ease the transaction costs

associated with the exchange of margin, the Commission also proposed a

minimum transfer amount of $650,000.\143\

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

\140\ Proposed Sec. 23.154.

\141\ Proposed Sec. 23.151, definition of ``initial margin

threshold amount.''

\142\ Proposed Sec. 23.154(a)(4).

\143\ Proposed Sec. 23.151.

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

b. Comments

A few commenters urged that the threshold should be set for

individual legal entities within a group instead of at the group

level,\144\ while at least one commenter expressed support for applying

the threshold to the larger consolidated group.\145\ One commenter

argued that firms should be required to disclose their aggregate

uncollateralized exposures from use of the initial margin threshold as

well as allocation of the threshold across counterparties, including

affiliated counterparties.\146\ The same commenter also argued that the

full amount of gross initial margin should be exchanged, and asked for

increased disclosure requirements regarding uncollateralized exposures

(e.g., exposures that fall below the initial margin threshold).

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

\144\ CEWG; BP; Shell TRM; ISDA; Sifma AMG.

\145\ Public Citizen.

\146\ CME.

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

Commenters also suggested that the minimum transfer amount should

apply separately to initial and variation margin.\147\ A commenter also

urged the Commission to revisit the amounts periodically to ensure

international consistency.\148\ Another commenter suggested that

entities for which the U.S. Dollar is not the common or transacting

currency or whose payment obligations are in another currency should be

allowed to use an average exchange rate between the U.S. Dollar and the

foreign currency for calculating thresholds.\149\ One commenter also

suggested that the Commission allow the counterparties to set a minimum

transfer amount below $650,000.\150\ Another commenter requested

confirmation that the rule allows a minimum transfer amount but does

not require it.

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

\147\ See ISDA; JBA; Sifma.

\148\ See Sifma.

\149\ See ICI.

\150\ See Shell TRM.

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

Commenters also asked for separate treatment of various

arrangements under which the assets of a single investment fund or

pension plan are treated as separate portfolios or accounts, each

assigned some portion of the fund's or plan's total assets for purposes

of managing them pursuant to different investment strategies or by

different investment managers as agent for the fund or plan.\151\

Commenters said these ``separate accounts'' are generally managed under

documentation that caps the asset manager's ability to incur

liabilities on behalf of the fund or plan at the amount of the assets

allocated to the account.

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

\151\ One industry group commenter also cited as an example a

securitization vehicle that creates separate issuances of asset-

backed securities through use of a series trust.

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

c. Discussion

As an initial matter, the final rules allow CSEs to choose between

model-based and table-based initial margin calculations. The Commission

expects that some CSEs may choose to adopt a mix of internal models and

standardized approaches to calculating initial margin requirements. For

example, it may be the case that a CSE engages in some swap

transactions on an infrequent basis to meet client demands but the

level of activity does not warrant all of the costs associated with

building, maintaining, and overseeing a quantitative initial margin

model. Further, some CSE clients may value the transparency and

simplicity of the standardized approach. In such cases, the Commission

expects that it would be acceptable to use the standardized approach to

margin such swaps.

Under certain circumstances it may be appropriate to employ both a

model based and standardized approach to calculating initial margins.

At the same time, the Commission is aware that differences between the

standardized approach and internal model based margins across different

types of swaps could be used to ``cherry pick'' the method that results

in the lowest margin requirement. Rather, the choice to use one method

over the other should be based on fundamental considerations apart from

which method produces the most favorable margin results. Similarly, the

Commission does not anticipate there should be a need for CSEs to

switch between the standardized or model-based margin methods for a

particular counterparty, absent a significant change in the nature of

the entity's swap activities. The Commission expects CSEs to provide a

rationale for changing methodologies if requested. The Commission will

monitor for evasion of the swap margin requirements through selective

application of the model and standardized approach as a means of

lowering the margin requirements.

The final rule does not require a CSE to collect or to post initial

margin collateral to the extent that the aggregate un-margined exposure

either to or from its counterparty remains below $50 million.\152\ In

this regard, the final rule is generally consistent with the 2013

international framework and the 2014 proposal. The initial margin

threshold amount of $50 million has been adjusted relative to the $65

million threshold in the proposed rule in the manner described below.

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

\152\ Sec. 23.151, definition of ``initial margin threshold

amount.''

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

The Commission believes that allowing CSEs to apply initial margin

thresholds of up to $50 million is consistent with the rule's risk-

based approach, as it will provide relief to counterparties, while

ensuring that initial margin is collected from those counterparties

with exposure over the threshold, which could pose greater systemic

risk to the financial system. The initial margin threshold also should

serve to reduce the aggregate amount of initial margin collateral

required by the final rule.

Under the final rule, the initial margin threshold applies on a

consolidated entity level. It will be calculated across all non-

exempted \153\ uncleared swaps between a CSE and its affiliates and the

counterparty and the counterparty's affiliates.\154\ The requirement to

apply the threshold on a fully consolidated basis applies to both the

counterparty to which the threshold is being extended and the

counterparty that is extending the threshold. Applying this threshold

on a consolidated entity level precludes the possibility that CSEs and

their counterparties could create legal entities and netting sets that

have no economic basis and are constructed solely for the purpose of

applying additional thresholds to evade margin requirements.

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

\153\ To the extent that an uncleared swap transaction is exempt

from the margin requirements pursuant to Sec. 23.150(b), consistent

with TRIPRA, the interim final rule excludes the exempted swap

transaction from the calculation of the initial margin threshold

amount.

\154\ The threshold may be allocated among entities within the

consolidated group, at the agreement of the CSE and the

counterparties, but the total must remain below $50 million on a

combined basis. For an example illustrating allocations, see the

2014 proposal.

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

Although some commenters suggested the Commission should not

implement the threshold across the CSE and counterparties on a

consolidated basis, and instead rely on general anti-evasion authority

to address efforts to exploit the threshold, the Commission has not

done so. The revisions to the affiliate and subsidiary definitions in

the final

[[Page 653]]

rule, described above, simplify implementation of the consolidated

approach and should help address some of the concerns raised by

commenters in this respect.

The Commission notes that the threshold represents a minimum

requirement and should not be viewed as preventing parties from

contracting with each other to require the collection of initial margin

at a lower threshold, using the same method as set forth in the final

rule. For such transactions, the Commission expects CSEs to make their

own internal credit assessments when making determinations as to the

credit and other risks presented by their specific counterparties.

Therefore, a CSE dealing with a counterparty it judges to be of high

credit quality may determine that a counterparty-specific threshold of

up to $50 million is appropriate.

In response to commenters, and to clarify the Commission's intent,

the Commission notes that the $50 million threshold is measured as the

amount of initial margin for the relevant portfolio of uncleared swaps

pursuant to either the internal model or standardized initial margin

table used by the CSE.\155\ The Commission has not incorporated

suggestions by a commenter that the Commission permit the threshold to

be calculated in foreign currencies. Conversion to USD can be readily

accomplished and provides a measure of relative consistency in

application from counterparty to counterparty within and across CSEs.

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

\155\ Although one commenter urged the Commission to require

CSEs to make granular disclosures about the use of the $65 million

threshold to their investors, credit providers, and the central

counterparties of which the CSE is a member, the suggestion is

beyond the scope of this margin rulemaking. The Commission notes the

final rule does not prohibit a CSE from providing this information,

should it wish to negotiate that arrangement with an interested

party.

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

In addition, the Commission has not incorporated suggestions by

commenters for separate treatment of various arrangements under which

the assets of a single investment fund vehicle or pension plan are

treated as separate portfolios or accounts, each assigned some portion

of the fund's or plan's total assets for purposes of managing them

pursuant to different investment strategies or by different investment

managers as agent for the fund or plan.\156\ Commenters said these

``separate accounts'' are generally managed under documentation that

caps the asset manager's ability to incur liabilities on behalf of the

fund or plan at the amount of the assets allocated to the account.

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

\156\ One industry group commenter also cited as an example a

securitization vehicle that creates separate issuances of asset-

backed securities through use of a series trust.

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

While the Commission recognizes these types of asset management

approaches are well-established industry practice, and that separate

managers acting for the same fund or plan do not currently take steps

to inform the fund or plan of their uncleared swap exposures on behalf

of their principal on a frequent basis, the Commission is not persuaded

that it would be appropriate to extend each separate account its own

initial margin threshold. Based on the comments, it appears the

liability cap on each account manager often will be reflected in the

fund's or plan's contract with the manager. If one manager breaches its

limit, there could be cross-default implications for other managed

accounts, and in periods of market stress, the cumulative effect of

multiple managers' uncleared swaps could, in turn, strain the fund or

plan's resources. Because all the swaps are transacted on behalf of a

single legal principal, the Commission does not believe that the

subdivision of these separately managed accounts is sufficient to merit

the extension of separate thresholds.\157\ Nevertheless, the Commission

expects that in most cases, two separate investment funds of a single

asset manager would not be consolidated under the relevant accounting

standards and thus would not be affiliates under this rule.

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

\157\ Some commenters expressing this concern made the same

point with respect to application of the material swaps exposure

threshold, which is also calculated on a legal entity basis. The

Commission has the same reservations about subdividing the material

swaps exposure test at the managed account level, and these

reservations are even somewhat compounded given that the Commission

has revised the threshold to $8 billion in reflection of the

financial end user's overall market exposure, instead of a CSE-

specific exposure.

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

The final rule provides for a minimum transfer amount for the

collection and posting of margin by CSEs. The final rule does not

require a CSE to collect or post margin from or to any individual

counterparty unless and until the combined amount of initial and

variation margin that must be collected or posted under the final rule,

but has not yet been exchanged with the counterparty, is greater than

$500,000.\158\ This minimum transfer amount is consistent with the 2013

international framework and has been adjusted relative to the amount

that appeared in the proposal in the manner described below.

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

\158\ See Sec. 23.151 of the final rule. The minimum transfer

amount only affects the timing of margin collection; it does not

change the amount of margin that must be collected once the $500,000

threshold is crossed. For example, if the margin amount due from (or

to) the counterparty were to increase from $500,000 to $800,000, the

CSE would be required to collect the entire $800,000 (subject to

application of any applicable initial margin threshold amount).

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

The final rule has been modified from the proposal to make clear

that the minimum transfer amount applies to the combined amount of

initial and variation margin. The Commission believes that the

proposal's minimum transfer amount of $500,000 is appropriately sized

to generally alleviate the operational burdens associated with making

de minimis margin transfers and that the amount applies to both initial

and variation margin transfers on a combined basis. The Commission also

confirms that the minimum transfer amount is allowed but not required

under the final rule, and parties are free to collect and post margin

below that amount.

2. Models

As in the proposed rule, the final rule adopts an approach whereby

CSEs may calculate initial margin requirements using an approved

initial margin model. As in the case of the proposal, the final rule

also requires that the initial margin amount be set equal to a model's

calculation of the potential future exposure of the uncleared swap

consistent with a one-tailed 99 percent confidence level over a 10-day

close-out period. More specifically, under the final rule, initial

margin models must capture all of the material risks that affect the

uncleared swap including material non-linear price characteristics of

the swap.\159\

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

\159\ See Sec. 23.154(b)(2) of the final rule. An exception to

this requirement has been made in the specific case of cross-

currency swaps. In a cross-currency swap, one party exchanges with

another party principal and interest rate payments in one currency

for principal and interest rate payments in another currency, and

the exchange of principal occurs upon the inception of the swap,

with a reversal of the exchange of principal at a later date that is

agreed upon at the inception of the swap.

Under the final rule, an initial margin model need not recognize

any risks or risk factors associated with the foreign exchange

transactions associated with the fixed exchange of principal

embedded in a cross-currency swap as defined in Sec. 23.151 of the

final rule. The initial margin model must recognize all risks and

risk factors associated with all other payments and cash flows that

occur during the life of the cross-currency swap. In the context of

the standardized margin approach, described further below, the gross

initial margin rates have been set equal to those for interest rate

swaps. This treatment recognizes that cross-currency swaps are

subject to risks arising from fluctuations in interest rates but

does not recognize any risks associated with the fixed exchange of

principal since principal is typically not exchanged on interest

rate swaps.

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

For example, the initial margin calculation for a swap that is an

option on an underlying asset, such as an option on a credit default

swap contract, would be required to capture material

[[Page 654]]

non-linearities arising from changes in the price of the underlying

asset or changes in its volatility. Moreover, the margin calculations

for derivatives in distinct product-based asset classes, such as equity

and credit, must be performed separately without regard to derivatives

contracts in other asset classes. Each derivative contract must be

assigned to a single asset class in accordance with the classifications

presented in the final rule (i.e., foreign exchange or interest rate,

commodity, credit, and equity). The presence of any common risks or

risk factors across asset classes cannot be recognized for initial

margin purposes.

The Commission's belief is that these modeling standards should

ensure a strong initial margin regime for uncleared swaps that

sufficiently limits systemic risk and reduces potential counterparty

exposures.

a. Commission Approval

The proposal required CSEs to obtain the written approval of the

Commission before using a model to calculate initial margin.\160\ The

CSE would have to demonstrate that the model satisfied all of the

requirements of this section on an ongoing basis.\161\ In addition, a

CSE would have to notify the Commission in writing before extending the

use of a model that has been approved for one or more types of products

to any additional product types, making any change to any initial

margin model that has been approved that would result in a material

change in the CSE's assessment of initial margin requirements, or

making any material change to assumptions used in an approved

model.\162\ The Commission could rescind its approval of a model if the

Commission determined that the model no longer complied with this

section.\163\

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

\160\ Proposed Sec. 23.154(b)(1). See BCBS/IOSCO Report at 12:

``any quantitative model that is used for initial margin purposes

must be approved by the relevant supervisory authority.''

\161\ Id.

\162\ Proposed Sec. 23.154(b)(1).

\163\ Id.

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

(i) Comments

While one commenter disapproved of the use of proprietary initial

margin models,\164\ several commenters supported the use of either a

proprietary \165\ or a standardized (developed by the industry) initial

margin model.\166\ One commenter urged the Commission to recognize a

model that has been approved by other regulators, including foreign

authorities in jurisdictions with margin requirements consistent with

the 2013 international standards.\167\ Another commenter suggested that

the Commission provide more information regarding the process for model

approval.\168\

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

\164\ See AFR (supporting instead the adoption of a unified

modeling capacity within the regulatory community).

\165\ See Barnard; SIFMA; GPC (cautioning that initial margin

models must be consistent with commonly accepted market practice and

should be open for review by market participants).

\166\ See CPFM; Sifma; MetLife; Freddie; AFR.

\167\ See IFM.

\168\ See JBA (asking the Commission to provide information

regarding the data and documents necessary to the process, and also

the timeline for the submissions); see also Shell TRM (urging the

Commission to adopt a process for provisional approval of models).

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

(ii) Discussion

Under the final regulations, all initial margin models must be

approved before being used for margin calculation purposes. In the

event that a model is not approved, initial margin calculations would

have to be performed according to the standardized initial margin

approach that is detailed in Regulation 23.154(c) and discussed below.

Given the number of SDs and the likely complexity of the models,

the Commission is concerned that, with its limited resources, it might

not be able to review models as thoroughly and expeditiously as it

would like. Accordingly, the Commission has determined to amend the

final rules to provide that a CSE may use a model approved by a

registered futures association (``RFA'') or the Commission. Currently,

the National Futures Association (``NFA'') is the only RFA.

As an RFA, NFA is required to establish minimum capital and other

financial requirements applicable to its members that are at least as

stringent as the capital and financial requirements imposed by the

Commission. This requirement to establish financial requirements

extends to SD and MSP margin requirements for uncleared swap

transactions.

The Commission anticipates that NFA margin rules will recognize the

use of models, and that the minimum requirements for such models,

including the quantitative and qualitative requirements of the models,

are the same as, or more stringent than, the requirements set forth in

final Sec. 23.154. Accordingly, final Sec. 23.154 provides that an SD

or MSP may use models to compute initial margin requirements if such

models have been approved by NFA.

Given that CSEs may engage in highly specialized and complex swap

dealing activity, it is expected that specific initial margin models

may vary across CSEs. Accordingly, the specific analyses that will be

undertaken in the context of any single model review may have to be

tailored to the specific swap dealing activity of the CSE. Initial

margin models will also undergo periodic reviews to ensure that they

remain compliant with the requirements of the rule and are consistent

with existing best practices over time.

Given the complexity and diverse nature of uncleared swaps, it is

expected that CSEs may choose to make use of vendor-supplied products

and services in developing their own initial margin models. The final

rule does not place any limitations or restrictions on the use of

vendor-supplied model components such as specific data feeds, computing

environments, or calculation engines beyond those requirements that

must be satisfied by any initial margin model. In particular, the

Commission will conduct a holistic review of the entire initial margin

model and assess whether the entire model and related inputs and

processes meet the requirements of the final rule.\169\

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

\169\ The Commission expects that NFA will conduct a similar

process for the models it reviews.

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

To the extent that a CSE uses vendor-supplied inputs in conjunction

with its own internal inputs and processes, the model approval decision

will apply to the specific initial margin model used by a CSE and not

to a generally available vendor-supplied model. To the extent that one

or more vendors provide models or model-related inputs (e.g.,

calculation engines) that, in conjunction with the CSEs' own internal

methods and processes, are part of an approved initial margin model,

the Commission may also approve those vendor models and model-related

inputs for use by other CSEs though that determination will be made on

a case-by-case basis depending on the entirety of the processes that

are employed in the application of the vendor-supplied inputs and

models by a CSE.

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

Commission or RFA review would be affiliates of entities whose margin

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

In such situations, the Commission or the RFA would coordinate with the

Prudential Regulators in order to avoid duplicative efforts and to

provide expedited approval of Prudential Regulator approved

models.\170\ For

[[Page 655]]

example, if a Prudential Regulator had approved a model of an insured

depository institution registered as an SD, Commission or RFA review of

a comparable model used by its non-bank affiliate would be greatly

facilitated. Similarly, the Commission or the RFA would coordinate with

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

foreign regulators that had approved margin models for foreign CSEs.

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

\170\ Whether an initial margin model has obtained a Prudential

Regulators approval will be given a significant weight in

determining whether the model meets the Commission's standards.

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

The provision permitting a CSE to use a model approved by an RFA is

a point of distinction between the Commission's rules and those of the

Prudential Regulators. The Prudential Regulators do not have a

comparable rule.

b. Applicability to Multiple Swaps

(i) Proposal

The proposal provided that to the extent more than one uncleared

swap is executed pursuant to an EMNA \171\ between a CSE and a covered

counterparty, the CSE would be permitted to calculate initial margin on

an aggregate basis with respect to all uncleared swaps governed by such

agreement.\172\ However, only exposures in certain asset classes could

be offset. If the agreement covered uncleared swaps entered into before

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

in the calculation.\173\

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

\171\ This term is defined in proposed Sec. 23.151.

\172\ Proposed Sec. 23.154(b)(2).

\173\ Id.

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

The proposal defined EMNA as any written, legally enforceable

netting agreement that creates a single legal obligation for all

individual transactions covered by the agreement upon an event of

default (including receivership, insolvency, liquidation, or similar

proceeding) provided that certain conditions are met. These conditions

include requirements with respect to the CSE's right to terminate the

contract and to liquidate collateral and certain standards with respect

to legal review of the agreement to ensure that it meets the criteria

in the definition.

(ii) Comments

A number of commenters requested that the Commission remove the

``suspends or conditions payment'' language.\174\ These commenters

argued that this provision would be inconsistent with the ISDA Master

Agreement which allows a non-defaulting counterparty to suspend payment

to a defaulting counterparty.\175\

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

\174\ ACLI; FSR; Freddie; ISDA; MetLife; Sifma AMG; Sifma; and

Vanguard.

\175\ One commenter urged the Commission not to ``outsource''

the EMNA definition to ISDA, noting that the vast majority of

existing master netting agreements are governed by the ISDA Master

Agreement. The commenter argued that the ISDA Master Agreement

contains provisions that may be contrary to the interests of

counterparties other than ISDA's large swap entity members, such as

mandatory arbitration covenants. See Better Markets. So long as an

agreement meets the requirements of the EMNA definition, however,

the Commission is not endorsing, requiring. or prohibiting use of a

particular master netting agreement in the final rule.

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

A few commenters urged the Commission to align its definition with

that of the Prudential Regulators,\176\ while others argued that ISDA

master agreements should qualify as ENMAs.\177\ One commenter supported

the use of netting agreements,\178\ while others cautioned that

entities operating in jurisdictions where netting is not enforceable

may be penalized by having to put up a greater amount of

collateral.\179\

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

\176\ See Sifma; FHLB.

\177\ See ETA; Joint Associations; NGSA/NGCA.

\178\ See Barnard.

\179\ See JFMC. See also ISDA (suggesting netting restrictions

on posting variation margin (where restricted by law for example) to

non-netting counterparties).

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

Commenters generally expressed support for the recognition of

foreign stays in the proposal's definition of ENMA.\180\ A few

commenters argued that a limited stay under State insolvency and

receivership laws applicable to insurance companies also should be

recognized under this provision.\181\ Some commenters also argued for

permitting appropriate contractual stays.\182\

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

\180\ AIMA; ICI; SIFMA. However, at least one commenter

expressed concern that allowing for foreign jurisdiction and

contractual stays could limit important bankruptcy protections for

commercial end users and argued that the rule should recognize and

clearly state that market participants' rights to avoid stays and

other limitations of their close-out rights should be protected.

CEWG.

\181\ See ACLI; MetLife.

\182\ See ISDA; Sifma AMG (a party should be allowed to suspend

ongoing performance where an event of default or potential event of

default has occurred and is continuing); AFR (upon the default of a

party, the non-defaulting party should be allowed to enter into a

limited contractual stay and suspend payment obligation to the

defaulting party according to the process set forth in the ISDA 2014

Resolution Stay Protocol).

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

A number of commenters expressed various concerns with the

provision of the EMNA that requires a CSE to conduct sufficient legal

review to conclude with a well-founded basis (and maintains sufficient

written documentation of that legal review) that the agreement meets

the requirements with respect to the CSE's right to terminate the

contract and liquidate collateral and that in the event of a legal

challenge (including one resulting from default or from receivership,

insolvency, liquidation, or similar proceeding), the relevant court and

administrative authorities would find the agreement to be legal, valid,

binding, and enforceable under the law of the relevant

jurisdictions.\183\ These commenters urged that requiring a legal

opinion would be expensive and may not be able to be given without

qualification, meaning parties can never be certain that a contract is

enforceable.\184\ Some of these commenters recommended removing the

requirement that the ENMA be enforceable in multiple jurisdictions

since it would be legally impractical.\185\

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

\183\ One commenter, for example, urged ``would'' should be

changed to ``should'' as ``would'' is difficult to satisfy in

bankruptcy courts making it difficult to state with certainty. CEWG.

\184\ ACLI; GPC; ICI; JBA; Sifma AMG; see also CEWG.

\185\ See GPC; Sifma AMG.

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

(iii) Discussion

The final rule defines an EMNA to be any written, legally

enforceable netting agreement that creates a single legal obligation

for all individual transactions covered by the agreement upon an event

of default (including receivership, insolvency, liquidation, or similar

proceeding) provided that certain conditions are met.\186\ These

conditions include requirements with respect to the CSE's right to

terminate the contract and liquidate collateral and certain standards

with respect to legal review of the agreement to ensure it meets the

criteria in the definition. The legal review must be sufficient so that

the CSE may conclude with a well-founded basis that, among other

things, the contract would be found legal, binding, and enforceable

under the law of the relevant jurisdiction and that the contract meets

the other requirements of the definition.

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

\186\ This definition of ENMA aligns with the recently adopted

definition of a ``qualifying master netting agreement'' for bank

regulatory capital purposes and the Prudential Regulators' margin

requirements. See Regulatory Capital Rules, Liquidity Coverage

Ratio: Interim Final Revisions to the Definition of Qualifying

Master Netting Agreement and Related Definitions, 79 FR 78287 (Dec.

30, 2014).

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

The EMNA definition includes a requirement that the agreement not

include a walkaway clause, which is defined as a provision that permits

a non-defaulting counterparty to make a lower payment than it otherwise

would make under the agreement, or no payment at all, to a defaulter or

the estate of a defaulter, even if the defaulter or the estate of the

defaulter is a net creditor under the agreement.

[[Page 656]]

The proposed EMNA definition included additional language in the

definition of walkaway clause that would expressly preclude an EMNA

from including a clause that permits a non-defaulting counterparty to

``suspend or condition payment'' to a defaulter or the estate of a

defaulter, even if the defaulter or the estate of the defaulter is or

otherwise would be, a net creditor under the agreement. This additional

language is not being included in the final rule's definition of EMNA.

Therefore, the commenters' concerns regarding the impact of the

additional proposed language on current provisions of the ISDA Master

Agreement are moot.

Like the proposal, the final rule's definition of EMNA contains a

stay condition regarding certain insolvency regimes where rights can be

stayed. In particular, the second clause of this condition has been

modified to provide that any exercise of rights under the agreement

will not be stayed or avoided under applicable law in the relevant

jurisdictions, other than (i) in receivership, conservatorship, or

resolution by a Prudential Regulator exercising its statutory

authority, or substantially similar laws in foreign jurisdictions that

provide for limited stays to facilitate the orderly resolution of

financial institutions, or (ii) in an agreement subject by its terms to

any of the foregoing laws.\187\

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

\187\ See Sec. 23.151.

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

The Commission did not modify the final rule's definition of EMNA

to recognize stays under State insolvency and receivership laws for

insurance companies. The Commission believes that other changes to the

rule should help address these concerns as explained further below.

The Commission did not modify the provision relating to the legal

enforceability of the EMNA definition in the final rule. The Commission

believes that the legal review must be sufficient so that the CSE may

conclude with a well-founded basis that, among other things, the

contract would be found legal, binding, and enforceable under the law

of the relevant jurisdiction and that the contract meets the other

requirements of the definition. In some cases, the legal review

requirement could be met by reasoned reliance on a commissioned legal

opinion or an in-house counsel analysis. In other cases, for example,

those involving certain new derivative transactions or derivative

counterparties in jurisdictions where a CSE has little experience, the

CSE would be expected to obtain an explicit, written legal opinion from

external or internal legal counsel addressing the particular situation.

The rules set an outcome-based standard for a review that is sufficient

so that an institution may conclude with a well-founded basis that,

among other things, the contract would be found legal, binding, and

enforceable under the law of the relevant jurisdiction and that the

contract meets the other requirements of the definition.

The Commission recognizes that there may be certain jurisdictions

where a netting arrangement may not be enforceable; the Commission will

address this issue in its final rule on the application of margin rule

to cross-border transactions.

c. Elements of a Model

The final rule specifies a number of conditions that a model would

have to meet to receive Commission approval.\188\ These conditions

relate to the technical aspects of the model as well as broader

oversight and governance standards. They include, among others, the

following.

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

\188\ Proposed Sec. 23.154(b)(3).

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

(i) Ten-Day Close-Out Period

Under the proposal, the model must calculate potential future

exposure using a one-tailed 99 percent confidence interval for an

increase in the value of the uncleared swap or netting set of uncleared

swaps due to an instantaneous price shock that is equivalent to a

movement in all material underlying risk factors, including prices,

rates, and spreads, over a holding period equal to the shorter of ten

business days or the maturity of the swap.

The Commission received a number of comments concerning the length

of the assumed close-out period used in the initial margin

calculations. Commenters suggested that ten days was too long and

suggested that a close-out period of three to five days was adequate to

ensure sufficient time to close out or hedge a defaulting

counterparty's swap contract.\189\ Another commenter suggested that a

ten day close out period was too short and that the resulting initial

margins would not always be larger and more conservative than initial

margins charged on cleared swaps.\190\ The same commenter also argued

that the Commission should require an ex-post 99% initial margin

coverage and not simply a 99% confidence level sampling to better

reflect the liquidity and risk profile of the uncleared markets and to

retain incentives to promote central clearing. One commenter argued

that mandating a 10 day close out period for all swaps is not

sufficiently risk-sensitive as the approach fails to take into account

the liquidity of any particular swap.\191\ Another commenter argued for

allowing market participants to determine appropriate market-based

liquidation periods.\192\ Two commenters supported the 10-day holding

period.\193\

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

\189\ Pension Coalition. See also CCMR (10 day horizon is not

risk-adjusted and the horizon should be set according to the type of

swap); ISDA (liquidity horizon should be consistent with

requirements in other jurisdictions); Sifma AMG (the horizon should

be closer to 5 days).

\190\ CME.

\191\ See CCMR.

\192\ See NERA.

\193\ See Public Citizen; AFR.

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

Since uncleared swaps are expected to be less liquid than cleared

swaps, the final rule specifies a minimum close-out period for the

initial margin model of 10 business days, compared with a typical

requirement of 3 to 5 business days used by central counterparties

(CCPs).\194\ Accordingly, to the extent that uncleared swaps are

expected to be less liquid than cleared swaps and to the extent that

related capital rules which also mitigate counterparty credit risk

similarly require a 10-day close-out period assumption, the

Commission's view is that a 10-day close-out period assumption for

margin purposes is appropriate.\195\

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

\194\ See Sec. 23.154(b)(2)(i) of the final rule.

\195\ In cases where a swap has a remaining maturity of less

than 10 days, the remaining maturity of the swap, rather than 10

days, may be used as the close-out period in the margin model

calculation.

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

At the same time, the Commission is aware that it may not be the

case that the regulatory minimum required initial margin on an

uncleared swap will always be larger than the initial margin required

on any related cleared swap as margining practices vary among DCOs. In

some cases, they may exceed minimum required margin levels due to the

specific risk of the swap in question and the margining practices of

the DCO. Moreover, given the complexity and diversity of the uncleared

swap market, the Commission believes that it is not possible and

unnecessary to prescribe a specific and different close-out horizon for

each type of uncleared swap that may exist in the marketplace. The

Commission does believe that it is appropriate for a CSE to use a

close-out period longer than ten-days in those circumstances in which

the specific risk of the swap indicates that doing so is prudent. In

terms of specifying a regulatory minimum requirement, however, the

Commission believes that a ten-day close-out period is sufficiently

[[Page 657]]

long to generally guard against the heightened risk of less liquid,

uncleared swaps.

Under the final rule, the initial margin model calculation must be

performed directly over a 10-day period. In the context of bank

regulatory capital rules, a long horizon calculation (such as 10 days),

under certain circumstances, may be indirectly computed by making a

calculation over a shorter horizon (such as 1 day) and then scaling the

result of the shorter horizon calculation to be consistent with the

longer horizon. The rule does not provide this option to CSEs using an

approved initial margin model. The Commission's view is that the

rationale for allowing such indirect calculations that rely on scaling

shorter horizon calculations has largely been based on computational

and cost considerations that were material in the past but are much

less so in light of advances in computational speeds and reduced

computing costs. Moreover, the Commission believes that the more

accurate approach would be to use the 10 day period rather than the

scaling approach. Therefore, as a result of the less burdensome

calculations, the Commission is retaining this requirement.

(ii) Portfolio Offsets

Under the proposal, an initial margin model may reflect offsetting

exposures, diversification, and other hedging benefits for uncleared

swaps that are governed by the same EMNA by incorporating empirical

correlations within the broad risk categories, provided the CSE

validates and demonstrates the reasonableness of its process for

modeling and measuring hedging benefits. Under the proposal, the

categories were agriculture, credit, energy, equity, foreign exchange/

interest rate, metals, and other. Empirical correlations under an

eligible master netting agreement could be recognized by the model

within each broad risk category, but not across broad risk categories.

In the proposal, the sum of the initial margins calculated for each

broad risk category would be used to determine the aggregate initial

margin due from the counterparty.

The Commission received comments on a range of issues that broadly

relate to the recognition of portfolio risk offsets.

One commenter requested that the rule specify only a single

commodity asset class rather than the four separate asset classes that

were set forth in the proposal (agricultural commodities, energy

commodities, metal commodities and other commodities).\196\ Another

commenter suggested that the margin requirements should be more

reflective of risk offsets that exist between disparate asset classes

such as equity and commodities.\197\

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

\196\ See Sifma (Bentsen) (suggesting that there are significant

and relatively stable correlations across related commodity

categories that should not be ignored for hedging and margining

purposes; commodity index swaps are a significant source of

uncleared commodity swap activity and these swaps are a significant

source of uncleared commodity swap activity and comprise exposures

to each of the four commodity sub-asset classes that were

identified; implementing the proposal's four separate sub-asset

classes would not be appropriately risk sensitive and would be

difficult and burdensome to implement for a significant class of

commodity swaps); see also ISDA (all commodities should be one asset

class as would be consistent with the 2013 international framework).

\197\ Sifma AMG

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

Many commenters generally argued for allowing a broader set of

offsets. Some commenters suggested that for the purposes of calculating

model-based initial margin amounts portfolio offsets should be

recognized between uncleared swaps, cleared swaps, and other products

such as positions in securities or futures.\198\ Some commenters

promoted a ``risk factor based'' approach and suggested that initial

margin models should allow for offsets across risk factors even if

these risk factors are present in uncleared swaps across multiple asset

classes such as equity and credit.\199\

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

\198\ CCMR; GPC; CEWG; Sifma; MFA; Sifma AMG (offsets should be

allowed for risk across all instruments and asset classes subject to

the same master netting agreement so long as there is sound

theoretical basis and significant empirical support); IECA and BP

(netting should be allowed across swaps and physical commodity

forward transactions entered pursuant to an ISDA master agreement

with physical annexes).

\199\ See ISDA (some assets may be classified as swaps in one

jurisdiction but as some other type of financial instrument in

another jurisdiction); Sifma; JBA.

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

For example, the commenters stated that both an equity swap and a

credit swap may be exposed to some amount of interest rate risk. The

commenters suggested that the interest rate risk inherent in the equity

and credit swaps should be recognized on a portfolio basis so that any

offsetting interest rate exposure across the two swaps could be

recognized in the initial margin model. This approach would effectively

require that all uncleared swaps be described in terms of a number of

``risk factors'' and the initial margin model would consider the

exposure to each risk factor separately. The initial margin amount

required on a portfolio of uncleared swaps would then be computed as

the sum of the amounts required for each risk factor.

This ``risk factor'' based approach described above is different

from the Commission's proposal. Under the proposal, initial margin on a

portfolio of uncleared swaps was calculated on a product-level basis.

In terms of the above example, initial margin would have been

calculated separately for the equity swap and calculated separately for

the credit swap. In the case of both the equity and credit swap,

interest rate risk in the swap would have been modeled and measured

without regard to the interest rate exposure of the other swap. The

total initial margin requirement would have been the sum of the initial

margin requirement for the equity swap and the credit swap.

Accordingly, no offset would have been recognized between any

potentially offsetting interest rate exposure in the equity and credit

swap.

The final rule permits a CSE to use an internal initial margin

model that reflects offsetting exposures, diversification, and other

hedging benefits within four broad risk categories: Credit, equity,

foreign exchange and interest rates (considered together as a single

asset class), and commodities when calculating initial margin for a

particular counterparty if the uncleared swaps are executed under the

same EMNA.\200\

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

\200\ See final rule Sec. 23.154(b)(2)(v).

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

The rule no longer divides commodities into smaller asset classes.

The Commission has decided to group all uncleared commodity swaps into

a single asset class for initial margin calculation purposes. The

Commission believes that there is enough commonality across different

commodity categories to warrant recognition of conceptually sound and

empirically justified risk offsets. Moreover, the Commission notes that

both the proposal and the final rule take a relatively broad view of

the other asset classes: Equity, credit, interest rates and foreign

exchange. In prescribing the granularity of the asset classes there is

a clear trade-off between simplicity and certainty around the stability

of hedging relationships in narrowly defined asset classes and the

greater flexibility and risk sensitivity that is provided by broader

asset class distinctions. Therefore, the Commission has decided to

adopt a commodity asset class definition that is consistent with the

other three asset classes and is appropriate in light of current market

practices and conventions.

The final rule does not permit an initial margin model to reflect

offsetting exposures, diversification, or other hedging benefits across

broad risk

[[Page 658]]

categories.\201\ Hence, the margin calculations for derivatives in

distinct product-based asset classes, such as equity and credit, must

be performed separately without regard to derivatives contracts in

other asset classes. Each derivative contract must be assigned to a

single asset class in accordance with the asset class classification

presented in the standardized minimum gross initial margin requirements

for uncleared swaps. The presence of any common risks or risk factors

across asset classes cannot be recognized for initial margin purposes.

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

\201\ Id.

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

As a specific example, if a CSE entered into two uncleared credit

swaps and two uncleared commodity swaps with a single counterparty

under an EMNA, the CSE could use an approved initial margin model to

perform two separate initial margin calculations: The initial margin

collection amount calculation for the uncleared credit swaps and the

initial margin collection amount calculation for the uncleared

commodity swaps. Each calculation could recognize offsetting and

diversification within the uncleared credit swaps and within the

uncleared commodity swaps. The result of the two separate calculations

would then be summed together to arrive at the total initial margin

collection amount for the four uncleared swaps (two uncleared credit

swaps and two uncleared commodity swaps).

The Commission believes that the qualitative and quantitative basis

for allowing for risk offsets among uncleared swaps within a given, and

relatively broad, asset class such as equities is conceptually stronger

and better supported by historical data and experience than is the

basis for recognizing such offsets across disparate asset classes such

as foreign exchange and commodities. Uncleared swaps that trade within

a given asset class, such as equities, are likely to be subject to

similar market fundamentals and dynamics as the underlying instruments

themselves trade in related markets and represent claims on related

financial assets. In such cases, it is more likely that a stable and

systematic relationship exists that can form the conceptual and

empirical basis for applying risk offsets.

By contrast, uncleared swaps in disparate asset classes such as

foreign exchange and commodities are generally unlikely to be

influenced by similar market fundamentals and dynamics that would

suggest a stable relationship upon which reasonable risk offsets could

be based. Rather, to the extent that empirical data and analysis

suggest some degree of risk offset exists between swaps in disparate

asset classes, this relationship may change unexpectedly over time in

ways that could demonstrably weaken the assumed risk offset.

Accordingly, the Commission has decided to allow for risk offsets that

have a sound conceptual and empirical basis across uncleared swaps

within the broad asset classes as listed in the final rule but not to

allow risk offsets across swaps in differing asset classes.

Moreover, the Commission notes that the final asset class described

above is interest rates and foreign exchange taken as a group.

Accordingly, the final rule will allow conceptually sound and

empirically supported risk offsets between an interest rate swap on a

foreign interest rate and a currency swap in a foreign currency.

The Commission has considered the risk factor based approach

described above and has decided not to adopt that approach, but to

adopt the proposed approach in the final rule for a number of reasons.

First, a product-based approach to calculating initial margin is

clear and transparent. In many market segments it is quite common to

report and measure swap exposures on a product-level basis.\202\ As an

example, the Bank for International Settlements regularly publishes

data on the outstanding notional amounts of OTC derivatives on a

product-level basis. In addition, existing trade repositories, such as

the DTCC global trade repositories for interest rate and credit swaps,

report credit and interest rate derivatives on a product-level basis.

Moreover, a risk factor based approach has the potential to be opaque

and unwieldy. Modern derivative pricing models that are used by banks

and other market participants may employ hundreds of risk factors that

are not standardized across products or models.

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

\202\ http://www.bis.org/statistics/dt1920a.pdf.

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

While it is the case that some swaps may have hybrid features that

make it challenging to assign them to one specific asset class, the

Commission believes that the incidence of this occurrence will be

relatively uncommon and can be dealt with under the final rule. In

particular, as of December 2014, the Bank for International Settlements

reports that of the roughly $630 trillion in gross notional

outstanding, roughly 3.6 percent of these contracts cannot be allocated

to one of the following broad asset categories: Foreign exchange,

interest rate, equity, commodity and credit. The Commission also notes

that this fraction has declined from roughly 6.6 percent in June 2012

which suggests that the challenges associated with such hybrid swaps

are declining over time. In such cases where the allocation of a

particular uncleared swap to a specific asset class is not certain, the

Commission expects an allocation to be made based on whichever broad

asset class represents the preponderance of the uncleared swap's

overall risk profile.

Second, a product-level initial margin model is well aligned with

current practice for cleared swaps. Some clearinghouses that offer

multiple swaps for clearing, such as the CME, do allow for risk offsets

within an asset class but do not generally allow for any risk offsets

across asset classes. Again, as a specific example, the CME offers both

cleared interest rate and credit default swaps. The CME's initial

margin model is a highly sophisticated risk management model that does

allow for offsetting among different credit swaps and among different

interest rate swaps but does not allow for risk offsets between

interest rate and credit swaps. This approach to calculating initial

margin also provides a significant amount of transparency as market

participants, regulators and the public can assess the extent to which

trading activity in specific asset classes generates counterparty

exposures that require initial margin.

To the extent that some risk factors may cut across more than one

asset class, the use of a risk factor-based margining approach would

make evaluating the quantum of risk posed by the trading activity in

any one set of products difficult to measure and manage on a systematic

basis. This would also pose significant challenges to users of

uncleared swaps as well as regulators and the broader public who have

an interest in monitoring and evaluating the risks of different

uncleared swap activities.

Third, the Commission notes that the final rule's product-level

approach to initial margin explicitly allows for risk offsets though

the precise form of these offsets differs from a ``risk factor'' based

approach. The Commission believes that conceptually sound and

empirically justified risk offsets for initial margin are appropriate

and have included such offsets in the final rule. In general, there are

a large number of possible approaches that could be taken to allow for

such offsets. The Commission considered the alternatives raised by the

commenters and adopted in the final rule an approach recognizing risk

offsets that provides for a significant amount of hedging and

diversification benefits while promoting transparency and simplicity in

the margining framework.

[[Page 659]]

Finally, the Commission notes that it may not have the authority to

prescribe margin requirements for all the types of products that may be

included in an ENMA. For example, the Commission's authority to set

margin requirements relates to certain types of swaps and does not

extend to other products such as equity-linked swaps or similar

financial instruments. Accordingly, the Commission believes that the

margin requirements should be reflective of the risks in a CSE's

portfolio of uncleared swaps but may not recognize risks--either as

offsets or sources of additional risk from other products that are

themselves not uncleared swaps and not subject to the margin

requirements of the final rule.

(iii) Stress Calibration and Non-Linear Price Characteristics

The proposed rule required the initial margin model to be

calibrated to a period of financial stress. In addition, the proposal

requires the model to use risk factors sufficient to measure all

material price risks inherent in the transactions for which initial

margin is being calculated. Under the proposal, the initial margin

model would have been required to include all material risks arising

from the nonlinear price characteristics of option positions or

positions with embedded optionality and the sensitivity of the market

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

rates, prices, or other material risk factors.

One commenter suggested that the overall level of the proposed

initial margin requirements were too high and that the proposed

requirement to calibrate the initial margin model to a period of

financial stress was too conservative.\203\ Another commenter supported

the stress period calibration requirement.\204\ A third commenter asked

for clarification on the term ``period of financial stress.'' \205\

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

\203\ MetLife

\204\ See AFR.

\205\ See Barnard.

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

Some commenters suggested that the proposal's requirement that the

initial margin model include all material nonlinear price

characteristics in the underlying uncleared swap was too stringent and

should be relaxed,\206\ while one commenter applauded the requirement

to include risk from nonlinearities.\207\ One commenter argued that the

initial margin model should incorporate the cost of liquidating large

portfolios during periods of stress as well as volatility floors to

guarantee a minimum level of volatility assumed.\208\

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

\206\ JBA, ISDA.

\207\ See AFR.

\208\ See CME.

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

As noted, the final rule requires the initial margin model to be

calibrated to a period of financial stress.\209\ In particular, the

initial margin model must employ a stress period calibration for each

broad asset class (commodity, credit, equity, and interest rate and

foreign exchange). The stress period calibration employed for each

broad asset class must be appropriate to the specific asset class in

question. While a common stress period calibration may be appropriate

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

asset classes would be considered appropriate only if it is appropriate

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

inform the stress period calibration must include at least one year,

but no more than five years of equally-weighted historical data.

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

\209\ See final rule Sec. 23.154(b)(2)(ii).

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

The final rule's requirement is intended to balance the tradeoff

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

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

idiosyncratic spikes in volatility. Longer data spans are less

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

little emphasis on periods of financial stress, resulting in

insufficient initial margins. The requirement that the data be equally

weighted will establish a degree of consistency in initial margin model

calibration while also ensuring that particular weighting schemes do

not result in excessive initial margin requirements during short-term

bouts of heightened volatility.

Calibration to a stress period helps to ensure that the resulting

initial margin requirement is sufficient in a period of financial

stress during which swap entities and financial end user counterparties

are more likely to default, and counterparties handling a default are

more likely to be under pressure. The stress calibration requirement

also reduces the systemic risk associated with any increase in initial

margin requirements that might occur in response to an abrupt increase

in volatility during a period of financial stress, as initial margin

requirements will already reflect a historical stress event.

The Commission continues to believe that the overall level of the

initial margin requirements is consistent with the goals of prescribing

margin requirements that are appropriate for the risk of uncleared

swaps and the safety and soundness of the CSE. Moreover, the

requirement to calibrate the initial margin model to a period of

financial stress has two important benefits. First, initial margin

requirements that are consistent with a period of financial stress will

help to ensure that counterparties are sufficiently protected against

the type of severe financial stresses that are most likely to have

systemic consequences. Second, calibrating initial margins to a period

of financial stress should have the effect of reducing the extent to

which margin changes increase stress.

Specifically, because initial margin levels will be consistent with

a period of above average market volatility and risk, a moderate rise

in risk levels should not require any increase or re-evaluation of

initial margin levels. In this sense, initial margin requirements will

be less likely to increase abruptly following a market shock. There may

be circumstances in which the financial system experiences a

significant financial stress that is even greater than the stress to

which initial margins have been calibrated. In these cases, initial

margin requirements will rise as margin levels are re-calibrated to be

consistent with the new and greater stress level. The Commission

expects such occurrences to be relatively infrequent and, ultimately,

any risk sensitive and empirically based method for calibrating a risk

model must exhibit some sensitivity to changing financial market risks

and conditions.

The Commission has decided to retain in the final rule the

requirement that initial margin models must include all material

nonlinear risks. The Commission is concerned that the uncleared swap

market will be comprised of a large number of complex and customized

swaps that will display significant nonlinear price characteristics

that will have a direct effect on their risk exposure. If the models

did not take these into account the initial margin amount collected

would be inadequate to cover the swap's or swap portfolio's potential

future exposure. Accordingly, the final rule requires that all material

nonlinear price characteristics of an uncleared swap be considered in

assessing the risk of the swap.

There may be nonlinear price characteristics of a particular

uncleared swap that are not material in assessing its risk profile. In

such cases, these nonlinear price characteristics need not be

explicitly included in the initial margin model. The Commission expects

that in determining whether or not a given nonlinear price

characteristic is

[[Page 660]]

material, CSEs will engage in a holistic review of the uncleared swap's

risk profile and make determinations based on the totality of the

uncleared swap's risks.

(iv) Frequency of Margin Calculation

The proposed rule required daily calculation of initial margin. The

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

initial margin amount on a daily basis.

One commenter argued that the Commission should follow the approach

of the European Union and require parties to establish procedures for

adjusting initial margin requirements in response to changing market

conditions.\210\ Another commenter sought clarification that the

initial margin calculation under a model would occur once daily based

on the prior day's prices.\211\

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

\210\ See Sifma (these procedures allow the counterparties to

post increased margin requirements resulting from the recalibration

of a model over a period longer than one day).

\211\ See MFA (suggesting also that the Commission should modify

the timing of recalculation to focus on the time at which a

collateral taker makes a demand for transfer of collateral and

provide that such transfer must be made promptly following the

demand).

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

The final rule retains the requirement that an approved initial

margin model be used to calculate the required initial margin

collection amount on a daily basis. As discussed below, the Commission

believes that swap portfolios and the variables that are used to

calculate the amount of initial margin on those swaps are constantly

changing. Therefore, to ensure the adequacy of the amount of initial

margin the Commission is requiring daily calculation. In cases where

the initial margin collection amount increases, this new amount must be

used as the basis for determining the amount of initial margin that

must be collected from a financial end user with material swaps

exposure or a swap entity counterparty.

In addition, when a CSE faces a financial end user with material

swaps exposure, the CSE must also calculate the initial margin

collection amount from the perspective of its counterparty on a daily

basis. In the event that this amount increases, the CSE must use this

new amount as the basis for determining the amount of initial margin

that it must post to its counterparty. In cases where this amount

decreases, the new amount would represent the new minimum required

amount of initial margin. Accordingly, any previously collected or

posted collateral in excess of this amount would represent additional

initial margin collateral that, subject to bilateral agreement, could

be returned.

The use of an approved initial margin model may result in changes

to the initial margin collection amount on a daily basis for a number

of reasons. First, the characteristics of the swaps that have a

material effect on their risk may change over time. As an example, the

credit quality of a corporate reference entity upon which a credit

default swap contract is written may undergo a measurable decline. A

decline in the credit quality of the reference entity would be expected

to have a material impact on the initial margin model's risk assessment

and the resulting initial margin collection amount.

More generally, as the swaps' relevant risk characteristics change,

so will the initial margin collection amount. In addition, any change

to the composition of the swap portfolio that results in the addition

or deletion of swaps from the portfolio will result in a change in the

initial margin collection amount.

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

model may change over time as underlying conditions change. As an

example, in the event that a new period of financial stress is

encountered in one or more asset classes, the initial margin model's

risk assessment of a swap's overall risk may also change. While the

stress period calibration is intended to reduce the extent to which

small or moderate changes in the risk environment influence the initial

margin model's risk assessment, a significant change in the risk

environment that affects the required stress period calibration could

influence the margin model's overall assessment of the risk of a swap.

Third, quantitative initial margin models are expected to be

maintained and refined on a continuous basis to reflect the most

accurate risk assessment possible with available best practices and

methods.\212\ As best practice risk management models and methods

change, so too may the risk assessments of initial margin models.

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

\212\ Section 23.154(b)(iii) of the final rule would require any

material change to the model be communicated to the Commission

before taking effect. The Commission, however, anticipates that some

changes will be made to initial margin models on an ongoing basis

consistent with regular and ongoing maintenance and oversight that

will not require Commission notification.

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

(v) Benchmarking

The proposed rule required a model used for calculating initial

margin requirements to be benchmarked periodically against observable

margin standards to ensure that the initial margin required is not less

than what a CCP would require for similar transactions.\213\

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

\213\ Proposed Sec. 23.154(b)(5).

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

While one commenter supported the benchmarking requirement,\214\

other commenters urged the Commission to remove the benchmarking

requirement, noting the differences between model parameters and the

availability of other risk-mitigating factors at a CSE, such as capital

requirements that are not applicable to DCOs.\215\ Another commenter

suggested that any differences in initial margin requirements for

cleared and uncleared swaps should be limited to the amount necessary

to reflect counterparty credit risk.\216\

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

\214\ See CME.

\215\ See ISDA; Sifma.

\216\ See MetLife.

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

The Commission is retaining the benchmarking requirements. This

benchmarking requirement is intended to ensure that any initial margin

amount produced by a model is subject to a readily observable minimum.

It will also have the effect of limiting the extent to which the use of

models might disadvantage the movement of certain types of swaps to

DCOs by setting lower initial margin amounts for uncleared transactions

than for similar cleared transactions.

d. Control Mechanisms

(i) Proposal

The proposal would have required CSEs to implement certain control

mechanisms.\217\ They include, among others, the following.

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

\217\ Proposed Sec. 23.154(b)(5).

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

The CSE must maintain a risk management unit in accordance with

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

senior management and is independent from the business trading

units.\218\ The unit must validate its model before implementation and

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

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

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

require for similar cleared products, and back testing.

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

\218\ Commission Regulation 23.600 requires each registered SD/

MSP to establish a risk management program that identifies the risks

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

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

variety of risks, including market, credit, liquidity, foreign

currency, legal, operational, settlement, and other applicable

risks. The risks would also include risks posed by affiliates. See

17 CFR 23.600.

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

If the validation process revealed any material problems with the

model, the

[[Page 661]]

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

describe to the Commission any remedial actions being taken, and adjust

the model to insure an appropriate amount of initial margin is being

calculated.

The CSE must have an internal audit function independent of the

business trading unit that at least annually assesses the effectiveness

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

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

chief compliance officer at least annually.

(ii) Comments

Some commenters suggested that the model governance, control and

oversight standards of the proposed rule were too strict and should not

be so closely aligned with the model governance requirements for bank

capital models.\219\ One commenter suggested that since initial margin

amounts must be agreed to between counterparties, it is not practical

to require strict model governance standards.\220\ Another commenter

suggested that the initial margin model not be required to be back

tested against the initial margin requirements for similar cleared

swaps.\221\ One commenter suggested that the frequency with which data

must be reviewed and revised as necessary should be annual rather than

monthly to better align with other aspects of the proposal that require

certain governance processes to be conducted on an annual rather than

monthly basis.\222\ One commenter also cautioned against creating

duplicative requirement for internal auditing since the effectiveness

of initial and variation margin calculations are routinely and

regularly evaluated as required in other Commission regulations.\223\

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

\219\ See JBA and SIFMA and IIB

\220\ JBA.

\221\ See SIFMA.

\222\ See ISDA.; see also NERA.

\223\ See BP (noting Commission Regulation 23.600).

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

The Commission believes that strong model governance, oversight and

control standards are crucial to ensuring the integrity of the initial

margin model so as to provide for margin requirements that are

commensurate with the risk of uncleared swaps. Moreover, the Commission

is aware that there will be incentives to minimize the amount of

initial margin and that strong governance standards that are intended

to result in strong and risk appropriate initial margin amounts is of

critical importance.

In light of the clear competitive forces that will exist between

cleared and uncleared swaps, the Commission believes that it is

appropriate to compare the initial margin requirements of uncleared

swaps to those of similar cleared swaps. Further, the Commission

understands that comparable cleared swaps with observable initial

margin standard may not always be available given the complexity and

variety of uncleared swaps. Nevertheless, the Commission believes that

where similar swaps trade on a cleared and uncleared basis such

comparisons are useful and informative.

More specifically, under the final rule a CSE must periodically,

and no less than annually, review its initial margin model in light of

developments in financial markets and modeling technologies and make

appropriate adjustments to the model. The Commission believes that

harmonizing the frequency with which certain model governance processes

must be performed will reduce the costs associated with the regular

oversight and maintenance of the initial margin model without

meaningfully altering the overall standards for model governance.

Accordingly, the final rule requires that data used in the initial

margin model be reviewed and revised as necessary, but at least

annually rather than monthly to ensure that the data is appropriate for

the products for which initial margin is being calculated. The

Commission notes that different, additional or more granular data

series may, at certain times, become available that would provide more

accurate measurements of the risks that the initial margin model is

intended to capture.

In addition to this regular review process, the final rule also

requires that strong oversight, control and validation mechanisms be in

place to ensure the integrity and validity of the initial margin model

and related processes. More specifically, the final rule requires that

the model be independently validated prior to implementation and on an

ongoing basis which would also include a monitoring process that

includes back-tests of the model and related analyses to ensure that

the level of initial margin being calculated is consistent with the

underlying risk of the swap being margined. Initial margin models must

also be subject to explicit escalation procedures that would make any

significant changes to the model subject to internal review and

approval before taking effect. Under the final rule, any such review

and approval must be based on demonstrable analysis that the change to

the model results in a model that is consistent with the requirements

of the final rule. Furthermore, under the final rule, any such changes

or extensions of the initial margin model must be communicated to the

Commission 60 days prior to taking effect to give the Commission the

opportunity to rescind its prior approval or subject it to additional

conditions.

The Commission also acknowledges that a CSE's internal audit

department is required to routinely and regularly audit the

effectiveness of initial and variation margin calculations. The

Commission believes that this requirement is necessary to ensure

compliance with a minimum standard.

e. Input From Counterparties

The Commission received comments regarding counterparty inputs on a

CSE's initial margin model. One commenter urged the Commission to allow

financial end users to have a role in determining the margin

methodology used and suggested that CSEs should not be able to switch

methodologies without the consent of the counterparty.\224\ Other

commenters suggested that the Commission require CSEs to disclose their

initial margin models to non-CSE counterparties so that counterparties

may validate the margin amount calculated \225\ or otherwise allow

financial end users access to the initial margin model and the inputs

used by the CSE to allow them to challenge margin calls or demand the

return of excess collateral during the life of a swap.\226\

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

\224\ See GPC.

\225\ See ICI; GPC; MFA.

\226\ See FHLB.

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

The Commission notes that counterparties to a swap with a CSE have

other mechanisms through which they could address their concerns

without requiring a CSE to disclose its initial margin model

methodologies. In particular, the Commission points to Commission

Regulation 23.504(b)(4)(i) prescribing trade documentation requirements

on counterparties. Specifically, Regulation 23.504(b)(4)(i) requires

``written documentation in which the parties [to a swap] agree on the

process, which may include any agreed upon methods, procedures, rules,

and inputs, for determining the value of each swap at any time from

execution to the termination, maturity, or expiration of such swap for

purposes of complying with the margin requirements . . . and

regulations . . . .'' \227\ The Commission believes that the

requirements on trade documentation specified in Regulation

23.504(b)(4)(i) should adequately address the concerns of commenters

and is not prescribing more specific

[[Page 662]]

disclosure requirements with respect to internal initial margin models

used by a CSE to its counterparties in the final rule.

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

\227\ 17 CFR 23.504(b)(4)(i).

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

3. Table-Based Method

a. Method of Calculation

Some CSEs might not have the internal technical resources to

develop initial margin models or have simple portfolios for which they

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

allow a CSE to calculate its initial margin requirements using a

standardized table.\228\ The table specifies the minimum initial margin

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

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

swap. Except as modified by the net-to-gross ratio adjustment,\229\ a

CSE would be required to calculate a minimum initial margin amount for

each swap and sum up all the minimum initial margin amounts calculated

under this section to arrive at the total amount of initial margin. The

table is consistent with international standards.\230\

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

\228\ Proposed Sec. 23.154(c).

\229\ See 79 FR 59898, at 59911 (Oct. 3, 2014).

\230\ BCBS/IOSCO Report at Appendix A.

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

b. Comments

Two commenters suggested that the Commission adopt an altogether

different approach to computing standardized initial margins in a

manner consistent with the standardized approach for measuring

counterparty credit risk exposures that was finalized and published by

the Basel Committee on Banking Supervision in March 2014.\231\ This

approach is intended to be used in bank regulatory capital requirements

for the purposes of computing capital requirements for counterparty

credit risk resulting from OTC derivative exposures. A third commenter

remarked that the table-based method should be modified to reflect

greater granularity, including increasing the number of asset

categories recognized by the standardized initial margin table.\232\

Among other things, this commenter suggested increasing the number of

asset categories recognized by the standardized initial margin table.

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

\231\ See JBA; CS.

\232\ See MFA.

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

c. Discussion

In the final rule, the Commission has adopted the proposed approach

to standardized initial margin. The Commission has decided not to adopt

a different approach advocated by the commenters in the final rule for

several reasons. First, the standardized approach for counterparty

credit risk has been developed for counterparty capital requirement

purposes and, while clearly related to the issue of initial margin for

uncleared swaps, it is not entirely clear that this framework can be

transferred to a simple and transparent standardized initial margin

framework without modification.

Second, the standardized approach that has been published by the

Basel Committee on Banking Supervision is not intended to become

effective until January 2017 which follows the initial compliance date

of the final rule. Accordingly, the Commission expects that some form

of the standardized approach will be proposed by U.S. banking

regulators prior to January 2017. Following the notice and comment

period, a final rule for capitalizing counterparty credit risk

exposures will be finalized in the United States. Once these rules are

in place and effective it may be appropriate to consider adjusting the

approach in this rule to standardized initial margins. Prior to the new

capital rules being effective in the United States for the purpose for

which they were intended, the Commission does not believe it would be

appropriate to incorporate the standardized approach to counterparty

credit risk that has been published by the Basel Committee on Banking

Supervision into the final margin requirements for uncleared swaps.

The Commission acknowledges the desire to reflect greater

granularity in the standardized approach but also notes that the

approach in the final rule distinguishes among four separate asset

classes and various maturities. The Commission also notes that no

commenter provided a specific and fully articulated suggestion on how

to modify the standardized approach to achieve greater flexibility

without becoming overly burdensome. The Commission also notes that the

standardized initial margins are a minimum margin requirement. CSEs and

their counterparties are free to develop standardized margin schedules

that reflect greater granularity than the final rule's standardized

approach so long as the resulting amounts would in all circumstances be

at least as large as those required by the final rule's standardized

approach to initial margin. Accordingly, the final rule affords CSEs

and their counterparties the opportunity to develop simple and

transparent margin schedules that reflect the granular and specific

nature of the swap activity being margined.

Under the final rule, standardized initial margins depend on the

asset class (commodity, equity, credit, foreign exchange and interest

rate) and, in the case of credit and interest rate asset classes,

further depend on the duration of the underlying uncleared swap. In

addition, the standardized initial margin requirement allows for the

recognition of risk offsets through the use of a net-to-gross ratio in

cases where a portfolio of uncleared swaps is executed under an EMNA.

The net-to-gross ratio compares the net current replacement cost of

the non-cleared portfolio (in the numerator) with the gross current

replacement cost of the non-cleared portfolio (in the denominator). The

net current replacement cost is the cost of replacing the entire

portfolio of swaps that are covered under the EMNA. The gross current

replacement cost is the cost of replacing those swaps that have a

strictly positive replacement cost under the EMNA.

As an example, consider a portfolio that consists of two uncleared

swaps under an EMNA in which the mark-to-market value of the first swap

is $10 (i.e., the CSE is owed $10 from its counterparty) and the mark-

to-market value of the second swap is -$5 (i.e., the CSE owes $5 to its

counterparty). Then the net current replacement cost is $5 ($10-$5),

the gross current replacement cost is $10, and the net-to-gross ratio

would be 5/10 or 0.5.\233\

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

\233\ Note that in this example, whether or not the

counterparties have agreed to exchange variation margin has no

effect on the net-to-gross ratio calculation, i.e., the calculation

is performed without considering any variation margin payments. This

is intended to ensure that the net-to-gross ratio calculation

reflects the extent to which the uncleared swaps generally offset

each other and not whether the counterparties have agreed to

exchange variation margin. As an example, if a swap dealer engaged

in a single sold credit derivative with a counterparty, then the

net-to-gross calculation would be 1.0 whether or not the dealer

received variation margin from its counterparty.

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

The net-to-gross ratio and gross standardized initial margin

amounts (provided in Sec. 23.154(c)) are used in conjunction with the

notional amount of the transactions in the underlying swap portfolio to

arrive at the total initial margin requirement as follows:

Standardized Initial Margin = 0.4 x Gross Initial Margin + 0.6 x NGR x

Gross Initial Margin

where:

Gross Initial Margin = the sum of the notional value multiplied by

the appropriate initial margin requirement percentage from Appendix

A of each uncleared swap under the EMNA; and

NGR = net-to-gross ratio

[[Page 663]]

As a specific example, consider the two-swap portfolio discussed

above. Suppose further that the swap with the mark-to-market value

of $10 is a sold 5-year credit default swap with a notional value of

$100 and the swap with the mark-to-market value of -$5 is an equity

swap with a notional value of $100. The standardized initial margin

requirement would then be:

[0.4 x (100 x 0.05 + 100 x 0.15) + 0.6 x 0.5 x (100 x 0.05 + 100 x

0.15)] = 8 + 6 = 14.

The Commission further notes that the calculation of the net-to-

gross ratio for margin purposes must be applied only to swaps subject

to the same EMNA and that the calculation is performed across

transactions in disparate asset classes within a single EMNA such as

credit and equity in the above example. That is, all uncleared swaps

subject to the same EMNA and subject to the final rule's requirements

can net against each other in the calculation of the net-to-gross

ratio, as opposed to the modeling approach that allows netting only

within each asset class.

This approach is consistent with the standardized counterparty

credit risk capital requirements. Also, the equations are designed such

that benefits provided by the net-to-gross ratio calculation are

limited by the standardized initial margin term that is independent of

the net-to-gross ratio, i.e., the first term of the standardized

initial margin equation which is 0.4 x Gross Initial Margin.

Finally, if a counterparty maintains multiple uncleared swap

portfolios under one or multiple EMNAs, the standardized initial margin

amounts would be calculated separately for each portfolio with each

calculation using the gross initial margin and net-to-gross ratio that

is relevant to each portfolio. The total standardized initial margin

would be the sum of the standardized initial margin amounts for each

portfolio.

The final rule's standardized approach to initial margin depends on

the calculation of a net-to-gross ratio. In the context of performing

margin calculations, it must be recognized that at the time uncleared

swaps are entered into it is often the case that both the net and gross

current replacement cost is zero. This precludes the calculation of the

net-to-gross ratio. In cases where a new swap is being added to an

existing portfolio that is being executed under an existing EMNA, the

net-to-gross ratio may be calculated with respect to the existing

portfolio of swaps. In cases where an entirely new swap portfolio is

being established, the initial value of the net-to-gross ratio should

be set to 1.0. After the first day's mark-to-market valuation has been

recorded for the portfolio, the net-to-gross ratio may be re-calculated

and the initial margin amount may be adjusted based on the revised net-

to-gross ratio.

The final rule requires that the standardized initial margin

collection amount be calculated on a daily basis. In cases where the

initial margin collection amount increases, this new amount must be

used as the basis for determining the amount of initial margin that

must be collected from a financial end user with material swaps

exposure or a swap entity. In addition, when a CSE faces a financial

end user with material swaps exposure, the CSE must also calculate the

initial margin collection amount from the perspective of its

counterparty on a daily basis. In the event that this amount increases,

the CSE must use this new amount as the basis for determining the

amount of initial margin that it must post to its counterparty. In the

event that this amount decreases, this new amount would also serve as

the basis for the minimum required amount of initial margin.

Accordingly, any previously collected or posted initial margin over and

above the new requirement could, subject to bilateral agreement, be

returned.

As in the case of internal-model-generated initial margins, the

margin calculation under the standardized approach must also be

performed on a daily basis. Because the standardized initial margin

calculation depends on a standardized look-up table (in Regulation

23.154(c)), there are fewer reasons for the initial margin collection

amounts to vary on a daily basis. However, there are some factors that

may result in daily changes in the initial margin collection amount

under the standardized margin calculations.

First, any changes to the notional size of the swap portfolio that

arise from any addition or deletion of swaps from the portfolio would

result in a change in the standardized margin amount. As an example, if

the notional amount of the swap portfolio increased as a result of

adding a new swap to the portfolio then the standardized initial margin

collection amount would increase.

Second, changes in the net-to-gross ratio that result from changes

in the mark-to-market valuation of the underlying swaps would result in

a change in the standardized initial margin collection amount.

Third, changes to characteristics of the swap that determine the

gross initial margin would result in a change in the standardized

initial margin collection amount. As an example, the gross initial

margin applied to interest rate swaps depends on the duration of the

swap. An interest rate swap with a duration between zero and two years

has a gross initial margin of one percent while an interest rate swap

with duration of greater than two years and less than five years has a

gross initial margin of two percent. Accordingly, if an interest rate

swap's duration declines from above two years to below two years, the

gross initial margin applied to it would decline from two to one

percent. Accordingly, the standardized initial margin collection amount

will need to be computed on a daily basis to reflect all of the factors

described above.

F. Calculation of Variation Margin

1. Proposal

Under the proposal, each CSE would be required to calculate

variation margin for itself and for each covered counterparty using a

methodology and inputs that to the maximum extent practicable, and in

accordance with existing Regulation 23.504(b)(4) rely on recently-

executed transactions, valuations provided by independent third

parties, or other objective criteria.\234\ In addition, each CSE would

need to have in place alternative methods for determining the value of

an uncleared swap in the event of the unavailability or other failure

of any input required to value a swap.\235\

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

\234\ Proposed Sec. 23.155(a)(1) and current Sec.

23.504(b)(4).

\235\ Proposed Sec. 23.155(a)(2).

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

Similar to the requirement for initial margin, the proposal would

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

margin to, each counterparty that is a swap entity or a financial end

user, on or before the end of the business day after execution for each

swap with that counterparty.\236\ The proposed rule required the CSEs

to continue to pay or collect variation margin each business day until

the swap is terminated or expires.\237\

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

\236\ Proposed Sec. 23.153(a).

\237\ Proposed Sec. 23.153(b).

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

The proposal would also set forth several control mechanisms.\238\

Each CSE would be required to create and maintain documentation setting

forth the variation margin methodology with sufficient specificity to

allow the counterparty, the Commission, and any applicable Prudential

Regulator to calculate a reasonable approximation of the margin

requirement independently. Each CSE would be required to evaluate the

reliability of its data sources at least annually, and to make

adjustments, as appropriate. The proposal would permit

[[Page 664]]

the Commission to require a CSE to provide further data or analysis

concerning the methodology or a data source.

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

\238\ Proposed Sec. 23.155(b).

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

2. Comments

Several commenters suggested that the Commission consider alternate

methods for calculating variation margin.\239\ Commenters stated that

the proposal appeared to require a CSE to determine minimum variation

margin requirements based on the market value of a swap calculated only

from the CSE's own perspective, rather than at a mid-market price

consistent with current market practice. These commenters urged that

using mid-market swap values to determine variation margin would align

more closely with industry practice and would not skew in favor of a

CSE.\240\ They also remarked that all calculations and methodologies

should be available to counterparties.

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

\239\ See MetLife; Sifma-AMG; Freddie; FHLB (parties should seek

prices based on recently-executed transactions, valuations provided

by independent third-parties or other objective criteria).

\240\ These commenters argued that this approach would result in

dealer exposures being over-collateralized and their counterparties'

exposures being under-collateralized.

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

Further, one commenter remarked that the requirements on the method

for calculating variation margin is redundant because other Commission

regulations already address variation margin calculation

methodology.\241\ Additionally, commenters also questioned the

Commission's view of variation margin as a settlement or payment,

noting for example concerns with the tax and accounting

consequences.\242\

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

\241\ See ISDA.

\242\ See e.g., ACLI.

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

Many commenters urged the Commission to provide more time for the

delivery of variation margin.\243\ One commenter asked for

clarification that the collection and calculation of variation margin

would occur only once a day based on the closing price of the previous

day.\244\ Another commenter argued that the frequency of posting

variation margin (i.e., daily) could possibly create liquidity

pressures and have pro-cyclicality effects.\245\

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

\243\ See JFMC; GPC; and ISDA.

\244\ See MFA.

\245\ See NERA.

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

One commenter also suggested that CSEs should not be required to

exchange variation margin with financial end users whose exposures to

the CSE fall below the material swaps exposure threshold.\246\

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

\246\ See ISDA.

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

3. Discussion

After carefully reviewing the comments, the Commission is adopting

the variation margin requirement largely as proposed, but with a

limited number of changes to address concerns raised by commenters with

respect to the calculation and exchange of variation margin.

When a CSE engages in an uncleared swap transaction with a

financial end user, regardless of whether or not the financial end user

has a material swaps exposure, the final rule will require the CSE to

collect and post variation margin with respect to the uncleared swap.

The final rule requires a CSE to collect or to post (as applicable)

variation margin on uncleared swaps in an amount that is at least equal

to the increase or decrease (as applicable) in the value of such swaps

since the previous exchange of variation margin.

Consistent with the proposal, a CSE may not establish a threshold

amount below which it need not exchange variation margin on swaps with

a swap entity or financial end user counterparty (although transfers

below the minimum transfer amount would not be required).

The Commission believes the bilateral exchange of variation margin

will support CSE safety and soundness as well as effectively reduce

systemic risk by protecting both the CSE and its counterparty from the

effects of a counterparty default.

Unlike the proposal, which used the terms ``pay'' and ``paid'' to

refer to the transfer of variation margin, the final rule refers to

variation margin in terms of ``post'' and ``collect.'' After carefully

reviewing the comments on the proposal that addressed the appropriate

characterization of the transfer of variation margin, the Commission

has determined that it is more appropriate to refer to variation margin

collateral as having been ``posted,'' rather than ``paid,'' consistent

with the treatment of initial margin.

Among the reasons underlying the Commission's proposal to refer to

variation margin in terms of payment, was the existing market practice

of swap dealers to exchange variation margin with other swap dealers in

the form of cash. As is discussed below in the final rule's provisions

on eligible collateral, the Commission has concluded that it is

appropriate to permit financial end users to use other, non-cash forms

of collateral for variation margin. This revision to the nomenclature

of the final rule is consistent with the Commission's inclusion of

eligible non-cash collateral for variation margin.

In the context of cash variation margin, commenters also expressed

concerns that the Commission's choice of the ``pay'' nomenclature

reflected an underlying premise of current settlement that may be

inconsistent with various operational, accounting, tax, legal, and

market practices. The Commission's use of the ``post'' and ``collect''

nomenclature for the final rule is not intended to reflect upon or

alter the characterization of variation margin exchanges--either as a

transfer and settlement or a provisional form of collateral--for other

purposes in the market.

Under the final rule, ``variation margin'' means the collateral

provided by one party to its counterparty to meet the performance of

its obligations under one or more uncleared swaps between the parties

as a result of a change in value of such obligations since the last

time such collateral was provided.\247\ The amount of variation margin

to be collected or posted (as appropriate) is the amount equal to the

cumulative mark-to-market change in value to a CSE of an uncleared

swap, as measured from the date it is entered into (or, in the case of

an uncleared swap that has a positive or negative value to a CSE on the

date it is entered into, such positive or negative value plus any

cumulative mark-to-market change in value to the CSE of a uncleared

swap after such date), less the value of all variation margin

previously collected, plus the value of all variation margin previously

posted with respect to such uncleared swap.\248\ The CSE must collect

this amount if the amount is positive, and post this amount if the

amount is negative.

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

\247\ Sec. 23.155.

\248\ Sec. 23.151.

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

The Commission wishes to clarify that the reference in the rule

text to the ``cumulative mark-to-market change in value to a CSE of an

uncleared swap'' is not designed or intended to have the effect

suggested by commenters. The market value used to determine the

cumulative mark-to-market change will be mid-market prices, if that is

consistent with the agreement of the parties.\249\ The final rule is

consistent with market practice in this respect. The rule text's

reference to ``change in value to a covered swap entity'' refers to

whether the value change is positive or negative from the CSE's

standpoint. This ties to the final rule's requirement

[[Page 665]]

for the CSE to post variation margin when the variation margin amount

is positive, or to collect variation margin when the variation margin

amount is negative.

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

\249\ Additionally, the Commission notes that the final margin

requirements should be viewed as minimums. To the extent that two

counterparties agree to transfer collateral in addition to the

minimum amount required by the final rule, the final rule will not

impede them.

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

In calculating variation margin amounts, the final rule permits

netting across a portfolio of uncleared swaps between the CSE and a

particular counterparty, subject to a number of conditions. These

provisions are discussed in more detail above.

Consistent with the proposal, the final rule requires a CSE to

exchange variation margin for uncleared swaps with swap entities and

financial end users (regardless of whether the financial end user has a

material swaps exposure). However, as discussed earlier, the enactment

of TRIPRA exempts certain nonfinancial counterparties from the scope of

this rulemaking for uncleared swaps that hedge or mitigate commercial

risk.\250\ The Commission is not requiring that CSEs exchange variation

margin with respect to the swaps that are exempted from the margin

final rule by TRIPRA.

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

\250\ The Commission is not requiring that CSEs collect initial

or variation margin from these so-called ``commercial end user''

counterparties.

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

Overall, this aspect of the variation margin provisions of the

final rule is consistent with the approach for initial margin. The

final rule largely retains the proposed rule's requirement for

variation margin to be posted or collected on a T+1 timeframe. The

final rule requires variation margin to be posted or collected no less

than once per business day, beginning on the business day following the

day of execution. These provisions of the final rule operate in the

same way as those discussed earlier in the description of the final

rule's initial margin requirements.

The one difference is that all transactions with financial end user

counterparties are subject to the variation margin requirements, while

only financial end user counterparties with material swaps exposure are

subject to initial margin requirements. The Commission believes it is

appropriate to apply the minimum variation margin requirements to non-

exempted transactions with all financial entity counterparties, not

just those with a material swaps exposure, because the daily exchange

of variation margin is an important risk mitigant that (i) reduces the

build-up of risk that may ultimately pose systemic risk; (ii) does not,

in aggregate, reduce the amount of liquid assets readily available to

posting and collecting entities because it simply transfers resources

from one entity to another; and (iii) reflects both current market

practice and a risk management best practice.

The final rule in this area is consistent with that of the

Prudential Regulators but is more detailed in one respect. The

Commission's rule requires that variation margin calculations use

methods, procedures, rules, and inputs that, to the maximum extent

practicable rely on recently-executed transactions, valuations provided

by independent third parties, or other objective criteria.

The Commission believes that the accurate valuation of positions is

a critical element in assuring the safety and soundness of CSEs and in

preserving the integrity of the financial system. The standard set

forth in the Commission's rule is consistent with recently-issued

international standards.\251\

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

\251\ Risk Mitigation Standards for Non-centrally Cleared OTC

Derivatives, International Organization of Securities Commissions

(January 28, 2015).

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

G. Forms of Margin

1. Initial Margin

a. Proposal

In general, the Commission believes that margin assets should share

the following fundamental characteristics. The assets should be liquid

and, with haircuts, hold their value in times of financial stress. The

value of the assets should not exhibit a significant correlation with

the creditworthiness of the counterparty or the value of the swap

portfolio.\252\

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

\252\ See BCBS/IOSCO Report at 16.

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

Guided by these principles, the Commission proposed that CSEs may

only post or accept certain assets to meet initial margin requirements

to or from covered counterparties.\253\ These are assets for which

there are deep and liquid markets and, therefore, assets that can be

readily valued and easily liquidated.

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

\253\ Proposed Sec. 23.156(a)(1).

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

Certain assets would be prohibited from use as initial margin

because the Commission was concerned that the use of those assets could

compound risk.\254\ These included any asset that is an obligation of

the party providing such asset or an affiliate of that party. These

also include instruments issued by bank holding companies, depository

institutions, and market intermediaries. These restrictions reflected

the Commission's view that the price and liquidity of securities issued

by the foregoing entities are very likely to come under significant

pressure during a period of financial stress when a CSE may be

resolving a counterparty's defaulted swap position and, therefore,

present an additional source of risk.

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

\254\ Proposed Sec. 23.156(a)(2).

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

b. Comments

Commenters generally supported the Commission's proposed asset

categories or sought limited modifications. Several commenters argued

in support of including other assets (such as interests in money market

funds and high quality liquid debt securities) in the list of eligible

collateral or allowing parties to negotiate acceptable forms of

collateral.\255\ Commenters who asked the Commission to consider GSE

securities as eligible collateral for variation margin joined many

others who opposed limiting variation margin collateral to cash only.

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

\255\ See ICI; ISDA; CPFM; GPC; Sifma-AMG; IECA (letters of

credit); Freddie; and CDEU.

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

Commenters representing the interests of asset managers, mutual

funds, and other institutional asset managers asked the Commission to

expand the list of eligible collateral to include money market mutual

funds and bank certificates of deposit, in the interests of providing

financial end users with a higher yield than cash held by the margin

custodian and more liquidity than direct holdings of government or

corporate bonds. Some commenters requested that bank certificates of

deposit be considered eligible collateral for margin purposes.

Commenters stated that GSE debt securities already are widely used

as collateral for uncleared swaps and should continue to be eligible

under the final rule given their historically low levels of volatility.

A smaller number of the commenters argued that GSE mortgage-backed

securities (``MBS'') also should be eligible collateral given that

markets have accepted GSE MBS as liquid, high-quality securities along

with other GSE debt. A number of commenters suggested that GSE debt

securities and MBS should qualify as eligible collateral, regardless of

whether or not the GSE is operating with capital support or another

form of financial assistance from the United States.

Some commenters also questioned why the minimum haircut for debt

securities of GSEs (operating without capital support or other

financial assistance from the U.S.) is not lower than the minimum

haircuts applicable to corporate debt. Another concern that some

commenters raised is that the capital and margin rule for uncleared

swaps is inconsistent in its treatment of GSE securities with the

liquidity

[[Page 666]]

coverage ratio rule that the Board, OCC, and FDIC issued in 2014.\256\

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

\256\ See 79 FR 61439 (October 10, 2014) (Liquidity Coverage

Ratio: Liquidity Risk Measurement Standards).

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

One commenter cautioned against classifying the debt securities of

federal home loan banks as eligible collateral and stated that asset-

backed securities issued by a U.S. Government-sponsored enterprises

(``GSE'') should not be precluded from the list of eligible collateral

solely because those securities are not unconditionally guaranteed by a

GSE whose obligations are fully guaranteed by the U.S. government.\257\

Another commenter cautioned against including equities in the list of

eligible collateral because of their inherent risky nature.\258\

Commenters also suggested that the Commission allow parties to model

haircuts for eligible collateral.\259\

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

\257\ See FHLB.

\258\ See Barnard.

\259\ See ISDA; Sifma.

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

Commenters also requested that the Commission provide guidance

about the rule's application to current market practice incorporating

contractual provisions specifying an agreed-upon currency of

settlement, transport, transit currencies and termination currencies.

Additionally, commenters urged the Commission to permit any cross-

currency sensitivity between the swap portfolio credit exposure and the

margin collateral provided against that exposure to be measured as a

component of the margin required to be exchanged under the rule.

Finally, some commenters urged the Commission to perform annual

reviews of the eligible collateral categories and the haircuts.\260\

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

\260\ As with all of its rules, the Commission will make

appropriate changes if it believes it is necessary.

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

c. Discussion

With respect to initial margin, the final rule includes an

expansive list of the types of collateral that is largely consistent

with the list set forth in the proposal. Eligible collateral for

initial margin includes immediately available cash funds denominated in

any major currency or the currency of settlement, debt securities that

are issued or guaranteed by the U.S. Department of Treasury or by

another U.S. government agency, the Bank for International Settlements,

the International Monetary Fund, the European Central Bank,

multilateral development banks, certain GSEs' debt securities, certain

foreign government debt securities, certain corporate debt securities,

certain listed equities, shares in certain investment funds, and gold.

The Commission is including equities as eligible collateral in the

final rule, with the requirement for a minimum 15 percent haircut on

equities in the S&P 500 Index and a minimum 25 percent haircut for

those in the S&P 1500 Composite Index but not in the S&P 500

Index.\261\ The Commission notes that, even with these restrictions

designed to address liquidity and volatility, CSEs should also take

concentrations into account, and prudently manage their acceptance of

initial margin collateral, with the idiosyncratic risk of equity--and

publicly traded debt--issuers in mind. The Commission notes that it is

important to consider longer time periods incorporating periods of

market stress, and the minimum haircuts are calibrated accordingly.

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

\261\ Although equities included in the S&P 500 Index are also

included in the S&P 1500 Composite Index, equities in the S&P 500

Index are subject to the 15 percent minimum haircut, not the 25

percent minimum haircut.

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

To accommodate the concern of certain commenters that argued for an

inclusion of money market mutual funds and bank certificates of deposit

in the list of eligible collateral for initial margin and to provide

flexibility while maintaining a level of safety, the final rule adds

redeemable securities in a pooled investment fund that holds only

securities that are issued by, or unconditionally guaranteed as to the

timely payment of principal and interest by, the U.S. Department of the

Treasury, and cash funds denominated in U.S. dollars. To provide a

parallel collateral option for uncleared swap portfolios in

denominations other than U.S. dollars, the pooled investment fund may

be structured to invest in pool of securities that are denominated in a

common currency and issued by, or fully guaranteed as to the timely

payment of principal and interest by, the European Central Bank or a

sovereign entity that is assigned no higher than a 20 percent risk

weight under applicable regulatory capital rules, and cash denominated

in the same currency.

The final rule requires these pooled investment vehicles to issue

redeemable securities representing the holder's proportional interest

in the fund's net assets, issued and redeemed only on the basis of the

fund's net assets prepared each business day after the holder makes its

investment commitment or redemption request to the fund. These criteria

are similar to those used for bank trust department common trust funds

and common investment funds, to facilitate liquidity of the redeemable

securities while still protecting holders of the fund's securities from

dilution. The final rule also provides that assets of the fund may not

be transferred through securities lending, securities borrowing,

reverse repurchase agreements, or similar arrangements. This is to

ensure consistency with the prohibition under the final rule against

custodian rehypothecation of initial margin collateral.

Consistent with the proposal, the final rule generally does not

include asset-backed securities (``ABS''), including MBS, within the

permissible category of publicly-traded debt securities. However, ABS

are included as eligible collateral if they are issued by, or

unconditionally guaranteed as to the timely payment of principal and

interest by, the U.S. Department of the Treasury or another U.S.

government agency whose obligations are fully guaranteed by the full

faith and credit of the United States government; or if they are fully

guaranteed by a U.S. GSE that is operating with capital support or

another form of direct financial assistance received from the U.S.

government that enables repayment of the securities.

Publicly traded debt securities (that are not ABS) issued by GSEs

are included in eligible collateral as long as the issuing GSE is

either operating with capital support or another form of direct

financial assistance received from the U.S. government that enables

full repayment of principal and interest on these securities, or the

CSE determines the securities are ``investment grade'' (as defined by

the appropriate prudential regulator).

Although the Commission received several comments concerning the

proposal's treatment of GSE securities, only modest changes have been

made in the final rule. In the final rule, the Commission recognizes

the unique nature of GSE securities by placing them in a category

separate from both securities issued directly by U.S. government

agencies and those from non-GSE, private sector issuers. However, the

Commission continues to believe the final rule should treat GSE

securities differently depending on whether or not the GSE enjoys

explicit government support, in the interests of both the safety and

soundness of CSE and the stability of the financial system.

GSE debt obligations are not explicitly guaranteed by the full

faith and credit of the U.S. government. Existing law, however,

authorizes the United States Treasury to provide lines of credit, up to

a specified amount, to certain GSEs in the event they face specific

financial difficulties. An act of Congress would be required to provide

adequate support if, for example, a GSE were to experience severe

difficulty in selling its securities

[[Page 667]]

in financial markets because investors doubted its ability to meet its

financial obligations.\262\ The treatment of GSE securities by market

participants as if those securities were nearly equivalent to Treasury

securities in the absence of explicit Treasury support creates a

potential threat to financial market stability, especially if

vulnerabilities arise in markets where one or more GSEs are dominant

participants, as occurred during the summer of 2008.

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

\262\ Congress provided such support with the passage of the

Agricultural Credit Act of 1987 and with the Housing and Economic

Recovery Act of 2008.

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

The final rule's differing treatment of GSE collateral based on

whether or not the GSE has explicit support of the U.S. government

helps address this source of potential financial instability and

recognizes that securities issued by an entity explicitly supported by

the U.S. government might well perform better during a crisis than

those issued by an entity operating without such support. The final

rule adopts the approach that was used in the proposed rule and assigns

the same minimum haircut to both corporate obligations and the debt

securities of GSEs that are operating without capital support or

another form of financial assistance from the U.S. From the

Commission's perspective, this approach facilitates appropriate due

diligence when a party considers the creditworthiness of a GSE security

that it may accept as collateral.

The final rule retains the 2014 proposal's provision excluding any

securities issued by the counterparty or any of its affiliates. To

avoid the compounding of risk, the final rule continues to exclude

securities issued by a bank holding company, a savings and loan holding

company, a foreign bank, a depository institution, a market

intermediary, or any company that would be one of the foregoing if it

were organized under the laws of the United States or any State, or an

affiliate of one of the foregoing institutions. For the same reason,

the Commission has expanded this restriction in the final rule also to

exclude securities issued by a non-bank systemically important

financial institution designated by the Financial Stability Oversight

Council. These entities are financial in nature and, like banks or

market intermediaries, would be expected to come under significant

financial stress in the event of a period of financial stress.

Accordingly, the Commission believes that it is also appropriate to

restrict securities issued by these entities as eligible margin

collateral to ensure that collected collateral is free from significant

sources of this type of risk.

The final rule does not allow a CSE to fulfill the rule's minimum

margin requirements with any assets not included in the eligible

collateral list, which is comprised of assets that should remain liquid

and readily marketable during times of financial stress. The use of

alternative types of collateral to fulfill regulatory margin

requirements would introduce concerns that the changes in the

liquidity, price volatility, or other risks of collateral during a

period of financial stress could exacerbate that stress) and could

undermine efforts to ensure that collateral is subject to low credit,

market, and liquidity risk. Therefore, the final rule limits the

recognition of margin collateral to the aforementioned list of assets.

Counterparties that wished to rely on assets that do not qualify as

eligible collateral under the proposed rule still would be able to

pledge those assets with a lender in a separate arrangement, such as

collateral transformation arrangements, using the cash or other

eligible collateral received from that separate arrangement to meet the

minimum margin requirements.

The Commission wishes to note here that because the value of

noncash collateral and foreign currency may change over time, the

proposal would require a CSE to monitor the value of such collateral

previously collected to satisfy initial margin requirements and, to the

extent the value of such collateral has decreased, to collect

additional collateral with a sufficient value to ensure that all

applicable initial margin requirements remain satisfied on a daily

basis.\263\

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

\263\ Proposed Sec. 23.156(a)(4).

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

Moreover, the Commission notes that the proposal would not restrict

the types of collateral that could be collected or posted to satisfy

margin terms that are bilaterally negotiated above required amounts.

For example, if, notwithstanding the $50 million threshold, a CSE

decided to collect initial margin to protect itself against the credit

risk of a particular counterparty, the CSE could accept any form of

collateral.

2. Variation Margin

a. Proposal

The proposal would require that variation margin be paid in U.S.

dollars, or a currency in which payment obligations under the swap are

required to be settled.\264\ When determining the currency in which

payment obligations under the swap are required to be settled, a CSE

would be required to consider the entirety of the contractual

obligation. For example, in cases where a number of swaps, each

potentially denominated in a different currency, are subject to a

single master agreement that requires all swap cash flows to be settled

in a single currency, such as the Euro, then that currency (Euro) may

be considered the currency in which payment obligations are required to

be settled.

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

\264\ Proposed Sec. 23.156(b).

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

Under this proposed rule, the value of cash paid to satisfy

variation margin requirements is not subject to a haircut.

b. Comments

The Commission received a large number of comments arguing for the

broadening of the list of eligible collateral for variation margin to

include noncash assets.\265\ These commenters generally argued that

limiting variation margin to cash is inconsistent with current market

practice for financial end users, is incompatible with the 2013

international framework agreement, and would drain the liquidity of

these financial end users by forcing them to hold more cash. The same

commenters suggested including securities such as U.S. Treasuries or

other government bonds.

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

\265\ See ICI; JFMC; ISDA; CCRM; CPFM; Sifma; MetLife; GPC;

Sifma-AMG; ABA; JBA; AIMA; MFA; FSR; Freddie; CDEU; FHLB; ACLI;

NERA; and TIAA-CREF. However, commenters representing public

interest groups generally favored the proposed approach.

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

While some commenters representing public interest groups favored

limiting variation margin exchanged between CSEs to cash, some

commenters representing the financial sector expressed concern that

regulators in other key market jurisdictions have not proposed

comparable variation margin restrictions. Commenters also asked the

Commission to consider GSE securities as eligible collateral for

variation margin.

One commenter asked for clarification on whether a haircut applies

if variation margin is paid in the currency in which the swap is

denominated.\266\ Another commenter asked for confirmation that a cash

payment of variation margin would not be subject to any haircuts.\267\

One commenter also proposed that the Commission grant the

counterparties the flexibility to specify a base currency in their

counterparty agreements on a case-by-case basis.\268\

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

\266\ See JBA.

\267\ See ISDA.

\268\ See CPFM.

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

[[Page 668]]

c. Discussion

With respect to variation margin, the proposal would have limited

eligible collateral to immediately available cash funds, denominated

either in U.S. dollars or in the currency in which payment obligations

under the uncleared swap are required to be settled. However, after

reviewing comments from financial end users of derivatives, such as

insurance companies, mutual funds, and pension funds, the Commission

has expanded the list of eligible variation margin for uncleared swaps

between a CSE and financial end users. These commenters generally

argued that limiting variation margin to cash is inconsistent with

current market practice for financial end users; is incompatible with

the 2013 international framework agreement; and would drain the

liquidity of these financial end users by forcing them to hold more

cash. In response to these comments, the final rule permits assets that

are eligible as initial margin to also be eligible as variation margin

for swap transactions between a CSE and financial end user, subject to

the applicable haircuts for each type of eligible collateral.

This change aligns the rule more closely with current market

practice. Commenters indicated many types of financial end users

exchange variation margin with their swap dealers in the form of non-

cash collateral that consists of their investment assets. This practice

permits them to maximize their investment income and minimize margin

costs, even though these assets are subject to valuation haircuts when

posted as variation margin.

The Commission notes however (as described in the 2014 proposal)

that most of the variation margin by total volume continues to be in

the form of cash exchanged between SDs. Therefore, consistent with the

proposal, variation margin exchanged by a CSE with another swap entity

must be in the form of immediately available cash. The Commission

continues to believe that limiting variation margin exchanged between a

CSE and a swap entity to cash is consistent with regulatory and

industry initiatives to improve standardization and efficiency in the

OTC swaps market. Swap entities have access to cash, and its continued

use as variation margin between swap entities will reduce the potential

for disputes over the value of variation margin collateral, due to the

absence of associated market and credit risks. Also, in periods of

severe market stress, the ultimate liquidity of cash variation margin

exchanged between CSEs--which occupy a key position to provide and

maintain trading liquidity in the market for uncleared swaps--should

assist in preserving the financial integrity of that market and the

stability of the U.S. financial system.

However, for reasons discussed below, the Commission is revising

the final rule to expand the denominations of immediately available

cash funds that are eligible. Whereas the proposal only recognized U.S.

dollars or the currency of settlement, the final rule expands the

category to include any major currency.\269\

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

\269\ The final rule defines the following as a ``major

currency'': United States Dollar (USD); Canadian Dollar (CAD); Euro

(EUR); United Kingdom Pound (GBP); Japanese Yen (JPY); Swiss Franc

(CHF); New Zealand Dollar (NZD); Australian Dollar (AUD); Swedish

Kronor (SEK); Danish Kroner (DKK); Norwegian Krone (NOK); and any

other currency as determined by a Prudential Regulator or the

Commission.

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

3. Currency of Settlement, Collateral Valuation, and Haircuts

For those assets whose values may show volatility during times of

stress, the final rule imposes an 8 percent cross-currency haircut, and

standardized prudential supervisory haircuts that vary by asset class.

When determining how much collateral will be necessary to satisfy the

minimum initial margin requirement for a particular transaction, a CSE

must apply the relevant standardized prudential supervisory haircut to

the value of the eligible collateral. The final rule's haircuts guard

against the possibility that the value of non-cash eligible margin

collateral could decline during the period between when a counterparty

defaults and when the CSE closes out that counterparty's swap

positions.

The Commission has revised the cross-currency haircut applicable to

eligible collateral under the final rule. The cross-currency haircut

will apply whenever the eligible collateral posted (as either variation

or initial margin) is denominated in a currency other than the currency

of settlement, except that variation margin in immediately available

cash funds in any major currency is never subject to the haircut. The

amount of the cross-currency haircut remains 8 percent, as it was in

the proposal.

The Commission has decided to eliminate the haircut on variation

margin provided in immediately available cash funds denominated in all

major currencies because the cash funds are liquid at the point of

counterparty default, and there are deep and liquid markets in the

major currencies that allow conversion or hedging to the currency of

settlement or termination at relatively low cost. The Commission is

including in the final rule the cross-currency haircut for all eligible

noncash variation and initial margin collateral, in consideration of

the limitations on market liquidity that can frequently arise on those

assets in periods of market stress.

In response to commenters' request for clarification, the

Commission has revised the final rule text for the cross-currency

haircut to refer to the ``currency of settlement,'' and have eliminated

the corresponding formulation offered for comment in the proposal.\270\

Commenters requested that the Commission provide guidance about the

rule's application to current market practice incorporating contractual

provisions specifying an agreed-upon currency of settlement, transport

currencies and transit, and termination currencies.\271\

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

\270\ The 2014 proposal was formulated as ``the currency in

which payment obligations under the swap are required to be

settled.'' Proposed Rule, Sec. 23.156(a)(1)(iii).

\271\ The guidance the Commission is providing about currencies

of settlement is specific to the application of this final rule on

margin collecting and posting requirements for uncleared swaps.

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

In identifying the ``currency of settlement'' for purposes of this

final rule, the Commission will look to the contractual and operational

practice of the parties in liquidating their periodic settlement

obligations for an uncleared swap in the ordinary course, absent a

default by either party. To provide greater clarity, the Commission has

added a new definition of ``currency of settlement'' to the rule. The

Commission has defined ``currency of settlement'' to mean a currency in

which a party has agreed to discharge payment obligations related to an

uncleared swap or a group of uncleared swaps subject to a master

agreement at the regularly occurring dates on which such payments are

due in the ordinary course.

For eligible non-cash initial margin collateral, the final rule

expressly carves out of the cross-currency haircut assets denominated

in a single termination currency designated as payable to the non-

posting counterparty as part of the eligible master netting agreement.

The final rule accommodates agreements under which each party has a

different termination currency. If the non-posting counterparty has the

option to select among more than one termination currency as part of

the agreed-upon termination and close-out process, the agreement does

not meet the final rule's single termination currency condition.

However, the single termination currency condition does not rule out an

[[Page 669]]

eligible master netting agreement establishing more than one discrete

netting set and establishing separate margining and early termination

provisions for such a select netting set with its own single

termination currency.\272\

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

\272\ As discussed above, the final rule permits discrete

netting sets under a single eligible master netting agreement,

subject to conditions specified in Sec. Sec. 23.152(c) and

23.153(c).

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

As an alternative to the 8 percent cross-currency haircut,

commenters urged the Commission to permit any cross-currency

sensitivity between the swap portfolio credit exposure and the margin

collateral provided against that exposure to be measured as a component

of the margin required to be exchanged under the rule. The Commission

is concerned this alternative presupposes the CSE's certain knowledge,

at the time margin amounts must be determined, of the collateral

denomination to be posted by the counterparty in response to the margin

call and the denomination of future settlement payments. The likelihood

of such information being predictably available to the CSE does not

square with commenters' depiction of the amount of optionality

exercised with respect to these factors by swap market participants in

current market practice.

The 8 percent foreign currency haircut--to the extent it arises in

application of the final rule--is additive to the final rule's

standardized prudential supervisory haircuts that vary by asset class.

These haircuts are unchanged from the proposal. They have been

calibrated to be broadly consistent with valuation changes observed

during periods of financial stress, as noted above.

Although commenters suggested that the Commission permit CSEs to

determine haircuts through the firm's internal models, the Commission

believes the simpler and more transparent approach of the standardized

haircuts is adequate to establish appropriately conservative discounts

on eligible collateral. The final rule permits initial margin

calculations to be performed using an initial margin model in

recognition of the fact that swaps and swap portfolios are

characterized by a number of complex and inter-related risks that

depend on the specifics of the swap and swap portfolio composition and

are difficult to quantify in a simple, transparent and cost-effective

manner. The exercise of establishing appropriate haircuts based on

asset class of eligible collateral across long exposure periods is much

simpler as the risk associated with a position in any particular margin

eligible asset can be reasonably and transparently determined with

readily available data and risk measurement methods that are widely

accepted.

Finally, because the value of collateral may change, a CSE must

monitor the value and quality of collateral previously collected or

posted to satisfy minimum initial margin requirements. If the value of

such collateral has decreased, or if the quality of the collateral has

deteriorated so that it no longer qualifies as eligible collateral, the

CSE must collect or post additional collateral of sufficient value and

quality to ensure that all applicable minimum margin requirements

remain satisfied on a daily basis.

4. Other Collateral

Consistent with the proposal, Sec. 23.156(a)(5) of the final rule

states that CSE may collect or post initial margin that is not required

pursuant to the rule in any form of collateral.

The Dodd-Frank Act provides that in prescribing margin

requirements, the Commission shall permit the use of noncash

collateral, as the Commission determines to be consistent with (1)

preserving the financial integrity of markets trading swaps; and (2)

preserving the stability of the United States financial system. The

Commission believes that the eligibility of certain non-cash

collateral, subject to the conditions and restrictions contained in the

final rule, is consistent with the Dodd-Frank Act, because the use of

such non-cash collateral is consistent with preserving the financial

integrity of markets by trading swaps and preserving the stability of

the United States financial system. The non-cash collateral permitted

is highly liquid and resilient in times of stress and the rule does not

permit collateral exhibiting other significant risk. The use of

different types of eligible collateral pursuant to the requirements of

the final rule should also incrementally increase liquidity in the

financial system.

H. Custodial Arrangements

1. Proposal

Under the proposal, each CSE that posts initial margin with respect

to an uncleared swap would be mandated to require that all funds or

other property that it provided as initial margin be held by one or

more custodians that are not the CSE or the counterparty or are not

affiliates of the CSE or the counterparty. Each CSE that collects

initial margin with respect to an uncleared swap would be mandated to

require that required initial margin be held at one or more custodians

that are not the CSE or the counterparty or are not affiliates of the

CSE or the counterparty.

Each CSE would be required to enter into custodial agreements

containing specified terms. These would include a prohibition on

rehypothecating the margin assets and standards for the substitution of

assets.

The Commission previously adopted rules implementing section 4s(l)

of the Act.\273\ The Commission proposed to amend those rules to

reflect the approach set out in the proposal where segregation of

initial margin would be mandatory under certain circumstances.

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

\273\ Protection of Collateral of Counterparties to Uncleared

Swaps; Treatment of Securities in a Portfolio Margining Account in a

Commodity Broker Bankruptcy, 78 FR 66621 (Nov. 6, 2013).

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

2. Comments

The Commission received several comments regarding custody of

margin collateral.

Several commenters that operate as custodian banks requested

clarification whether the final rule's prohibition against the

custodian rehypothecating, repledging, reusing or otherwise

transferring initial margin funds or property means that a custodian

bank is not permitted to accept cash funds that it holds pursuant to

Sec. 23.157 as a general deposit, and use such funds as it would any

other funds placed on deposit with it.\274\

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

\274\ State Street; SIFMA; ABA, Sifma-AMG.

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

Under Sec. 23.156, eligible collateral for initial margin includes

``immediately available cash funds'' that are denominated in a major

currency or the currency of settlement for the uncleared swap. It is

not practical for cash funds to be held by a custodian as currency that

remains the property of the posting party with a security interest

being granted to its counterparty, e.g., by placing such currency in a

safety deposit box or in the custodian's vault. Rather, the custodian

banks explained in their joint comment letter that, under their current

business practices, when a customer provides them with cash funds to

hold as a custodian, the custodian bank accepts the funds as a general

deposit, with the cash becoming property of the custodian bank and the

customer holding a contractual debt obligation, i.e., a general deposit

account, of the custodian bank.\275\

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

\275\ State Street.

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

When holding cash under the arrangement described by the custodian

bank commenters, a custodian is not a custodian of a discrete asset but

rather a recipient of cash under a contractual arrangement that

establishes a debt

[[Page 670]]

obligation to be paid on demand, i.e., the custodian is acting as a

bank. When such a customer has pledged cash funds as collateral under

the arrangements described by the commenters, the commenter's property

interest is the deposit account liability that the custodian bank owes

to the customer.

Several commenters supported the requirement that initial margin be

held at a third party custodian that was not affiliated with either the

CSE or its counterparty.\276\ Other commenters contended that the

independent third-party custodian requirement is unnecessary and the

Commission should allow for more flexibility in how initial margin is

kept, including permitting the counterparties to negotiate acceptable

custodians, including affiliated custodians.\277\ These commenters

expressed concern about complexities that additional parties bring to

the relationship, as well as reservations about the capacity and

availability of established custodians in the marketplace. One

commenter argued against independent third-party custodians, citing

increased costs arising from the negotiation of custodial contracts and

the cost of developing operational infrastructure, as it is not the

current practice for certain financial entities.\278\

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

\276\ See State Street; ICI (in addition to urging the

Commission to require mandatory segregation for excess margin

amounts); AFR; and Public Citizen.

\277\ See ISDA; Sifma; GPC; Sifma-AMG; ABA; JBA; MFA; JFMC.

\278\ See GPC.

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

Commenters also expressed concerns with meeting the proposal's

requirement that the custodial agreement be legal, valid, binding, and

enforceable under the laws of all relevant jurisdictions, including

asking the Commission to specify that the only relevant jurisdiction is

that of the custodian.\279\ The same commenters urged more flexibility

in custodial agreements to be consistent with current market practice.

Another commenter noted that custodians should not be excluded solely

because they are affiliates of either the CSE or the counterparty since

the number of custodians is limited and many of the largest custodians

are affiliates of CSEs.\280\ The same commenter also argued that CSEs

should not be required to segregate initial margin that is not subject

to mandatory posting or collection.

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

\279\ See BP; Shell; TRM; GPC; ISDA (asking for clarification of

the enforceability requirements, including whether the

enforceability in bankruptcy provisions refer to the bankruptcy of

the CSE or the counterparty); Sifma-AMG (contending that the

Commission instead adopt disclosure instead of enforceability

requirements).

\280\ See ISDA.

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

Several commenters recommended lifting the restriction on

rehypothecation and reuse of initial margin collateral, either

generally or on a conditional basis.\281\ One commenter recommended

that the final rule allow limited rehypothecation that would meet the

requirements of the 2013 international framework if a model for such

rehypothecation could be developed for use by counterparties. The

commenter also noted that other regulators may permit rehypothecation

and, if so, a prohibition would create a competitive disadvantage for

market participants subject to the Commission's rule. Other commenters

supported the restriction on rehypothecation and reuse.\282\ Two

commenters argued that the prohibition on rehypothecation and reuse of

initial margin should not restrict the custodian's ability to accept

cash collateral, as cash collateral would be reinvested in the

custodian's account.\283\

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

\281\ See CPFM; CCMR; IFM; ISDA; Sifma; ABA; CS; and FSR.

\282\ See ICI; Sifma-AMG; GPC; PublicCitizen; and AFR.

\283\ See Sifma-AMG and MetLife.

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

Several commenters requested that the final rule allow greater

flexibility in segregation arrangements. These commenters requested

that the final rule permit arrangements such as title transfer and

charge-back of margin, segregation of margin on the books of the CSE or

within an affiliate if such collateral is insulated from the CSE's

insolvency.

One commenter requested that the final rule clarify that the

required custodian arrangements be tri-party, i.e., entered into

pursuant to an agreement between the CSE, its counterparty, and the

custodian.\284\ The commenter wrote that if a CSE's counterparty is not

a party to the custodial agreement, it would not be in contractual

privity with the unaffiliated custodian, and the CSE essentially would

exercise exclusive control over its counterparty' initial margin.

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

\284\ MFA.

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

3. Discussion

a. Initial Margin

The final rule establishes minimum standards for the safekeeping of

collateral. Section 23.157(a) addresses requirements for when a CSE

posts any collateral other than variation margin. Posting collateral to

a counterparty exposes a CSE to risks in recovering such collateral in

the event of its counterparty's insolvency. To address these risk and

to protect the safety and soundness of the CSE, Sec. 23.157(a)

requires a CSE that posts any collateral required under the final rule

other than variation margin with respect to a uncleared swap to require

that such collateral be held by one or more custodians that are neither

the CSE, its counterparty, or an affiliates of either counterparty.

This requirement applies to initial margin posted by a CSE pursuant to

Sec. 23.152.

Section 23.157(b) addresses requirements for when a CSE collects

initial margin required by Sec. 23.152. Under Sec. 23.157(b), the CSE

shall require that initial margin collateral collected pursuant to

Sec. 23.152 be held at one or more custodians that are neither the

CSE, its counterparty, or an affiliate of either counterparty. As is

the case with initial margin that a CSE posts, the Sec. 23.157(b)

applies only to initial margin that a CSE collects as required by Sec.

23.154, rather than all collateral collected.

For collateral subject to Sec. 23.157(a) or Sec. 23.157(b), Sec.

23.157(c) requires the custodian to act pursuant to a custodial

agreement that is legal, valid, binding, and enforceable under the laws

of all relevant jurisdictions, including in the event of bankruptcy,

insolvency, or similar proceedings. Such a custodial agreement must

prohibit the custodian from rehypothecating, repledging, reusing or

otherwise transferring (through securities lending, repurchase

agreement, reverse repurchase agreement, or other means) the funds or

other property held by the custodian. Cash collateral may be held in a

general deposit account with the custodian if the funds in the account

are used to purchase other forms of eligible collateral, such eligible

noncash collateral is segregated pursuant to Sec. 23.157, and such

purchase takes place within a time period reasonably necessary to

consummate such purchase after the cash collateral is posted as initial

margin.\285\

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

\285\ As described earlier, collateral other than certain forms

of cash is subject to a haircut. As a result, when cash collateral

is used to purchase other forms of eligible collateral, a haircut

will need to be applied.

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

In response to the comments, the Commission notes that the ultimate

purpose of the custody agreement is twofold: (1) That the initial

margin be available to a counterparty when its counterparty defaults

and a loss is realized that exceeds the amount of variation margin that

has been collected as of the time of default; and (2) initial margin be

returned to the posting party after its swap obligations have been

fully discharged.

[[Page 671]]

The jurisdiction of the custodian is certainly one of the relevant

jurisdictions. Thus, a CSE must conduct sufficient legal review to

conclude with a well-founded basis and maintain sufficient written

documentation of that legal review that in the event of a legal

challenge, including one resulting from default or from receivership,

conservatorship, insolvency, liquidation, or similar proceedings of the

custodian, the relevant court or administrative authorities would find

the custodial agreement to be legal, valid, binding, and enforceable

under the law applicable to the custodian. A CSE would also be expected

to establish and maintain written procedures to monitor possible

changes in relevant law and to ensure that the agreement continues to

be legal, valid, binding, and enforceable under that law.

The jurisdiction of a CSE's counterparty, however, is also a

relevant jurisdiction. The CSE would have to ensure that if a

counterparty were to become insolvent, or otherwise be placed under the

control of a resolution authority, that there would not be a legal

basis to set aside the custodial arrangement, allowing the resolution

authority to reclaim for the estate assets that the counterparty had

placed with the custodian. Thus, the CSE would have to conduct a

sufficient legal review to conclude with a well-founded basis that in

the event of a legal challenge, including one resulting from default or

from receivership, conservatorship, insolvency, liquidation, or similar

proceedings of the counterparty, the relevant court or administrative

authorities would find the custodial agreement to be legal, valid,

binding, and enforceable by the CSE under the law applicable to the

counterparty. For this reason, the Commission declines to follow the

commenters' request that the Commission clarify that the only relevant

jurisdiction is that of the custodian.

Under Sec. 23.156, eligible collateral for initial margin includes

``immediately available cash funds'' that are denominated in a major

currency or the currency of settlement for the uncleared swap. However,

permitting initial margin collateral to be held in the form of a

deposit liability of the custodian bank is inconsistent with the final

rule's prohibition against rehypothecation of such collateral. In

addition, employing a deposit liability of the custodian bank--or

another depository institution--is inconsistent with the final rule's

prohibition against use of obligations issued by a financial firm.

On the other hand, as a practical matter, it is very difficult to

eliminate cash entirely. For example, the final rule's T+1 margin

collection requirement means that it will often be necessary to use

cash to cover the first days of a margin call. In addition, income

generated by non-cash assets in custody will be paid in cash.

Collateral reinvestments involving replacement of one category of non-

cash asset with another category of non-cash asset may create cash

balances between settlements. While the parties all have strong

business incentives to manage and limit these cash fund balances,

eliminating them entirely would result in a number of inefficiencies.

To address these concerns, the Commission has revised the final

rule to allow cash funds that are placed with a custodian bank in

return for a general deposit obligation to serve as eligible initial

margin collateral only in specified circumstances. However, the rule

requires the posting party to direct the custodian to reinvest the

deposited funds into eligible non-cash collateral of some type, or the

posting party to deliver eligible non-cash collateral to substitute for

the deposited funds. As noted above, the appropriate haircut must be

applied. This reinvestment must occur within a reasonable period of

time after the initial placement of cash collateral to satisfy the

initial margin requirement, and the amount of eligible collateral must

be sufficient to cover the initial margin amount in light of the

applicable haircut on the non-cash collateral pursuant to the final

rule.

CSEs must appropriately oversee their own initial margin collateral

posting and that of their counterparties in order to constrain the use

of cash funds, and achieve efficient reinvestment of cash funds in

excess of operational and liquidity needs into eligible margin

securities. In connection with implementing the final rule, CSEs should

ensure these procedures are adequate to assess the levels of cash

necessary under the circumstances of each counterparty relationship,

and to ensure the custodian will be directed to reinvest the remainder

in non-cash collateral promptly, or that the posting party will

substitute non-cash assets promptly, as applicable.

Section 23.157(c)(2) provides that, notwithstanding this

prohibition on rehypothecating, repledging, reusing or otherwise

transferring the funds or property held by the custodian, the posting

party may substitute or direct any reinvestment of collateral,

including, under certain conditions, collateral collected pursuant to

Sec. 23.152(a) or posted pursuant to Sec. 23.152(b).

In particular, for initial margin collected pursuant to Sec.

23.152(a) or posted pursuant to Sec. 23.152(b), the posting party may

substitute only funds or other property that meet the requirements for

eligible collateral under Sec. 23.156 and where the amount net of

applicable haircuts described in Sec. 23.156 would be sufficient to

meet the initial margin requirements of Sec. 23.152. The posting party

also may direct the custodian to reinvest funds only in assets that

would qualify as eligible collateral under Sec. 23.156 and ensure that

the amount net of applicable haircuts described in Sec. 23.156 would

be sufficient to meet the initial margin requirements of Sec. 23.152.

In the cases of both substitution and reinvestment, the final rule

requires the CSE to ensure that the value of eligible collateral net of

haircuts that is collected or posted remains equal to or above the

minimum requirements.

In the cases of both substitution and reinvestment, the final rule

requires the posting party to ensure that the value of eligible

collateral net of haircuts remains equal to or above the minimum

requirements contained in Sec. 23.152. In addition, the restrictions

on the substitution of collateral described above do not apply to cases

where a CSE has posted or collected more initial margin than is

required under Sec. 23.152. In such cases, the initial margin that has

been posted or collected in satisfaction of Sec. 23.152 is subject to

the restrictions on collateral substitution but any additional

collateral that has been posted or collected is not subject to the

restrictions on collateral substitution and, as noted above, is not

subject to any of the requirements of Sec. 23.157.

The Commission is adopting the segregation requirement in this rule

to help ensure the safety and soundness of CSEs subject to the rule and

to offset the greater risk to the financial system arising from the use

of uncleared swaps. The Commission has retained the requirement that

the custodian be unaffiliated with either the CSE or its counterparty.

In adopting this requirement, the Commission is more concerned that

customer confidence in a particular CSE could be correlated with

customer confidence in the affiliated custodian, especially in times of

high market stress, whereas the use of independent custodians should

offer counterparties a greater measure of confidence. Thus, the

Commission believes that it is necessary for the safety and soundness

of CSE and to minimize risk to the financial system that collateral be

held by a custodian that is neither a counterparty to the swap nor an

affiliate of either

[[Page 672]]

counterparty. This arrangement protects both counterparties from the

risk of the initial margin being held as part of one counterparty's

estate (or its affiliate's estate) in the event of failure, and

therefore not available to the other counterparty.

The Commission does not believe that the alternative arrangements

suggested by the commenters (e.g., arrangements involving title

transfer and charge back of margin) adequately ensure the safety and

soundness of the CSE nor adequately offset the risk to the financial

system arising from the use of uncleared swaps. In addition, the

Commission believes the specific structure of the custody arrangements

required by the rule are better left, on balance, to negotiations of

the parties, in accordance with the specific concerns of those parties.

Tri-party custody may be an optimal arrangement for some firms, while

for others, it has not typically been sought under established market

practice.

Further, the Commission is declining to revise the proposed

regulation to accommodate rehypothecation pursuant to some future model

that may be developed. Commenters who argued for allowing limited

rehypothecation did not propose a specific model, and hence the

Commission is not inclined to permit rehypothecation at this time due

to hypothetical scenarios that may or may not develop in the future.

b. Variation Margin

Section 23.157 does not require collateral that is collected or

posted as variation margin to be held by a third party custodian or

subject such collateral to restrictions on rehypothecation, repledging,

or reuse. So, subject to negotiations between the counterparties, a CSE

that is a depository institution could collect cash posted to it in

satisfaction of section 23.153 from a counterparty without establishing

a separate account for the counterparty. The cash funds would be the

property of the CSE, which would be permitted to reuse such funds

without restriction. Similarly, a CSE's counterparty would not be

required to segregate cash funds posted as variation margin by the CSE.

The same is true with respect to eligible non-cash collateral exchanged

as variation margin with a financial end user pursuant to Sec. 23.156;

the segregation and custody requirements of Sec. 23.157 do not apply.

Section 23.156(b) of the final rule permits eligible non-cash

collateral to be posted as variation margin for swaps between a CSE and

a financial end user. In such circumstances, a CSE or its financial end

user counterparty could reach an agreement under which either party

could itself hold non-cash collateral posted by the other and such non-

cash collateral could be rehypothecated, repledged, or reused.

The final rules in this area are consistent with those of the

Prudential Regulators.

I. Documentation

1. Proposal

The proposal sets forth documentation requirements for CSEs.\286\

For uncleared swaps between a CSE and a counterparty that is a swap

entity or a financial end user, the documentation would be required to

provide the CSE with the contractual right and obligation to exchange

initial margin and variation margin in such amounts, in such form, and

under such circumstances as are required by Sec. 23.150 through Sec.

23.161 of this part. For uncleared swaps between a CSE and a non-

financial end user, the documentation would be required to specify

whether initial and/or variation margin will be exchanged and, if so,

to include the information set forth in the rule. That information

would include the methodology and data sources to be used to value

positions and to calculate initial margin and variation margin, dispute

resolution procedures, and any margin thresholds.

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

\286\ Proposed Sec. 23.158.

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

The Commission proposal contains a cross-reference to an existing

Commission rule which already imposes documentation requirements on SDs

and MSPs.\287\ Consistent with that rule, the proposal would apply

documentation requirements not only to covered counterparties but also

to non-financial end users. Having comprehensive documentation in

advance concerning these matters would allow each party to a swap to

manage its risks more effectively throughout the life of the swap and

to avoid disputes regarding issues such as valuation during times of

financial turmoil. This would benefit not only the CSE but the non-

financial end user as well.

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

\287\ Commission Regulation 23.504.

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

2. Comments

The Commission received several comments regarding documentation.

Commenters sought clarification over aspects of the documentation

requirement.\288\ One commenter contended that the documentation

standards are too burdensome since initial margin methodologies may be

proprietary and complex while the other Commission regulations already

address documentation standards for valuations.\289\ Another commenter

argued that it would be difficult to comply with the documentation

standards with respect to valuations, and noting that valuation

standards are already addressed in other Commission regulations.\290\

Commenters remarked that non-financial end users should not be subject

to the documentation requirement.\291\

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

\288\ See Sifma (the Commission should clarify the dispute

resolution and documentation provisions to indicate that (i) the a

CSE would not violate its obligations if it releases margin

collateral to a counterparty at the conclusion of a dispute

mechanism consistent with the U.S. implementation of Basel; and (ii)

the parties would not be required to lock in dispute valuation

methods); JBA (seeking clarification on the level of documentation

and recommending that the documentation required take into account

the composition and size of derivative portfolios); ACLI

(documentation requirements should be clarified and harmonized with

the requirements from the Prudential Regulators and the SEC); and

FHLB (the final rule should require CSEs to have documentation that

provides for resolution of disputes regarding the calculation of

variation and initial margin and the value of collateral collected

or posted).

\289\ See ISDA.

\290\ See Freddie.

\291\ See CDEU (non-financial end users are already subject to

documentation requirements in other Commission regulations); and

COPE (noting that it is market practice for non-financial end users

to use ISDAs); BP; Joint Associations.

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

3. Discussion

The Commission is adopting the documentation requirements

substantially as proposed, with one exception for non-financial end

users. The Commission has removed the documentation requirements with

respect to non-financial end users. To the extent that other aspects of

the Commission's regulations address similar requirements, the

Commission believes that counterparties should be well-positioned to

comply with the documentation requirements and should reduce any

additional burdens in implementing this requirement.

Under the final rule, the documentation must grant the CSE the

contractual right to collect and to impose the obligation to post

initial and variation margin in such amounts, in such form, and under

such circumstances as are required by the rule. The documentation must

also specify the methods, procedures, rules, and inputs for determining

the value of each uncleared swap and the procedures by which any

disputes concerning the valuation of uncleared swaps may be resolved.

Finally, the documentation must also describe the methods, procedures,

rules, and inputs used to calculate initial and variation

[[Page 673]]

margin for uncleared swaps entered into between the CSE and the

counterparty.

J. Inter-Affiliate Trades

1. Proposal

The proposal effectively would have required two-way initial margin

and variation margin for swaps between CSEs and affiliates that were

swap entities or financial end users. The Prudential Regulators'

proposal set forth the same requirements.

2. Comments

Many commenters urged the Commission to exclude swaps between

affiliates from margin requirements.\292\ Commenters generally argued

that inter-affiliate swaps are already centrally risk managed and

requiring margin on inter-affiliate trades could discourage effective

risk management \293\ and the current practice of exchanging variation

margin should be sufficient to mitigate the risk posed by inter-

affiliate trades.\294\ They argued that requiring margin generally, and

initial margin in particular, on inter-affiliate swaps was unnecessary

for systemic stability. They further argued that imposing margin

requirements on inter-affiliate swaps would impose significant

costs,\295\ tie up liquidity,\296\ be inconsistent with the approach

taken in a number of other jurisdictions,\297\ and introduce group-wide

third-party credit risk.\298\ Sifma also argued that inter-affiliate

swaps should not count towards the margin thresholds and a covered swap

entity's material swaps exposure. Another commenter suggested that the

Commission conduct a study prior to imposing margin on inter-affiliate

trades.\299\

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

\292\ See ISDA, JFMC; Sifma, ABA, JBA, CS, Shell TRM (if inter-

affiliate transactions are subject to margin requirements, the

Commission should define the term ``affiliate'' consistently with

other Commission regulations); BP; and FSR. Sifma suggested

excluding inter-affiliate swaps from margin requirements if the

swaps are subject to a group-wide consolidated risk management

program and the exchange of variation margin, and the CSE is part of

a group that is subject to consolidated capital requirements

consistent with Basel. JBA argued that the risks posed by inter-

affiliate trades are generally lower and pointed out the

difficulties associated with entering into a CSA with all covered

counterparties within a limited timeframe.

\293\ See Sifma, JBA, ABA, TCH, and CS.

\294\ See ISDA, Sifma, and CS.

\295\ See ISDA, Sifma, ABA, and TCH.

\296\ See ISDA, ABA, TCH, and CS.

\297\ See ISDA.

\298\ See ISDA, ABA, TCH, and CS.

\299\ See FSR.

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

Commenters also suggested alternatives to a full two-way collect-

and-post regime for initial margin for affiliate swaps. For example,

some commenters proposed that instead of each CSE posting and

collecting segregated initial margin to and from its affiliate, the CSE

would only collect from its affiliate (subject to a wholly owned

subsidiary exemption and a de minimis exemption) and the CSE would be

permitted to segregate the initial margin within its group, so as to

prevent undue third-party custodial risk.\300\ Some suggested a CSE

would only collect from an affiliate that is not subject to margin and

capital requirements.\301\ These commenters further argued that certain

highly regulated affiliates like U.S. bank holding companies should

benefit from an exception to initial margin requirements.\302\ Some

commenters also suggested an alternative where the Commission would

permit the common parent of an affiliate pair to post a single amount

of segregated initial margin in which each affiliate would have a

security interest.\303\

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

\300\ See The Clearing House.

\301\ Id.

\302\ See ISDA.

\303\ See The Clearing House.

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

3. Discussion

The Commission has determined a CSE shall not be required to

collect initial margin from a margin affiliate provided that the CSE

meets the following conditions: (i) The swaps are subject to a

centralized risk management program that is reasonably designed to

monitor and to manage the risks associated with the inter-affiliate

swaps; and (ii) the CSE exchanges variation margin with the margin

affiliate. These two conditions are consistent with recommendations

from commenters. They are similar to conditions that were previously

established by the Commission when providing an exemption from the

clearing requirement for certain inter-affiliate swaps.\304\

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

\304\ See Sec. 50.52.

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

The Commission has determined, however, to require CSEs to collect

initial margin from non-U.S. affiliates that are financial end users

that are not subject to comparable initial margin collection

requirements on their own outward-facing swaps with financial end

users. For many of the reasons listed by the commenters, as well as in

light of the treatment of inter-affiliate swaps by the prudential

regulators, the Commission has determined not to otherwise require CSEs

to collect initial margin from, or to post initial margin to,

affiliates that are CSEs or financial end users. (As discussed below,

pursuant to the Prudential Regulators' rules, CSEs would be required to

post initial margin to affiliates that are swap entities subject to

those rules.)

The Commission first notes that the Prudential Regulators decided

not to impose a general two-way initial margin requirement. Instead,

the Prudential Regulators have required swap entities subject to their

rules to collect initial margin from affiliates that are swap entities

or financial end users. Thus, if a CSE enters into a swap with a swap

entity subject to the Prudential Regulators' rules, the CSE will post

initial margin but will not collect initial margin for the transaction.

The Commission considered the comments that inter-affiliate swaps

do not increase the overall risk profile or leverage of the group. The

Commission further considered the fact that inter-affiliate two-way

margin would substantially increase the overall amount of margin being

collected, and thus the cost of swap transactions generally, without a

commensurate benefit to risk reduction to the overall group. The

Commission notes that considering the risk exposure of the overall

group of which a CSE is a part is consistent with the approach taken in

its margin rules (and the Prudential Regulators' rules) in other key

areas--as in the calculation of material swaps exposure to determine

overall swaps exposure and the calculation of the initial margin

threshold amount to determine whether there is an obligation to collect

or post initial margin.

Second, the Commission notes that the treatment of inter-affiliate

transactions is related to what the Commission did when it adopted an

exemption to the clearing mandate for inter-affiliate transactions in

2013. In that rulemaking, it considered, but decided against, requiring

the exchange of initial margin or variation margin as a condition to

using the exemption. It stated that such requirements ``would limit the

ability of U.S. companies to efficiently allocate risk among affiliates

and manage risk centrally.'' \305\

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

\305\ Clearing Exemption for Swaps between Certain Affiliated

Entities, 78 FR 21750 at 21760 (April 11, 2013).

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

Third, the Commission considered the decision of the Prudential

Regulators' not to impose two-way initial margin and impose a collect

only obligation instead. If the Commission were to impose two-way

margin, it would be inconsistent with the Prudential Regulators' rule.

The Commission further considered whether to impose a collect-only

obligation. However, this would result in a two-way requirement in

transactions between a swap dealer subject to the Prudential

Regulators'

[[Page 674]]

rules and a CSE, a result which the Prudential Regulators determined

not to impose. In addition, the Commission considered the difference in

mission and overall regulatory framework between the Prudential

Regulators and the Commission. For example, the Commission notes that

the imposition of a collect only initial margin requirement on swap

entities subject to the Prudential Regulators' rules is similar to

existing requirements of law, in that banks are subject to significant

regulatory restrictions and requirements on inter-affiliate

transactions under Sections 23A and 23B of the Federal Reserve Act. The

same cannot be said of a collect-only requirement imposed on CSEs,

since the restrictions under Sections 23A and 23B do not apply to

nonbank affiliates such as CSEs.

For purposes of symmetry, however, the Commission has determined to

require a CSE that enters into an inter-affiliate swap with a swap

entity that is subject to the rules of the Prudential Regulators to

post initial margin with that swap entity in an amount equal to the

amount that the swap entity is required to collect under the rules of

the Prudential Regulators. This provision imposes no additional burden

on the CSE because the other swap entity would be required to collect

the initial margin in any case. This provision simply means that a CSE

will be required under CFTC rules to post initial margin to the extent

that the other swap entity is required under Prudential Regulator rules

to collect it.

The Commission also considered its objective of harmonizing its

margin rules as much as possible with international standards. The BCBS

standards, for example, state that the exchange of initial and

variation margin by affiliated parties ``is not customary'' and that

initial margin in particular ``would likely create additional liquidity

demands.'' \306\ The Commission recognized that requiring the posting

and collection of initial margin for inter-affiliate swaps would be

likely to put CSEs at a competitive disadvantage to firms in other

jurisdictions. The Commission understands that many authorities, such

as those in Europe and Japan, are not expected to require initial

margin for inter-affiliate swaps. These savings could enable such firms

to offer swaps to third parties on better terms than firms that incur

the costs of inter-affiliate initial margin.

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

\306\ BCBS IOSCO Report at 21.

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

The Commission has determined, however, to require CSEs to exchange

variation margin with affiliates that are swap entities or financial

end users, as is also required under the Prudential Regulators' rules.

Marking open positions to market each day and requiring the posting or

collection of variation margin will reduce the risks of inter-affiliate

swaps.

As noted above, CSEs will be required to collect initial margin

from non-U.S. affiliates that are not subject to comparable initial

margin collection requirements on their own outward-facing swaps with

financial entities. These affiliates generally would include entities

located in jurisdictions for which substituted compliance has not been

granted with regard to the collection of initial margin. This

requirement would also apply in the case of a series of transactions

involving, directly or indirectly, an affiliate that is not subject to

comparable initial margin collection requirements. That is, even if the

CSE is only in privity of contract with an affiliate who is subject to

such requirements, but that affiliate, directly or indirectly, is

transacting with another affiliate who is not subject to such

requirements, the CSE would be required to collect initial margin.

This provision is an important anti-evasion measure. It is designed

to prevent the potential use of affiliates to avoid collecting initial

margin from third parties. For example, suppose that an unregistered

non-U.S. affiliate of a CSE enters into a swap with a financial end

user and does not collect initial margin. Suppose further that the

affiliate then enters into a swap with the CSE. Effectively, the risk

of the swap with the third party would have been passed to the CSE

without any initial margin. The rule would require this affiliate to

post initial margin with the CSE in such cases. The rule would further

require that the CSE collect initial margin even if the affiliate

routed the trade through one or more other affiliates.

K. Implementation Schedule

1. Proposal

The proposed rules set out an implementation schedule for initial

margin ranging from December 1, 2015 to December 1, 2019.\307\ This

extended schedule was designed to give market participants ample time

to develop the systems and procedures necessary to exchange margin and

to make arrangements to have sufficient assets available for margin

purposes. The requirements would be phased-in in steps from the largest

covered parties to the smallest.

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

\307\ Proposed Sec. 23.160.

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

Variation margin requirements would be implemented on the scheduled

first date.

2. Comments

Commenters generally stated that, to the extent practicable, there

should be international harmonization of implementation dates for

margin and capital requirements.\308\ While one commenter supported the

proposed compliance date schedules set out in the 2014 proposal,\309\ a

number of commenters argued that compliance with the final rule should

be delayed for 18 months to 2 years in order to allow for operational

changes and the need for additional or revised documentation that will

be required for CSEs to comply with the rule.\310\

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

\308\ See Sifma; ABA; Australian Banks.

\309\ See CME.

\310\ See JFMC; GPC; JBA; ISDA; Sifma-AMG; JBA; CPFM; and

Freddie. ISDA further argues that financial end users that fall

below the implementation schedule threshold for each relevant time

period should not be subject to initial margin.

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

With respect to phasing-in the implementation of the initial margin

requirements, a commenter stated that the phase-in provisions should be

revised to apply only to uncleared swaps between CSEs.\311\ The

commenter further stated that non-CSEs should not be required to comply

with the initial margin requirements until December 2019. The

Commission also received a comment stating that the implementation of

the compliance date schedule should not coincide with code freezes and

that margin requirements for over-the-counter derivatives should be

taken into consideration when finalizing this rule.\312\ Still another

commenter argued for a delay in implementation to allow the use of the

latest developments from BCBS regarding margin calculation best

practices and the development of a universal model.\313\

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

\311\ See GPC.

\312\ See Sifma.

\313\ See CS.

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

Several commenters urged that the compliance date for variation

margin requirements be phased in, in a manner similar to the compliance

dates for the initial margin requirements.\314\ These commenters

argued, among other things, that the phase-in of the variation margin

requirements would allow CSEs the time to re-document all necessary

swap contracts at one time. Commenters stated that variation margin

requirements should be phased in based

[[Page 675]]

on decreasing notional amount thresholds over a two-year period

commencing upon the latter of the publication of the margin rules for

over-the-counter derivatives in the U.S., the EU and Japan or the

publication of the Commission's comparability determinations with

respect to the EU and Japan.\315\

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

\314\ See ACLI; MefLife; ICI; Sifma; Sifma-AMG; JFMC; GPC; JBA;

ISDA; ABA; Freddie; CDEU; and FHLB.

\315\ See Sifma; ABA.

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

Certain commenters also requested that the Commission extend the

meaning of swaps entered into prior to the compliance date to include

(1) swaps entered into prior to the applicable compliance date (legacy

swaps) that are amended in a non-material manner; (2) novations; and

(3) new derivatives that result from portfolio compression of legacy

derivatives.\316\ These commenters urged that if a general exclusion

for novated legacy swaps is not provided, there should be an exclusion

for novated swaps between affiliates resulting from organizational

restructuring or regulatory requirements such as the swaps push-out

rule.

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

\316\ See CS; ISDA.

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

One commenter urged that, during the phase-in period, only entities

whose swap volume currently exceeds the applicable threshold should be

subject to the margin requirements.\317\ The commenter stated that, if

the swap activity of either party to a swap declines below the

applicable threshold, that party should cease being subject to the

initial margin requirements until such time as it exceeds the

applicable threshold. Another commenter asked how the margin

requirements would apply in the event of a change in status of the

counterparty.\318\ One commenter requested that the Commission revise

the phase-in schedule so that entities that are not CSEs would be

subject to the margin requirements in December 2019.\319\

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

\317\ See ISDA.

\318\ See ISDA.

\319\ See GPC (noting issues with providing confidential

position information regarding its uncleared swaps to CSEs).

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

3. Discussion

a. Initial Margin

Under the proposal, the implementation of both initial and

variation margin requirements would have started on December 1, 2015.

With respect to initial margin requirements, the requirements would

have been phased-in between December 1, 2015 and December 1, 2019.

Variation margin requirements for all CSE with respect to covered swaps

with any counterparty would have been effective as of December 1, 2015.

This proposed set of compliance dates was consistent with those set

forth in the 2013 international framework.

On March 18, 2015, the BCBS and IOSCO issued a press release

announcing that the implementation of the 2013 international framework

would be delayed by nine months. This announcement was in response to

the fact that to date in March 2015, no jurisdiction had yet finalized

rules for margin requirements for non-centrally cleared derivatives.

Accordingly, the final rule has been revised to delay the

implementation of both initial and variation margin requirements by

nine months from the compliance schedule set forth in the proposal.

This delay results in a uniform approach with respect to compliance

dates across the final rule and the international framework.

The changes to the proposed compliance dates should help address

concerns raised by commenters. The Commission agrees that international

harmonization of margin and capital requirements are prudent. In light

of the concerns raised by the commenters and the delay of the

implementation of the 2013 international framework, the Commission has

incorporated into the final rule provisions reflecting the

implementation schedule for the 2013 international framework that was

recently set out by the BCBS and IOSCO.

The final rule adopts a phase-in arrangement for variation margin

requirements that is different from the proposal. The Commission

believes that a phase-in of variation margin requirements similar to

the phase-in of initial margin requirements is not necessary because

the collection of daily variation margin is currently an industry best

practice and will not require many changes in current swaps business

operations for CSE covered swaps entities. However, the Commission has

revised the 2014 proposal to include the phase-in of compliance dates

for variation margin as set forth above to align with the dates

suggested by the BCBS and IOSCO on March 18, 2015.

The Commission further believes that classifying new swap

transactions as swaps entered into prior to the compliance date could

create significant incentives to engage in amendments and novations for

the purpose of evading the margin requirements. Moreover, limiting the

extension to ``material'' amendments or ``legitimate'' novations is

difficult to do within the final rule as the specific motivation for an

amendment or novation is generally not observable. Finally, the

Commission believes that classifying some new swap transactions and

transactions entered into prior to the compliance date would make the

process of identifying those swaps to which the rule applies overly

complex and non-transparent. Accordingly, the Commission has elected

not to extend the meaning of swaps entered into prior to the compliance

date in this manner requested by some commenters at this time. The

Commission recognizes that questions have arisen about the effect of

compression exercises which may have implications in a variety of

contexts. The Commission is open to further discussion before

implementation about the best way to address these questions.

For purposes of initial margin, as reflected in the table below,

the compliance dates range from September 1, 2016, to September 1,

2020, depending on the average daily aggregate notional amount of

uncleared swaps, uncleared security-based swaps, foreign exchange

forwards and foreign exchange swaps (``covered swaps'') of the CSE and

its counterparty (accounting for their respective affiliates) for

March, April and May of that year.\320\

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

\320\ ``Foreign exchange forward'' and ``foreign exchange swap''

are defined to mean any foreign exchange forward, as that term is

defined in section 1a(24) of the Commodity Exchange Act (7 U.S.C.

1a(24)), and foreign exchange swap, as that term is defined in

section 1a(25) of the Commodity Exchange Act (7 U.S.C. 1a(25)).

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

Compliance date Initial margin requirements

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

September 1, 2016................. Initial margin where both the CSE

combined with all its affiliates

and its counterparty combined with

all its affiliates have an average

daily aggregate notional amount of

covered swaps for March, April and

May of 2016 that exceeds $3

trillion.

September 1, 2017................. Initial margin where both the CSE

combined with all its affiliates

and its counterparty combined with

all its affiliates have an average

daily aggregate notional amount of

covered swaps for March, April and

May of 2017 that exceeds $2.25

trillion.

[[Page 676]]

 

September 1, 2018................. Initial margin where both the CSE

combined with all its affiliates

and its counterparty combined with

all its affiliates have an average

daily aggregate notional amount of

covered swaps for March, April and

May of 2018 that exceeds $1.5

trillion.

September 1, 2019................. Initial margin where both the CSE

combined with all its affiliates

and its counterparty combined with

all its affiliates have an average

daily aggregate notional amount of

covered swaps for March, April and

May of 2019 that that exceeds $0.75

trillion.

September 1, 2020................. Initial margin for any other CSE

with respect to covered swaps with

any other covered counterparty.

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

In calculating the amount of covered swaps as set forth in the

table above, the final rule provides that a CSE shall count the average

daily aggregate notional amount of an uncleared swap, an uncleared

security-based swap, a foreign exchange forward or a foreign exchange

swap between the entity and an affiliate only one time, and shall not

count a swap that is exempt from the Commission's margin requirements

under Sec. 23.150(b).\321\ These provisions were not included in the

proposed rule. The purpose of the first provision in the final rule is

to prevent double counting of covered swaps between affiliates, a

concern raised by number of commenters, which could artificially

increase a CSE's average daily aggregate notional amount. The purpose

of the second provision is to ensure that swaps that have been exempted

from the margin requirements are fully exempted and do not influence

other aspects of the rule such as whether an entity maintains a

material swaps exposure.

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

\321\ See Sec. 23.150(b) of the final rule.

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

The Commission expects that CSEs likely will need to make a number

of operational and legal changes to their current swaps business

operations in order to achieve compliance with the provisions of the

final rule relating to the initial margin requirements, including

potential changes to internal risk management and other systems,

trading documentation, collateral arrangements, and operational

technology and infrastructure. In addition, the Commission expects that

CSEs that wish to calculate initial margin using an initial margin

model will need sufficient time to develop such models and obtain

regulatory approval for their use. Accordingly, the compliance dates

have been structured to ensure that the largest and most sophisticated

CSEs and counterparties that present the greatest potential risk to the

financial system comply with the requirements first. These swap market

participants should be able to make the required operational and legal

changes more rapidly and easily than smaller entities engaging in swaps

less frequently and pose less risk to the financial system.

b. Variation Margin

For purposes of variation margin, the compliance dates are

September 1, 2016 and March 1, 2017. Theses compliance dates also

depend on the average daily aggregate notional amount of covered swaps

of the CSE combined with its affiliates and its counterparties

(combined with that counterparty's affiliates) for March, April and May

of that year (the ``calculation period'').\322\ Thus, a given CSE may

have multiple compliance dates depending on both the combined average

daily aggregate notional amount of covered swaps of the CSE and its

affiliates during the calculation period as well as the combined

average daily notional amount of covered swaps of its counterparties

and that counterparty's affiliates during the calculation period.

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

\322\ See Regulation 23.161.

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

Compliance date Initial margin requirements

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

September 1, 2016................. Variation margin where both the CSE

combined with all its affiliates

and its counterparty combined with

all its affiliates have an average

daily aggregate notional amount of

covered swaps for March, April and

May of 2016 that exceeds $3

trillion.

March 1, 2017..................... Variation margin for any other CSE

with respect to covered swaps with

any other counterparty that is a

swap entity or financial end user.

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

Calculating the amount of covered swaps set forth in the table

above for the purposes of determining variation margin is done in the

same manner as calculating the amount of covered swaps for purposes of

determining initial margin.\323\ A CSE shall count the average daily

aggregate notional amount of a uncleared swap, an uncleared security-

based swap, a foreign exchange forward or a foreign exchange swap

between the entity and an affiliate only one time, and shall not count

a swap that is exempt from the Commission's margin requirements under

Sec. 23.150(b).

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

\323\ As a specific example of the calculation, consider a U.S.

based financial end user (together with its affiliates) with a

portfolio consisting of two uncleared swaps (e.g., an equity swap,

an interest rate swap) and one uncleared security-based credit swap.

Suppose that the notional value of each swap is exactly $1 trillion

on each business day of March, April and May of 2016. Furthermore,

suppose that a foreign exchange forward is added to the entity's

portfolio at the end of the day on April 29, 2016, and that its

notional value is $1 trillion on every business day of May 2016. On

each business day of March and April of 2016, the aggregate notional

amount of uncleared swaps, security-based swaps and foreign exchange

forwards and swaps is $3 trillion. Beginning on May 1, 2016, the

aggregate notional amount of uncleared swaps, security-based swaps

and foreign exchange forwards and swaps is $4 trillion. The daily

average aggregate notional value for March, April and May 2016 is

then (23 x $3 trillion + 21 x $3 trillion + 21 x $4 trillion)/(23 +

21 + 21) = $3.3 trillion, in which case this entity would have a

gross notional exposure that would result in its compliance date

beginning on September 1, 2016.

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

c. Changes in Material Swaps Exposure

Once a CSE and its counterparty must comply with the margin

requirements for uncleared swaps based on the compliance dates set

forth in Sec. 23.161, the CSE and its counterparty shall remain

subject to the margin requirements from that point forward. For

example, September 1, 2017 is the relevant compliance date where both

the CSE combined with all its affiliates and its counterparty combined

with all its affiliates have an average aggregate daily notional amount

of covered swaps that exceeds $2.25 trillion. If the notional amount of

the swap activity for the CSE or the counterparty drops below that

threshold amount of covered swaps in subsequent years, their swaps

would nonetheless remain subject to the margin requirements. On

September 1, 2020, any CSE that did not have an earlier compliance date

becomes subject

[[Page 677]]

to the initial margin requirements with respect to uncleared swaps.

The Commission has declined to make a change in the final rule that

would allow a counterparty whose swap activity declines below the

applicable threshold set forth in Sec. 23.161 to cease being subject

to margin requirements. The Commission believes that allowing entities

coverage status to change over time results in additional complexity

with little benefit since all entities will be subject to the rule as

of September 1, 2020. Accordingly, allowing an entity's coverage status

to fluctuate would only be consequential for a limited period of time.

d. Changes in Counterparty Status

The Commission has added Sec. 23.161(c) to the final rule to

clarify the applicability of the margin requirements in the event a CSE

's counterparty changes its status (for example, if the counterparty is

a financial end user without material swaps exposure and becomes a

financial end user without material swaps exposure). Under Sec.

23.161(c), in the event a counterparty changes its status such that an

uncleared swap with that counterparty becomes subject to stricter

margin requirements, then the CSE shall comply with the stricter margin

requirements for any uncleared swap entered into with that counterparty

after the counterparty changes its status.

Section 23.161(c) states that in the event a counterparty changes

its status such that a uncleared swap with that counterparty becomes

subject to less strict margin requirements (such as when a counterparty

changes status from a financial end user with material swaps exposure

to a financial end user without material swaps exposure), then the CSE

may comply with the less strict margin requirements for any swap

entered into with that counterparty after the counterparty changes its

status as well as for any outstanding uncleared swap entered into after

the applicable compliance date and before the counterparty changed its

status. As a specific example, if a CSE's counterparty transitioned

from a financial end user with material swaps exposure to a financial

end user without material swaps exposure, initial margin that had been

previously collected could be returned if agreed by both parties since

the rule would not require an exchange of initial margin on pre-

existing or future uncleared swaps.

e. Applicable EMNA

A CSE may enter into swaps on or after the final rule's compliance

date pursuant to the same master netting agreement that governs

existing swaps entered into with a counterparty prior to the compliance

date. The final rule permits a CSE to (1) calculate initial margin

requirements for swaps under an EMNA with the counterparty on a

portfolio basis in certain circumstances, if it does so using an

initial margin model; and (2) calculate variation margin requirements

under the final rule on an aggregate, net basis under an EMNA with the

counterparty. Applying the final rule in such a way would, in some

cases, have the effect of applying it retroactively to swaps entered

into prior to the compliance date under the EMNA.

The Commission received several comments expressing concern that

the proposal might require swaps entered into before the compliance

dates to be documented under a different EMNA than swaps entered into

after the compliance dates in order for the margin requirements not to

apply to the pre-compliance dates swaps. As described further above,

the Commission has revised the final rule to allow for the

establishment of separate netting sets under a single ENMA to avoid

this outcome.

f. Standards Expressed in U.S. Dollars

The proposal contained a number of numerical amounts that are

expressed in U.S. dollar terms. The amounts include the effective date

phase-in thresholds, the initial margin threshold amount, the material

swap exposure amount, and the minimum transfer amount. These numerical

amounts are expressed in the 2013 international framework in terms of

Euros. In the proposal, the Commission translated the Euro amounts from

the 2013 international framework using a Euro-U.S. Dollar exchange rate

that was broadly consistent with the exchange rate that prevailed at

the time of the proposal's publication.

In the proposal, the Commission sought comment on how to deal with

fluctuations in exchange rates and how such fluctuations may create

inconsistencies in the numerical amounts that are established across

differing jurisdictions. One commenter suggested using an average

exchange rate calculated over a period of time. Another commenter

suggested that the Commission should periodically recalibrate these

amounts in response to broad movements in underlying exchange rates.

The Commission believes that persistent and significant

fluctuations in exchange rates could result in significant differences

across jurisdictions that would complicate cross-border transactions

and create competitive inequities. The Commission does not agree,

however, that the final rule's numerical amounts should be mechanically

linked to either prevailing exchange rates or average exchange rates

over a period of time as short term fluctuations in exchange rates

would result in high frequency changes that would create significant

operational and logistical burdens. Rather, and consistent with the

view of one commenter, the Commission expects to consider periodically

the numerical amounts expressed in the final rule and their relation to

amounts denominated in other currencies in differing jurisdictions. The

Commission will then propose adjustments, as appropriate, to these

amounts.

In the final rule, the Commission is adjusting the numerical

amounts described above in light of significant shifts in the Euro-U.S.

Dollar exchange rates since the publication of the proposal.

Specifically, the Commission is reducing the value of each numerical

quantity expressed in dollars to be consistent with a one for one

exchange rate with the Euro. As a specific example, the amount of the

initial margin threshold is being changed from $65 million in the

proposal to $50 million in the final rule. This change will align the

U.S dollar denominated numerical amounts in the final rule with those

in the 2013 international framework, will be consistent with amounts

that have been proposed in margin rules by the European and Japanese

authorities, and will be more consistent with the Euro-U.S. Dollar

exchange rate prevailing at the time the final rule is published.

III. Interim Final Rule

A. Background

Title VII of the Dodd-Frank Act established a comprehensive new

regulatory framework for derivatives, which the Act generally

characterizes as ``swaps'' and ``security-based swaps.'' \324\ As part

of this new regulatory framework, sections 731 of the Dodd-Frank Act

added a new section 4s to the CEA which requires registration with the

CFTC of swap dealers and major swap participants.\325\

[[Page 678]]

These registrants are collectively referred to in this preamble as

``swap entities.''

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

\324\ ``Swaps'' are defined in section 721 of the Dodd-Frank Act

to include interest rate swaps, commodity-based swaps, equity swaps

and credit default swaps. See 7 U.S.C. 1a(47).

\325\ See 7 U.S.C. 6s; 15 U.S.C. 78o-10. Section 731 of the

Dodd-Frank Act requires swap dealers and major swap participants to

register with the CFTC, which is vested with primary responsibility

for the oversight of the swaps market under Title VII of the Dodd-

Frank Act.

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

As noted earlier, sections 731 of the Dodd-Frank Act requires the

Commission to adopt rules that apply to all swap dealer and major swap

participants without a prudential regulator, imposing capital

requirements and initial and variation margin requirements on all

uncleared swaps. The capital and margin requirements under sections 731

of the Dodd-Frank Act apply to uncleared swaps and complement other

provisions of the Dodd-Frank Act that require the Commission to make

determinations as to whether certain swaps, or a group, category, or

class of such transactions, should be required to be cleared.\326\ If

the CFTC has made such a determination, it is generally unlawful for

any person to engage in such a swap unless the transaction is submitted

to a derivatives clearing organization, as applicable, for clearing.

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

\326\ 7 U.S.C. 2(h). The CEA sets out standards that the

Commission is required to apply when making determinations about

clearing, which generally address whether a swap is sufficiently

standardized to be cleared. 7 U.S.C. 2(h)(2)(D). To date, the

Commission has determined that certain interest rate swaps and

credit default swaps are required to be cleared. 17 CFR 50.4.

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

The clearing requirements, however, do not apply to an entity that

is not a financial entity, is using a swap to hedge or mitigate

commercial risk, and notifies the Commission, in a manner set forth by

the Commission, how it generally meets its financial obligations.\327\

Thus, a particular swap might be subject to the capital and margin

requirements of section 731 either because it is not subject to the

mandatory clearing requirement, or because one of the parties to the

swap is eligible for, and elects to use, an exception or exemption from

the mandatory clearing requirement. Such a swap is a ``uncleared'' swap

for purposes of the capital and margin requirements established under

sections 731 of the Dodd-Frank Act.

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

\327\ See 7 U.S.C. 2(h)(7). Further, the Commission has

authority to exempt swaps from the clearing requirement. 7 U.S.C.

6(c)(1).

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

Sections 731 direct the Commission to impose initial and variation

margin requirements on all swaps that are not cleared. Under the

proposed rule, the Commission distinguished among different types of

counterparties on the basis of risk.\328\

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

\328\ The final rule takes a similar approach. In implementing

this risk-based approach, the final rule distinguishes among four

separate types of swap counterparties: (i) Counterparties that are

themselves swap entities; (ii) counterparties that are financial end

users with a material swaps exposure; (iii) counterparties that are

financial end users without a material swaps exposure, and (iv)

other counterparties, including nonfinancial end users, sovereigns,

and multilateral development banks.

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

On January 12, 2015, President Obama signed into law TRIPRA. Title

III of TRIPRA, the ``Business Risk Mitigation and Price Stabilization

Act of 2015,'' amends statutory provisions added by the Dodd-Frank Act

relating to margin requirements for swaps and security-based swaps.

Specifically, section 302 of TRIPRA's Title III amends sections 731 and

764 of the Dodd-Frank Act to provide that the initial and variation

margin requirements do not apply to certain transactions of specified

counterparties that would qualify for an exemption or exception from

clearing, as explained more fully below. Uncleared swaps that are

exempt under section 302 of TRIPRA will not be subject to the

Commission's rules implementing margin requirements. In section 303 of

TRIPRA, Congress required that the Commission implement the provisions

of Title III by promulgating an interim final rule and seeking public

comment on the interim final rule.

The Commission is therefore promulgating this interim final rule

with a request for comment. As noted above, swaps may be uncleared

swaps either because (i) there is an exemption or exception from

clearing available; or (ii) the Commission has not determined that such

swap is required to be cleared. The exclusions and exemptions from the

final margin rule will apply to both categories of uncleared swaps when

they involve a counterparty that meets the requirements for an

exception or exemption from clearing (e.g., a non-financial end user

using swaps to hedge or mitigate commercial risk).

Clearing requirements pursuant to the CEA began to take effect with

respect to certain interest rate and credit default swap indices swaps

on March 11, 2013.\329\ CSEs have accordingly already established

methods and procedures to engage in transactions with counterparties

that are eligible for the clearing exceptions or exemptions and for

recording and reporting the eligibility of these transactions for the

exception or exemptions as required under the statute.\330\ The

Commission expects these processes will function equally well as a

basis for the parallel statutory exemptions from initial and variation

margin requirements for uncleared swaps implemented pursuant to this

interim final rule.

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

\329\ 17 CFR 50.25. See 77 FR 44441 (July 30, 2012)

\330\ See, e.g., 17 CFR 50.50(b).

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

B. Description of the Interim Final Rule

This interim final rule, which adds a new section 23.150(b) to the

final rule, adopts the statutory exemptions and exceptions as required

under TRIPRA. TRIPRA provides that the initial and variation margin

requirements do not apply to the uncleared swaps of three categories of

counterparties. In particular, section 302 of TRIPRA amends section 731

so that initial and variation margin requirements will not apply to a

swap in which a counterparty (to a CSE) is (1) a non-financial entity

(including small financial institution and a captive finance company)

that qualifies for the clearing exception under section 2(h)(7)(A) of

the Act; (2) a cooperative entity that qualifies for an exemption from

the clearing requirements issued under section 4(c)(1) of the Act; or

(3) a treasury affiliate acting as agent that satisfies the criteria

for an exception from clearing in section 2(h)(7)(D) of the Act.

1. Entities Qualifying for a Clearing Exception

TRIPRA provides that the initial and variation margin requirements

of the final rule shall not apply to a uncleared swap in which a

counterparty qualifies for an exception under section 2(h)(7)(A) of the

CEA.\331\ Section 2(h)(7)(A) excepts from clearing swaps where one of

the counterparties is not a financial entity, is using the swap to

hedge or mitigate commercial risk, and notifies the Commission how it

generally meets its financial obligations associated with entering into

uncleared swaps. A number of different types of counterparties may

qualify for an exception from clearing under section 2(h)(7)(A),

including: Non-financial end users, small banks, savings associations,

Farm Credit System Institutions, and credit unions. In addition,

captive finance companies qualify for an exception from clearing under

section 2(h)(7)(A).

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

\331\ See 7 U.S.C. 2(h)(7)(A); 15 U.S.C. 78c-3(g)(1).

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

a. Non-Financial End Users

A counterparty that is not a financial entity \332\ (sometimes

referred to as

[[Page 679]]

``commercial end users'') that is using swaps to hedge or mitigate

commercial risk generally would qualify for an exception from clearing

under section 2(h)(7)(A) and thus from the requirements of the final

rule for uncleared swaps pursuant to section 23.150(b).

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

\332\ See 7 U.S.C. 2(h)(7)(A); 15 U.S.C. 78c-3(g)(1); 17 CFR

50.50. A ``financial entity'' is defined to mean (i) a swap dealer;

(ii) a security-based swap dealer; (iii) a major swap participant;

(iv) a major security-based swap participant; (v) a commodity pool;

(vi) a private fund as defined in section 202(a) of the Investment

Advisers Act of 1940; (vii) an employee benefit plan as defined in

sections 3(3) and 3(32) of the Employment Retirement Income Security

Act of 1974; (viii) a person predominantly engaged in activities

that are in the business of banking, or in activities that are

financial in nature, as defined in section 4(k) of the Bank Holding

Company Act of 1956. See 7 U.S.C. 2(h)(7)(C)(i); 15 U.S.C. 78c-

3(g)(3).

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

b. Small Banks, Savings Associations, Farm Credit System Institutions,

and Credit Unions

The definition of ``financial entity'' in section 2(h)(7)(C)(ii)

provides that the Commission shall consider whether to exempt small

banks, savings associations, Farm Credit System Institutions, and

credit unions with total assets of $10 billion or less. Pursuant to

this authority, the Commission has exempted small banks, savings

associations, Farm Credit System Institutions, and credit unions with

total assets of $10 billion or less from the definition of ``financial

entity,'' thereby permitting these institutions to avail themselves of

the clearing exception when they are using swaps to hedge or mitigate

risk.\333\ As a result, these small financial institutions that are

using uncleared swaps to hedge or mitigate commercial risk would also

qualify for an exemption from the initial and variation margin

requirements of the final rule pursuant to section 23.150(b).

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

\333\ See 7 U.S.C. 2(h)(7)(C)(ii); 17 CFR 50.50; 77 FR 42560

(July 19, 2012); as recodified by 77 FR 74284 (Dec 13,2012).

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

c. Captive Finance Companies

Section 2(h)(7)(C) also provides that the definition of ``financial

entity'' does not include an entity whose primary business is providing

financing and uses derivatives for the purposes of hedging underlying

commercial risks relating to interest rate and foreign exchange

exposures, 90 percent or more of which arise from financing that

facilitates the purchase or lease of products, 90 percent or more of

which are manufactured by the parent company or another subsidiary of

the parent company (``captive finance company'').\334\ These entities

can avail themselves of a clearing exception when they are using swaps

to hedge or mitigate commercial risk and thus would be eligible for the

exemption in the Commission's margin rules pursuant to section

23.150(b).

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

\334\ See 7 U.S.C. 2(h)(7)(C)(iii).

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

2. Certain Cooperative Entities

TRIPRA provides that the initial and variation margin requirements

shall not apply to an uncleared swap in which a counterparty qualifies

for an exemption issued under section 4(c)(1) of the Commodity Exchange

Act from the clearing requirements of section 2(h)(1)(A) of the

Commodity Exchange Act for cooperative entities as defined in such

exemption.\335\ The Commission, pursuant to its authority under section

4(c)(1) of the Commodity Exchange Act, adopted a regulation that allows

cooperatives that are financial entities to elect an exemption from

mandatory clearing of swaps that: (1) They enter into in connection

with originating loans for their members; or (2) hedge or mitigate

commercial risk related to loans to members or swaps with their members

which are not financial entities or are exempt from the definition of

financial entity.\336\ The swaps of these cooperatives that would

qualify for an exemption from clearing also would qualify pursuant to

section 23.150(b) for an exemption from the margin requirements of the

final rule.

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

\335\ See 7 U.S.C. 6(c)(1). The CFTC, pursuant to its authority

under section 4(c)(1) of the Commodity Exchange Act, adopted 17 CFR

50.51, which allows cooperative financial entities that meet certain

qualifications to elect not to clear certain swaps that are

otherwise required to be cleared pursuant to section 2(h)(1)(A) of

the Commodity Exchange Act.

\336\ See 7 U.S.C. 6(c)(1);17 CFR 50.51.

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

3. Treasury Affiliates Acting as Agent

TRIPRA provides that the initial and variation margin requirements

shall not apply to an uncleared swap in which a counterparty satisfies

the criteria in section 2(h)(7)(D) of the Commodity Exchange Act. These

sections provide that, where a person qualifies for an exception from

the clearing requirements, an affiliate of that person (including an

affiliate predominantly engaged in providing financing for the purchase

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

the exception as well, but only if the affiliate is acting on behalf of

the person and as an agent and uses the swap to hedge or mitigate the

commercial risk of the person or other affiliate of the person that is

not a financial entity (``treasury affiliate acting as agent'').\337\ A

treasury affiliate acting as agent that meets the requirements for a

clearing exemption would also be eligible for an exemption pursuant to

section 23.150(b) from the Commission's final rule.

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

\337\ See 7 U.S.C. 2(h)(7)(D); 15 U.S.C. 78c-3(g)(4). This

exception does not apply to a person that is a swap dealer,

security-based swap dealer, major swap participant, major security-

based swap participant, an issuer that would be an investment

company as defined in section 3 of the Investment Company Act of

1940 (15 U.S.C. 80a-3) but for section 3(c)(1) or 3(c)(7) of that

Act, a commodity pool, or a bank holding company with over $50

billion in consolidated assets.

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

The Commission requests comments on all aspects of the interim

final rule.

IV. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA'') requires that agencies

consider whether the regulations they propose will have a significant

economic impact on a substantial number of small entities.\338\ The RFA

does not require agencies to consider the impact of the final rule,

including its indirect economic effects, on small entities that are not

subject to the requirements of the final rule.\339\ In the Proposal,

the Commission certified that the proposed rule would not have a

significant economic impact on a substantial number of small entities.

Following the publication of the proposal, the Commission received a

comment on the potential for costs to be passed on to market

participants using swaps, including small entities that are not subject

to the margin requirements.\340\

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

\338\ 5 U.S.C. 601 et seq.

\339\ See e.g., In Mid-Tex Electric Cooperative v. FERC, 773

F.2d 327 (D.C. Cir. 1985); United Distribution Cos. v. FERC, 88 F.3d

1105, 1170 (D.C. Cir. 1996); Cement Kiln Recycling Coalition v. EPA,

255 F.3d 855 (D.C. Cir. 2001).

\340\ NERA's comment is addressed below.

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

The final rule implements the new statutory framework of Section

4s(e) of the CEA, added by Section 731 of the Dodd-Frank Act, which

requires the Commission to adopt capital and initial and variation

margin requirements for CSEs on all uncleared swaps in order to offset

the greater risk to the swap entity and the financial system arising

from the use of swaps and security-based swaps that are not cleared.

The final margin requirements will apply to uncleared swaps between

covered swap entities and their financial end user counterparties.\341\

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

\341\ In contrast to the proposal, the final rule does not

require a CSE to calculate hypothetical initial and variation margin

amounts each day for positions held by non-financial end users that

have MSEs to the CSE. This should further reduce the possibility

that small entities may be indirectly impacted by the final rule.

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

As discussed in the Proposal, the Commission previously established

certain definitions of ``small entities'' to be used in evaluating the

impact of its regulations on small entities in accordance with the

RFA,\342\ and that it has determined that SDs, MSPs and eligible

contract participants (``ECPs'') are not small entities for purposes of

the RFA.\343\ Accordingly, CSEs that are subject to the final rule are

not small entities for purposes of the RFA.

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

\342\ 47 FR 18618 (Apr. 30, 1982).

\343\ See 77 FR 30596, 30701 (May 23, 2012) (SDs and MSPs); 66

FR 20740, 20743 (April 25, 2001) (ECPs).

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

[[Page 680]]

With respect to certain financial end users \344\ that may be

impacted by the Proposed Rule, the Commission expects that such

entities would be similar to eligible contract participants (``ECPs'')

and, as such, they would not be small entities.\345\ As discussed

above, the final rule applies on a cross-border basis and therefore, to

uncleared swaps between CSEs and foreign financial end users. Even

assuming that there are any foreign financial entities that would not

be considered ECPs (and thus, would be small entities), the Commission

expects that only a small number of foreign financial entities that are

not ECPs, if any, would trade in uncleared swaps.

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

\344\ The RFA focuses on direct impact to small entities and not

on indirect impacts on these businesses, which may be tenuous and

difficult to discern. See Mid-Tex Elec. Coop., Inc. v. FERC, 773

F.2d 327, 340 (D.C. Cir. 1985); Am. Trucking Assns. v. EPA, 175 F.3d

1027, 1043 (D.C. Cir. 1985).

\345\ As noted in paragraph (1)(xii) of the definition of

``financial end user'' in section 23.151 of the final rule, a

financial end user includes a person that would be a financial

entity described in paragraphs (1)(i)-(xi) of that definition, if it

were organized under the laws of the United States or any State

thereof. The Commission believes that this prong of the definition

of financial end user would capture the same type of U.S. financial

end users that are ECPs, but for them being foreign financial

entities. Therefore, for purposes of the Commission's RFA analysis,

these foreign financial end users will be considered ECPs and

therefore, like ECPs in the U.S., not small entities.

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

The Commission notes that to the extent that small entities may be

impacted, the final rule contains numerous provisions that are intended

to mitigate--or have the effect of mitigating--the cost on such

entities. For example, under the final rule, the level of the aggregate

notional amount of transactions that give rise to material swaps

exposure has been raised from $3 billion to $8 billion, which should

result in a fewer financial end users being required to post initial

margin. In addition, the final rule provides an initial margin

threshold of $50 million from all uncleared swaps between a covered

swap entity and its counterparties, which should further reduce the

impact of the rule on financial counterparties that may be small

entities.

For the reasons discussed above, the Commission finds that there

will not be a substantial number of small entities impacted by the

final rule. Therefore, the Chairman, on behalf of the Commission,

hereby certifies pursuant to 5 U.S.C. 605(b) that the final rule will

not have a significant economic impact on a substantial number of small

entities.

B. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 (``PRA'') \346\ imposes certain

requirements on Federal agencies, including the Commission, in

connection with their conducting or sponsoring any collection of

information, as defined by the PRA. This final rule will result in a

mandatory collection of information within the meaning of the PRA. The

collection is necessary to implement section 4s(e) of the CEA, which

directs the Commission to adopt rules governing margin requirements for

SDs and MSPs. In accordance with the requirements of the PRA, the

Commission may not conduct or sponsor, and a person is not required to

respond to, this collections of information unless it displays a

currently valid OMB control number.

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

\346\ 44 U.S.C. 3501 et seq.

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

As described below, all of the collections of information required

by the final rule are covered by existing OMB Control Number 3038-0024

and OMB Control Number 3038-0088, with OMB Control Number 3038-0024

requiring a revision of the burden hours. The titles for these

collections of information are ``Regulations and Forms Pertaining to

Financial Integrity of the Market Place, OMB control number 3038-0024''

and ``Swap Trading Relationship Documentation Requirements for Swap

Dealers and Major Swap Participants, OMB control number 3038-0088.''

\347\

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

\347\ The Commission notes that certain provisions of Regulation

23.158 are already covered by OMB Control Number 3038-0104, which is

not affected by this final rule.

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

1. Clarification of Collection 3038-0088

The final rule contains reporting and recordkeeping requirements

that are part of the existing Commission regulations pertaining to swap

trading relationship documentation requirements. The collection of

information related to that existing Commission regulation is covered

by OMB Control Number 3038-0088.\348\

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

\348\ See OMB Control No. 3038-0088, available at http://www.reginfo.gov/public/do/PRAOMBHistory?ombControlNumber=3038-0088.

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

Specifically, under the final rule, both the formula employed in

the standardized method and the approach of the risk-based model that

reflect offsetting exposures require that offsets be reflected only for

swaps that are subject to the same eligible master netting agreement

(``EMNA''). Regulation 23.151 defines the term EMNA and provides that a

CSE that relies on the agreement for purpose of margin calculation must

establish and maintain written procedures for monitoring relevant

changes in the law and to ensure that the agreement continues to

satisfy the requirements of this section. Regulation 23.153(d) further

specifies that a CSE must demonstrate upon request to the satisfaction

of the Commission that it has made appropriate efforts to collect or

post the required margin. In addition, Regulation 23.154 establishes

standards for initial margin models and requires CSEs to describe to

the Commission any remedial actions being taken, and report internal

audit findings regarding the effectiveness of the initial margin model

to the CSE's board of directors or a committee thereof, to adequately

documents all material aspects of its initial margin model; and, to

adequately documents internal authorization procedures, including

escalation procedures that require review and approval of any change to

the initial margin calculation under the initial margin model,

demonstrable analysis that any basis for any such change is consistent

with the requirements of this section, and independent review of such

demonstrable analysis and approval. Regulation 23.155(b) requires a

covered swap entity to create and maintain documentation setting forth

the variation margin methodology, evaluate the reliability of its data

sources at least annually, and make adjustments, as appropriate. It

also provides that the Commission at any time may require a covered

swap entity to provide further data or analysis concerning the

methodology or a data source. Regulation 23.157(c) requires the

custodian to act pursuant to a custody agreement that prohibits the

custodian from re-hypothecating, repledging, reusing, or otherwise

transferring the funds held by the custodian. Regulation 23.158

requires a covered swap entity to execute trading documentation with

each counterparty that is either a swap entity or financial end user

regarding credit support arrangements.

The reporting and recordkeeping requirements of Regulations

23.154(b)(4) through 23.154(b)(7), and Regulations 23.155(b), 23.157(c)

and 23.158, described above, fall under the Commission Regulations

23.500 through 23.506 \349\ and are covered by OMB

[[Page 681]]

Control Number 3038-0088. Further, the reporting and recordkeeping

requirements in Regulation 23.154(b)(4) through 23.154(b)(7) and

Regulations 23.155(b), 23.157(c) and 23.158, would not materially

impact the burden estimates currently provided for in OMB Control

Number 3038-0088.\350\

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

\349\ See 77 FR 55904 (Sept. 12, 2012). Commission Regulation

23.504(b) requires an SD or MSP to maintain written swap trading

relationship documentation that must include all terms governing the

trading relationship between the SD or MSP and its counterparty, and

Commission Regulation 23.504(d) requires that each SD and MSP

maintain all documents required to be created pursuant to Commission

Regulation 23.504. Commission Regulation 23.502(c) requires each SD

and MSP to notify the Commission and any applicable Prudential

Regulator of any swap valuation dispute in excess of $20 million if

not resolved in specified timeframes.

\350\ The Commission is publishing a separate notice in the

Federal Register to renew OMB Control Number 3038-0088, which will

revise the burden estimates relating to the collection titled ``Swap

Trading Relationship Documentation Requirements for Swap Dealers and

Major Swap Participants.''

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

2. Revisions to Collection 3038-0024

As noted above, the final will require a new information

collection, which is covered by OMB Control Number 3038-0024.\351\

However, the final rule will revise the burden hours associated with

the collection, as discussed below.

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

\351\ The Commission previously proposed to adopt regulations

governing standards and other requirements for initial margin models

that would be used by SDs and MSPs to margin uncleared swap

transactions. See Capital Requirements of Swap Dealers and Major

Swap Participants, 76 FR 27,802 (May 12, 2011). As part of the

October 3, 2014 proposal, the Commission submitted proposed

revisions to collection 3038-0024 for the estimated burdens

associated with the margin model to OMB.

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

Regulation 23.154(b)(1) requires CSEs that wish to use initial

margin models to obtain the Commission's approval, and to demonstrate,

on a continuing basis, to the Commission that the models satisfy

standards established in Regulation 23.154. These standards include:

(i) A requirement that a CSE notify the Commission in writing 60 days

before extending the use of the model to additional product types,

making certain changes to the initial margin model, or making material

changes to modeling assumptions; and (ii) a variety of quantitative

requirements, including requirements that the CSE validate and

demonstrate the reasonableness of its process for modeling and

measuring hedging benefits, demonstrate to the satisfaction of the

Commission that the omission of any risk factor from the calculation of

its initial margin is appropriate, demonstrate to the satisfaction of

the Commission that incorporation of any proxy or approximation used to

capture the risks of the covered swap entity's non-cleared swaps is

appropriate, periodically review and, as necessary, revise the data

used to calibrate the initial margin model to ensure that the data

incorporate an appropriate period of significant financial stress.

Currently, there are approximately 106 SDs and MSPs provisionally

registered with the Commission. The Commission further estimates that

approximately 54 of the SDs and MSPs will be subject to the

Commission's margin rules as they are not subject to a Prudential

Regulator. The Commission further estimates that all SDs and MSPs will

seek to obtain Commission approval to use models for computing initial

margin requirements. The Commission estimates that the information

collection requirement associated with this aspect of the final rule

will impose an average of 240 burden hours per registrant.

Based upon the above, the estimated additional hour burden for

collection 3038-0024 was calculated as follows:

Number of registrants: 54.

Frequency of collection: Initial submission and periodic

updates.

Estimated annual responses per registrant: 1.

Estimated aggregate number of annual responses: 54.

Estimated annual hour burden per registrant: 240 hours.

Estimated aggregate annual hour burden: 12,960 hours [54

registrants x 240 hours per registrant].

V. Cost Benefit Considerations

A. Introduction

Section 15(a) of the CEA requires the Commission to consider the

costs and benefits of its discretionary actions before promulgating a

regulation under the CEA or issuing certain orders.\352\ Section 15(a)

further specifies that the costs and benefits shall be evaluated in

light of five broad areas of market and public concern: (1) Protection

of market participants and the public; (2) efficiency, competitiveness,

and financial integrity of futures markets; (3) price discovery; (4)

sound risk management practices; and (5) other public interest

considerations. In this section, the Commission discusses the costs and

benefits resulting from its discretionary determinations with respect

to the section 15(a) factors.\353\ This rulemaking implements the new

statutory framework of Section 4s(e) of the CEA, added by Section 731

of the Dodd-Frank Act, which requires the Commission to adopt capital

and initial and variation margin requirements for CSEs. Section 4(s)(e)

of the CEA requires the Commission to adopt initial and variation

margin requirements for CSEs on all of their uncleared swaps, which

should be designed to ensure the CSE's safety and soundness and be

appropriate for the risk associated with the uncleared swap. In

addition, section 4s(e)(3)(D) of the CEA provides that the Commission,

the Prudential Regulators, and the SEC, must ``to the maximum extent

practicable'' establish and maintain comparable margin rules.

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

\352\ 7 U.S.C. 19(a).

\353\ The Commission notes that the costs and benefits

considered in finalizing the margin rule, and highlighted below,

have informed the policy choices described throughout this release.

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

The Commission recognizes that there are inherent trade-offs in

developing minimum collateral standards for uncleared swaps. Margin

rules for uncleared swaps are designed to reduce the probability of

default by the CSE and limit the amount of leverage that can be

undertaken by CSEs (and other market participants, in the aggregate),

which ultimately mitigates the possibility of a systemic event. The

financial crisis of 2008 has had profound and long-lasting adverse

effects on the economy, and therefore reducing the potential for

another systemic event provides significant, if unquantifiable,

benefits. At the same time, the final margin rule will entail new costs

for CSEs and financial end users as they will need to provide liquid,

high-quality collateral to meet those requirements that exceed current

practice and as a result, incur costs in terms of lost returns from

investments or in securing additional sources of funding (e.g.,

interest expenses associated with borrowing funds).\354\ In addition,

CSEs and financial end users will face certain startup and ongoing

costs relating to technology and other operational infrastructure, as

well as new or updated legal agreements.\355\ The final rule reflects

the Commission's reasoned judgment of how best to ensure the safety and

soundness of CSEs and the U.S. financial system, in a manner that

considers the economic consequences of its policy choices.

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

\354\ See Appendix A for the Commission's estimates of the

funding costs for initial margin and variation margin, as well as a

more detailed discussion of certain administrative costs.

\355\ For the reasons discussed in Appendix A, these

administrative costs are difficult to quantify at this time.

Therefore, the Commission discusses the administrative costs related

to margin for uncleared swaps qualitatively instead.

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

The Commission also recognizes that many CSEs are part of bank

holding companies with global operations that are subject to

overlapping jurisdictions by multiple supervisory authorities, both

domestic and foreign. Significant disparities in margin rules can lead

to undue competitive distortions and ultimately, opportunities for

regulatory arbitrage.\356\ It could also lead to

[[Page 682]]

operational inefficiencies as entities within the same corporate group

may be precluded from utilizing congruent operational and compliance

infrastructure. In light of these concerns, and in accordance with the

statutory mandate, the Commission, in developing the final rule,

closely consulted and coordinated with the Prudential Regulators and

foreign regulators in order to harmonize our respective margin rules to

the greatest extent possible.\357\

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

\356\ That is, if the Commission's margin rules are

substantially stricter than that of the Prudential Regulators, such

difference could make it less costly to conduct swaps trading in a

bank swap dealer as compared to a non-bank swap dealer. Likewise,

U.S. and financial end users could be advantaged or disadvantaged

depending on how the Commission's margin rule compares with

corresponding requirements in other jurisdictions.

\357\ The Commission, in a separate rulemaking, will address the

cross-border application of the Commission's margin rules, including

the availability of substituted compliance and exclusion, as

appropriate. The cross-border margin rules are intended to further

promote global harmonization of margin rules and consequently,

mitigate the potential for competitive distortions and market

inefficiencies.

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

The baseline against which the costs and benefits associated with

this rule will be compared is the status quo, i.e., the uncleared swaps

markets as they exist today. At present, swap market participants are

not legally required to post either initial or variation margin when

engaging in uncleared swaps. Nevertheless, the Commission understands

that, for risk management purposes, many CSEs collect initial margin

from certain non-CSE counterparties and exchange variation margin with

CSEs and financial end users for uncleared swaps. Further, section

4s(e), read together with section 2(i) of the CEA,\358\ applies the

margin rules to a CSE's swap activities outside the United States,

regardless of the domicile of the CSE (or its counterparties). Because

the Commission found no information that indicates that there are

material differences in the costs and benefits discussed herein between

foreign and cross-border swaps activities of CSEs and financial end

users affected by the rule, the Commission's consideration of the costs

and benefits of the final rule applies to all swap activities, domestic

and cross-border, to which the final rule applies. CSEs, wherever

domiciled, by definition are involved in a large volume of swaps

activity in, or significantly affecting, United States markets and are

registered with the Commission. Accordingly, they can be expected

already to have in place personnel and infrastructure for compliance

with United States law. To the extent that there may be differences in

the particulars of costs to foreign CSEs or financial end users, the

record of this proceeding generally did not provide information that

would permit the evaluation of any such differences.\359\

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

\358\ See 7 U.S.C. 2(i). Section 2(i) of the CEA states that the

provisions of the Act relating to swaps that were enacted by the

Wall Street Transparency and Accountability Act of 2010 (including

any rule prescribed or regulation promulgated under that Act), shall

not apply to activities outside the United States unless those

activities (1) have a direct and significant connection with

activities in, or effect on, commerce of the United States; or (2)

contravene such rules or regulations as the Commission may prescribe

or promulgate as are necessary or appropriate to prevent the evasion

of any provision of this Act that was enacted by the Wall Street

Transparency and Accountability Act of 2010.

\359\ As foreign jurisdictions put in place their own margin

rules in the future, the existence of these rules may affect the

costs and benefits of the Commission's rules for foreign CSEs and

financial end users. However, the still developing state of foreign

law in this area and the absence of specific information in the

record of this proceeding does not permit a detailed evaluation of

such possible effects in the present proceeding. As noted above, the

Commission will be addressing certain issues relating to the effects

of foreign margin rules, including the availability of substituted

compliance, in a separate rulemaking.

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

In the sections that follow, the Commission considers: (i) The

costs and benefits associated with its choices regarding the scope and

extent to which it would apply its margin rule to uncleared swaps of a

CSE and certain financial end users; (ii) the alternatives considered

by the Commission and the costs and benefits relative to the approach

adopted herein; and (iii) impact of the margin rule on the market and

the public, in light of the 15(a) factors, as applicable. In the

proposing release, the Commission addressed the costs and benefits of

the proposed rules, taking into account the considerations described

above. The Commission also requested comments on these assessments and

for any data or other information that would be useful in estimation of

the quantifiable costs and benefits of this rulemaking. A total of 59

comment letters were received. Some commenters generally addressed the

cost-and-benefit aspect of the proposed rule; \360\ one commenter

provided quantitative data and analysis of the Commission's proposal.

The discussion of the costs and benefits that follows is largely

qualitative in nature, although where possible the Commission attempts

to quantify these benefits and costs.

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

\360\ As discussed in this release, the relevant comments have

informed the Commission's decisions regarding the final rule and are

highlighted below.

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

B. Final Rule

1. Covered Entities: CSEs and Financial End Users

Margin requirements apply to uncleared swaps entered into by CSEs

\361\--and by extension, to the counterparties to such swaps. Because

different types of counterparties can pose different levels of risk,

the final rule establishes three categories of counterparty: (i) CSEs;

(ii) financial end users; and (iii) non-financial end users. Under the

final rule, the initial and variation margin requirements apply to

uncleared swaps of CSEs with certain counterparties, namely, other

CSEs, swap entities that are not a CSE and financial end users (and in

the case of initial margin, only those financial end users with

material swaps exposure).\362\ The final rule defines ``financial end

user'' as a counterparty that is not a swap dealer or a major swap

participant but which falls within one of the categories of entities

primarily engaged in financial activities.\363\ These categories are

nearly identical to the Prudential Regulators' definition of

``financial end user.'' \364\

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

\361\ As discussed above, however, certain uncleared swaps of

CSEs with their affiliates are not subject to initial margin; the

related cost-benefit considerations are addressed below.

\362\ The Commission recognizes that a CSE may enter into a swap

with another non-CSE swap entity, which would result in the non-CSE

swap entity collecting under the Prudential Regulators' margin

regime. Therefore, this section does not consider costs and benefits

as they relate to the non-CSE swap entity.

\363\ Sec. 23.151.

\364\ The Commission notes that its definition of ``financial

end user'' includes security-based swap dealers and major security-

based swap participants, as these entities are included in the

Prudential Regulators' definition of swap entities.

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

In developing the definition of financial end user, the Commission

was mindful of the significant new costs associated with the new

minimum collateral requirements and has attempted to tailor the

definition carefully to avoid undue burden on market participants,

without undermining the objectives of the margin rules. Accordingly,

the definition is intended to capture those market participants that by

the nature and scope of their financial activities present a higher

level of risk of default and are integral to the financial system, and

thus, pose greater risk to the safety and soundness of their CSE

counterparties and the stability of the financial system. Consistent

with this risk-based approach to the definition, the definition

specifically excludes entities that may be considered financial in

nature but that perform different functions in the financial system

than those included in the definition of financial end user. These

include, among others, multi-lateral development banks, the Bank for

International Settlements, and a subset

[[Page 683]]

of financial entities that engage in swaps to hedge or mitigate

commercial risks.

A number of commenters also requested that the Commission exclude

from the financial end user definition structured finance vehicles,

including securitization special purpose vehicles (``SPVs'') and

covered bond issuers.\365\ These commenters argued that margin

requirements on structured finance vehicles would restrict their

ability to hedge interest rate and currency risk and potentially force

these vehicles to exit the swaps market since these vehicles generally

do not have ready access to liquid collateral. Other commenters argued

that pension plans should not be subject to margin requirements because

they are highly regulated, highly creditworthy, have low leverage and

are prudently managed counterparties whose swaps are used primarily for

hedging and, as such, pose little risk to their counterparties or the

broader financial system.\366\

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

\365\ See SIFMA, SFIG and ISDA.

\366\ See ABA (pension plans should not be subject to margin and

should be treated as non-financial end users); AIMA (benefit plans

should not be subject to margin and there is ambiguity involving

whether non-U.S. public and private employee benefit plans would be

financial end users); JBA (securities investment funds should be

exempt from variation margin).

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

The Commission is not excluding, as commenters urged, pension

plans, and structured finance vehicles. The Commission observes that

these entities engage in the same range of activities as the other

entities encompassed by the final rule's definition of financial end

user. The Commission notes that the increase in the material swaps

exposure threshold, as finalized in the final rule, should address some

of the concerns raised by these commenters regarding the applicability

of initial margin requirements.\367\

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

\367\ In addition, with respect to pension plans, the Commission

notes that Congress explicitly listed employee benefit plans as

defined in paragraph (3) and (32) of section 3 of the Employee

Retirement Income Security Act of 1974 in the definition of

``financial entity'' in the Dodd-Frank Act. As a result, pension

plans do not benefit from an exclusion from clearing even where they

use swaps to hedge or mitigate commercial risk.

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

The enumerated list in the definition of financial end user is

intended to provide enhanced clarity to ease the burden associated with

determining whether a counterparty is a financial end user.\368\ The

Commission also considered alternative definitions, including using a

broad-based definition similar to that listed in section 2(h)(7)(C) of

the CEA. The Commission is not adopting this approach because it

believes that it would be difficult for the market participants to

implement and the Commission to monitor. In addition, the broad-based

definition would not provide the level of clarity that an enumerated

list provides market participants when engaging in uncleared swaps.

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

\368\ In this regard, the Commission recognizes that the

definition--particularly, the test that deems an entity a financial

end user if it were organized under the laws of the United States--

may impose a greater incremental cost with respect to foreign

counterparties. However, the Commission believes that it is

necessary to cover all financial end users that are counterparties

to a CSE, including those that are foreign-domiciled, to effectuate

the purposes of the margin requirements.

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

Initial margin requirements apply only to those financial end users

that meet the specified MSE threshold. The MSE threshold is intended to

identify entities that engage in significant derivatives activity as

measured by the end user's overall exposure in the market. In the

proposal, the Commission proposed to define materiality as $3 billion

average notional amount. The final rule increases the level of the

aggregate notional amount of transactions that gives rise to MSE to $8

billion, which is broadly consistent with the [euro]8 billion

established by the 2013 international framework and consistent with the

EU and Japanese proposals. The increased MSE threshold should further

reduce the number of financial end users subject to the initial margin

requirement in relation to the Commission's proposal.

The final rule defines ``material swaps exposure'' as the aggregate

notional amount of swaps not only of a particular entity, but also of

its affiliates and subsidiaries. The Commission recognizes that

calculation of MSE on an aggregate basis across affiliates and

subsidiaries would require new reporting and tracking systems. As

discussed above, the aggregation requirement is primarily intended to

address the potential circumvention, as CSEs may disperse their swap

activities through their affiliates to avoid exceeding the MSE

threshold. The aggregation approach provides the Commission with a more

complete picture of a firm's systemic risk profile by measuring the

risk at the consolidated level. The Commission believes that

aggregating exposure across affiliates is necessary to achieve the

objectives of the margin requirements.

The definition of MSE also contains a number of other changes from

the proposed definition to address commenters' concerns. Notably, in

response to commenters, a financial end user needs to count only one

side of an inter-affiliate swap in calculating its MSE. The Commission

believes that double counting (as proposed) would result in an

inaccurate measure of the swaps exposure of a financial end user as it

would inflate the total exposure within the consolidated group. By

modifying the calculation in this way, the Commission believes that it

is reducing the number of financial end users with MSE, which should

lessen the costs for financial entities that would have exceeded the $8

billion threshold.\369\

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

\369\ The Commission made a similar change to the definition of

``initial margin threshold amount'' as described in Regulation

23.151.

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

The final affiliate definition uses financial accounting standards

as the trigger for affiliation, rather than a legal control test. The

Commission believes that determining affiliate status based on whether

a company is or would be consolidated with another company on financial

statements prepared in accordance with U.S. GAAP, the International

Financial Reporting Standards or other similar standards, reflects a

more accurate method for discerning control and should be less

burdensome to apply.\370\ The Commission expects that most entities

prepare financial statements under an acceptable accounting standard.

For companies that do not prepare these statements, the Commission

believes that industry participants are more familiar with the relevant

accounting standards and tests, and they will be less burdensome to

apply.

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

\370\ Commenters raised the concern that the proposed

``control'' test was difficult to apply and over-inclusive. See

e.g., ACLI.

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

2. Initial Margin

Initial margin is intended to address potential future exposure.

That is, in the event of a counterparty default, initial margin

protects the non-defaulting party from the loss that may result from a

swap or portfolio of swaps, during the period of time needed to close

out the swap(s). Initial margin augments variation margin, which

secures the current mark-to-market value of swaps. Under the final

rule, CSEs would be required to both collect initial margin from and to

post initial margin to financial end users with material swaps

exposure. This represents a departure from current industry practice

and hence, introduces new costs for CSEs and their covered

counterparties, but is in accordance with the BCBS-IOSCO framework and

the Prudential Regulators' final rules.

These costs include the costs of the requisite collateral, namely,

the cost of securing external funds or the foregone return from

investments. It is difficult to estimate these costs due to the fact

that funding costs would vary widely depending on the type of entities

and

[[Page 684]]

their sources of liquidity, differences in funding costs over time,

differences on their return on investments and differences in the rate

of return on different collateral assets that may be used to satisfy

the initial margin requirements, among other things.\371\

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

\371\ Further, it is expected that due to the cost of the final

rules, some market participants may be incentivized to use

alternatives to uncleared swaps. Futures contracts and cleared

swaps, which tend to be more standardized and liquid than uncleared

swaps, typically require less initial margin; however, this may

result in basis risk given the standardization of these products. A

futures contract has a one day minimum liquidation time and a

cleared swap has a three- to five-day minimum liquidation time; in

contrast, under the final rule, a ten day minimum liquidation time

is required for uncleared swaps.

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

At one extreme, it may be that some entities providing initial

margin, such as pension funds and asset managers, will provide assets

as initial margin that they already own and would have owned even if no

requirements were in place. In such cases the economic cost of

providing initial margin collateral is anticipated to be low. In other

cases, entities engaging in uncleared swaps will have to raise

additional funds to secure assets that can be pledged as initial

margin. The greater the costs of their funding, relative to the rates

of return on the initial margin collateral, the greater the cost of

providing collateral assets.\372\

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

\372\ To the extent that the same funding could have been used

to fund investment opportunities, there is also an opportunity cost

on that lost investment.

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

At the same time, a two-way exchange of initial margin protects

both the CSE and the financial end user from the build-up of

counterparty credit risk from uncollateralized credit exposures. As

noted above, these entities are critical to the stability of the

financial system and therefore, need the protection of initial margin

in the event of the default of a CSE, as the potential of a cascading

event is increased without the collection of initial margin by these

financial end users. In regards to the CSE, posting margin restricts

the CSE from accumulating too large of an exposure in relation to its

financial capacity. Therefore, the two-way exchange of initial margin

should increase the overall stability of the financial system.

Further, as a result of the reduced risk of default, the posting

party could receive a benefit from changes to the relationship between

the CSE and the counterparty. As a result of the reduction in the

overall credit exposure with the CSE, the counterparty may be able to

realize better credit terms when transacting with the CSE and it

consolidated group. To the extent any such benefit is realized, it

would offset a portion of the cost incurred in posting collateral.

Some commenters recommended that the Commission adopt a ``collect-

only'' approach with respect to foreign end users.\373\ In response,

the Commission notes that, in contrast to the proposed Japanese and

European margin regimes, which would cover a very broad array of

financial entities, a collect-only regime under the U.S. regime would

be applicable only to CSEs and thus could leave a large number of

financial entities with significant uncollateralized future exposures

to their swap dealers.\374\

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

\373\ See, e.g., ISDA.

\374\ The Commission notes that under the latest EU proposal, if

a counterparty to a European-registered entity is a non-European

registered entity, then the European-registered entity must post

initial margin to the non-European registered entity. See, Second

Consultation Paper on draft regulatory technical standards on risk-

mitigation techniques for OTC-derivative contracts not cleared by a

CCP under Article 11(15) of Regulation (EU) No 648/2012 (for the

European Market Infrastructure Regulation) (Jun. 10, 2015),

available at https://www.eba.europa.eu/documents/10180/1106136/JC-CP-2015-002+JC+CP+on+Risk+Management+Techniques+for+OTC+derivatives+.pdf.

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

The Commission is requiring that CSEs calculate initial margin on a

daily basis and that initial margin be posted within one day after the

date of execution. The Commission is adopting this approach to preserve

the margin period of risk, e.g., 10 day calculation period for initial

margin models. Daily calculation is necessary as the risk factors and

the portfolio are subject to daily change. If the Commission were to

adopt a less restrictive timeframe for posting initial margin, the

margin period of risk would increase, reducing the protection provided

by initial margin. The Commission considered adding days to the 10 day

margin period of risk to account for the additional time given to post

initial margin collateral; however, the Commission believes that it

would be difficult to implement as models would need to be adjusted to

account for different posting timeframes, which could create

difficulties for the Commission in validating the initial margin model

calculations.

The Commission recognizes that the T+1 posting requirement may lead

to additional funding costs in the form of excess margin being held at

the custodian to meet the one day requirement.\375\ However, the

Commission expects that counterparties will post cash or some other

eligible assets that can be pledged in one day and subsequently

substitute other eligible assets for these highly liquid assets, which

should mitigate the burdens placed by this requirement. The Commission

notes that it has modified the date of execution to account for

different time zones and holidays to further reduce the burdens

associated with the T+1 requirement.

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

\375\ The excess amount held at the custodian would only need to

be the incremental change from day-to-day.

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

Under the final rule, consistent with the BCBS-IOSCO standard,

initial margin will not be required to be collected or posted by a CSE

to its covered counterparty, to the extent that the aggregate un-

margined exposure to its covered counterparty remains below $50

million. In effect, the $50 million threshold will provide a certain

level of relief to all counterparties that are required to post and

collect initial margin. It should also serve to reduce the aggregate

amount of initial margin--and consequently, incrementally reduce

overall funding cost--of all covered counterparties. At the same time,

the Commission recognizes that the $50 million threshold represents

uncollateralized risk of potential future exposure. However, the

Commission believes that this amount of uncollateralized swaps

exposure, calculated on a consolidated basis within a corporate group,

is acceptable in the context of initial margin, particularly in light

of the benefits to the financial system. To further ease the

transaction costs associated with the exchange of margin, the

Commission is not requiring a CSE to collect or post any amount below

the transfer amount of $500,000.\376\

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

\376\ This amount applies to both initial and variation margin

transfers on a combined basis.

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

3. Calculation of Initial Margin

Under the final rule, a CSE must calculate the required amount of

initial margin daily, on the basis of either a risk-based model or a

table-based method. The use of either model is predicated on the

satisfaction of certain baseline requirements to ensure that initial

margin is calculated in a manner that is sufficient to protect CSEs as

intended. Further, the choice of two alternatives allows CSEs to choose

the methodology that is the most cost efficient for managing their

business risks and thereby better compete. The costs and benefits

associated with the use of each approach are addressed below.

a. Risk-Based Model

Generally, the baseline requirements of this risk-based model

reflect the current practice for calculating bank regulatory capital

and value at risk

[[Page 685]]

(``VaR'') and conform to the BCBS/IOSCO standard for calculating margin

for uncleared swaps.\377\ To the extent CSEs are familiar with these

requirements and have infrastructure in place to calculate the initial

margin amount under this model approach, burdens associated with

utilizing the model should be mitigated.

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

\377\ The same model requirements have been proposed by the EU,

Japan, and Singapore. See ``Consultation Paper: Draft regulatory

technical standards on risk-mitigation techniques for OTC-derivative

contracts not cleared by a CCP under Article 11(15) of Regulation

(EU) No 648/2012,'' available at https://www.eba.europa.eu/documents/10180/655149/JC+CP+2014+03+%28CP+on+risk+mitigation+for+OTC+derivatives%29.pdf;

``Publication of draft amendments to the ``Cabinet Office Ordinance

on Financial Instruments Business'' and ``Comprehensive Guidelines

for Supervision'' with regard to margin requirements for non-

centrally cleared derivatives,'' available at http://www.fsa.go.jp/news/26/syouken/20140703-3.html; and ``Policy Consultation for

Margin for Non-Centrally Cleared OTC Derivatives,'' available at

http://www.mas.gov.sg/~/media/MAS/News%20and%20Publications/

Consultation%20Papers/

Policy%20Consultation%20on%20Margin%20Requirements%20for%20NonCentral

ly%20Cleared%20OTC%20Derivatives%201Oct.pdf.

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

Under this model, a CSE would be required to generally calculate

their initial margin based on the assumption of a ``holding period'' of

10 business days with a one-tailed 99% confidence interval. The

Commission believes that a 10 day close-out period is necessary to

ensure that the non-defaulting party has sufficient time to close out

and replace its positions in the event of counterparty default.\378\

The Commission recognizes that certain swaps may not require a 10 day

period to liquidate or replace and hence a 10 day close-out period may

lead to excessive initial margin. However, the Commission expects that

most of the instruments that could be liquidated in less than 10 days

are currently being cleared, and therefore, the impact of the requisite

10 day close-out period may be limited. Moreover, the Commission

believes that under market stress, these same instruments that may be

replaced or liquidated in less than 10 days may not maintain that same

level of liquidity.

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

\378\ Studies on capital requirements conducted by BCBS-IOSCO

have shown that a 10 day margin period of risk is adequate to

address the moves in the market. See ``Margin Requirements for Non-

Centrally Cleared Derivatives,'' BCBS-IOSCO, Sept. 2013, available

at http://www.bis.org/publ/bcbs261.pdf.

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

The Commission considered the alternative of setting the individual

margin period of liquidation for separate instruments or by broad asset

class. However, under these alternatives, there would be substantial

operational burdens on market participants in determining the

appropriate margin period of risk for each individual swap or broad

asset class. Substantial burdens would be imposed on regulators as well

as they would be required to review each CSE's determination of

appropriate liquidation periods, which would not be uniform across each

CSE for each individual swap or asset class, resulting in disputes as a

result of each CSE determining its own liquidation period for the

specific swap or swap asset class.

The Commission is also requiring that the data used in calculating

initial margin be based on an equally-weighted historical observation

period of at least 1 year and not more than 5 years, and must

incorporate a period of significant financial stress for each broad

asset class that is appropriate to the uncleared swaps to which the

initial margin model is applied. The Commission believes that this

approach would give an estimation period that is more representative of

the underlying risks over time and thus, mitigate the pro-cyclical

nature of initial margin calculations. In addition, under the final

rule, the initial margin model must be recalibrated on an on-going

basis to incorporate any change that results from a current period

stress. The Commission believes that this aspect of the final rule is

necessary as the initial margin calculated without a period of

financial instability would not be adequate to ensure the safety and

soundness of CSEs or the stability of financial markets during a period

of significant market volatility. The Commission understands that this

stress period element may increase the level of initial margin

required; however, in a time of stress, any change in the required

margin amount should be not be pro-cycle, as the amount requirement

would already contain a period of stress.

Under a risk-based model, offsetting risk exposures for a swap may

be recognized only in relation to another swap in the same category;

offsetting risk exposures may not be recognized across asset classes.

This will result in a greater amount of initial margin, all things

being equal. The Commission is concerned that cross-asset class

correlations break down during times of stress, increasing the

likelihood that in the event of default, the initial margin amount

calculated using these correlations would be insufficient to cover the

amount needed to replace the positions.

The risk-based model must also include material risks arising from

non-linear price characteristics, as many swaps have optionality. The

Commission understands that this requirement may increase costs in

developing models and result in a greater amount of initial margin.

However, the Commission believes that without this requirement the

initial margin calculation would not be adequate to cover the inherent

risks of the swap or a portfolio of swaps. Moreover, the Commission

understands that these risks are already imputed in the price of the

swap. Therefore, the incremental burden should be minimal.

A CSE using a risk-based model to calculate initial margin would be

required to establish and maintain a rigorous risk controls process to

re-evaluate, update, and validate the model as necessary to ensure its

continued applicability and compliance with the baseline requirements.

While certain of these measures may already be in place as part of a

CSE's risk management program (established under section

23.600(c)(4)(i)), others will result in additional costs for CSEs.\379\

The Commission believes that these measures are essential to ensuring

the efficacy of risk-based models used by CSEs. In addition, given that

a CSE subject to the Commission's margin rules may be affiliated with

one or more prudentially-supervised swap entities, the Commission would

closely coordinate with the Prudential Regulators for expedited review

of the model. The expedited review process should reduce unnecessary

delay or duplication.\380\

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

\379\ See Sec. 23.504(b)(4).

\380\ Additionally, the final rule provides that a CSE may use

models that have been approved by NFA.

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

b. Standardized Approach

As an alternative to a risk-based model, a CSE may calculate

initial margin using a standardized table. The standardized approach

could result in excess initial margin being calculated. For this

reason, the standardized approach is likely to appeal to those CSEs

with smaller swap portfolios with limited offsets, for whom a risk-

based margin model would not be cost-effective. Since many CSEs and

financial end users with material swaps exposure tends to have large

swaps positions with significant offsets, the Commission expects that

the risk-based model will be more widely favored.

c. Netting

Netting should reduce overall initial margin in relation to initial

margin that would result from a calculation based on a gross measure.

Both the formula employed in the standardized method and the approach

of the risk-based model require that offsets be reflected only for

swaps that are subject to the same eligible master netting agreement

[[Page 686]]

(``EMNA''). The eligibility criteria for netting are consistent with

industry standards currently being used for bank regulatory capital

purposes,\381\ which should reduce the administrative costs that would

be incurred in connection with any renegotiation of the terms of

existing netting agreements.

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

\381\ See 12 CFR 3.2, 12 CFR 217.2, and 12 CFR 324.2. Regulatory

Capital Rules, Liquidity Coverage Ratio: Interim Final Revisions to

the Definition of Qualifying Master Netting Agreement and Related

Definitions, 79 FR 78287 (Dec. 30, 2014).

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

A number of commenters argued that, in order to allow close-out

netting and contain costs, the final rule should not require new master

agreements to separate pre- and post-compliance date swaps, and that

parties should be permitted to use credit support annexes that are part

of the EMNA instead of new master agreements to distinguish pre-and

post-compliance date swaps.\382\ In response to commenters, the final

rule provides that an EMNA may identify one or more separate netting

portfolios that independently meet the requirement for close-out

netting \383\ and to which, under the terms of the EMNA, the collection

and posting of margin applies on an aggregate net basis separate from

and exclusive of any other uncleared swaps covered by the agreement.

This rule should facilitate the ability of the parties to document two

separate netting sets, one for uncleared swaps that are subject to the

final rule and one for swaps that are not subject to the margin

requirements. A netting portfolio that contains only uncleared swaps

entered into before the applicable compliance date is not subject to

the requirements of the final rule.

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

\382\ See TIAA-CREF; CPFM; ICI; SIFMA; ISDA; SIFMA-AMG; ABA;

JBA; CS; AIMA; MFA; FSR; Freddie; ACLI; and FHLB.

\383\ See Sec. 23.151 (paragraph 1 of the EMNA definition).

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

Notably, for an agreement to qualify as an EMNA, the CSE must

conduct sufficient legal review to conclude with a well-founded basis

that the agreement, among other things, would be legal, valid, binding,

and enforceable under the law of the relevant jurisdictions. The

Commission recognizes that the requisite ``sufficient legal review''

will require, as a practical matter, a legal opinion, which will

adversely affect costs for CSEs. Additionally, to the extent that a

``sufficient legal review'' cannot be obtained (e.g., because the

foreign jurisdiction is lacking in comparable close-out netting

arrangements), a CSE would need to collect and post on a gross basis.

Nevertheless, given the importance of a legally binding and enforceable

netting arrangement in the event of default, the Commission is

retaining the legal review requirement.

Finally, CSEs may include legacy swaps in the same EMNA through the

use of multiple CSAs. This approach would allow CSEs to preserve the

benefit of close-out netting with all their swaps with a specific

counterparty. However, legacy swaps may not be included when multiple

CSAs are used in calculating the initial margin amount for that

counterparty. The Commission designed this approach to prevent cherry-

picking as a CSE could select specific legacy trades that would reduce

the amount of initial margin required on any certain day.

4. Variation Margin

Variation margin provides an important risk mitigation function by

preventing the build-up of total uncollateralized credit exposure of

outstanding uncleared swaps. Under the final rule, a CSE must collect

variation margin from or pay variation margin to its counterparty on or

before the business day after the date of execution of an uncleared

swap. Variation margin would be required for all financial end users,

regardless of whether the entity has material swaps exposure. In this

regard, the final rule is consistent with the Prudential Regulators'

rules and the 2013 International Standards. In addition, the Commission

is requiring a daily, two-way exchange of variation margin since mark-

to-market is based on unrealized gains of either party (i.e., if one

party has an unrealized gain, the other party has an unrealized loss).

The exchange of variation margin would result in additional costs

to CSEs and financial end users that currently are exchanging variation

margin or exchanging variation margin less frequently than daily. These

financial entities may also need to adjust their portfolio to ensure

the availability of eligible collateral for exchanging variation

margin.\384\

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

\384\ The next section discusses the expanded eligible

collateral for variation margin.

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

The final rule requires certain control and validation mechanisms

for the calculation of variation margin to ensure that the variation

margin calculated would be adequate to cover the current exposure of

the uncleared swaps, including the requirement to create and maintain

documentation setting forth the CSEs' calculation methodology with

sufficient specificity to allow the counterparty, the Commission and

any applicable Prudential Regulator to calculate a reasonable

approximation of the margin requirement independently; and evaluate the

reliability of its data sources at least annually, and make

adjustments, as appropriate. Implementation of these measures will

result in additional costs to CSEs. Nevertheless, the Commission is

adopting these control and validation mechanisms as they are necessary

to ensure the accuracy of the variation margin calculation methodology

used by a CSE.

There are, however, several factors that should have a mitigating

effect on the cost of variation margin. First, as discussed below, the

final rule expands the list of eligible collateral for non-CSE

financial end users, which may reduce funding costs. In addition, the

final rule will include a minimum transfer threshold of $500,000, which

should mitigate some of the administrative burdens and counter-cyclical

effects associated with the daily exchange of variation margin, without

resulting in an unacceptable level of uncollateralized credit risk. In

addition, competitive disparities may be lessened by the fact that

daily exchange of variation margin is required with respect to all

financial end users under both the final rule and international

standards.

5. Eligible Collateral

Limiting eligible collateral to the most highly liquid categories

could limit the potential that a CSE would incur a loss following

default of a counterparty based on changes in market values of less

liquid collateral that occur before the CSE is able to sell the

collateral, and therefore could limit the potential for a default by

the CSE to other counterparties. On the other hand, an overly

restrictive eligibility standard could have the effect of draining

liquidity from the counterparty in a way that may not be necessary to

account for the CSE's potential future exposure to the counterparty,

and may increase costs for both counterparties.\385\ The Commission

considered these competing concerns in developing the list of eligible

collateral.

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

\385\ This could also lead to a greater demand on a relatively

few instruments.

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

For example, the Commission is allowing certain equities as

eligible collateral to prevent adverse effect on investment returns for

collective investment vehicles, insurance companies, and pension

funds.\386\ To accommodate the concern of certain commenters that

argued for an inclusion of money market mutual funds and bank

certificates of deposit in the list of

[[Page 687]]

eligible collateral for initial margin, the final rule also adds

redeemable securities in a pooled investment fund that holds only

securities that are issued by, or unconditionally guaranteed as to the

timely payment of principal and interest by, the U.S. Department of the

Treasury, and cash funds denominated in U.S. dollars.

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

\386\ See, e.g., ICI; ISDA; CPFM; GPC; SIFMA-AMG; IECA; Freddie;

and CDEU.

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

Although the Commission received several comments concerning the

proposal's treatment of the securities of certain GSEs, only modest

changes have been made in the final rule. The Commission continues to

believe the final rule should treat GSE securities differently

depending on whether or not the GSE enjoys explicit government support,

in the interests of both the safety and soundness of CSEs and the

stability of the financial system. In other words, the treatment of GSE

securities by market participants as if those securities were nearly

equivalent to Treasury securities in the absence of explicit Treasury

support creates a potential threat to financial market stability,

especially if vulnerabilities arise in markets where one or more GSEs

are dominant participants, as occurred during the summer of 2008. The

final rule's differing treatment of GSE collateral based on whether or

not the GSE has explicit support of the U.S. government helps address

this source of potential financial instability and recognizes that

securities issued by an entity explicitly supported by the U.S.

government might well perform better during a crisis than those issued

by an entity operating without such support.

In addition, the final rule prohibits the use of certain assets as

collateral because their use might compound risk, i.e., wrong way risk.

The list of prohibited assets include instruments that represent an

obligation of the party providing such asset or an affiliate of that

party and instruments issued by bank holding companies, depository

institutions, systemically important financial institutions, and market

intermediaries. The Commission notes that the price and liquidity of

securities issued by these entities are likely to lose value at the

same time that the counterparty's obligation under the swap increases,

resulting in an additional increase in risk. For this reason,

notwithstanding the additional funding costs that may result, the

Commission believes that including these instruments as eligible

collateral would be inappropriate.

Under the final rule, for swaps between a CSE and a financial end

user, the Commission is expanding the form of eligible collateral that

can be posted for variation margin to accommodate the assets held by

the affected financial end users. The Commission believes that this

should mitigate the potential for investment drag of financial end

users, as well as mitigate the pro-cyclical effects potentially

resulting from restricting eligible collateral to cash.

As noted above, the Commission is limiting eligible collateral to

cash for variation margin between CSEs since these entities pose a

significant level of risk to the financial system and cash is the most

liquid asset and holds its value in times of stress. Since CSEs

currently exchange variation margin in cash, the cash-only requirement

could have minimal impact on CSEs. On the other hand, the Commission

understands that, in times of stress when cash may be difficult to

obtain, it is possible that CSEs may be cash constrained and therefore,

could fall into a technical default. The Commission considered these

competing concerns in developing this requirement.

The Commission is adopting standardized haircuts on instruments

other than cash.\387\ For example, in the case where equities are used

as eligible collateral, there is a requirement for a minimum 15 percent

haircut on equities in the S&P 500 Index and a minimum 25 percent

haircut for those in the S&P 1500 Composite Index but not in the S&P

500 Index.\388\ The Commission is not allowing CSEs to use internal

models to calculate haircuts on eligible collateral. The Commission

recognizes that, as a result, more assets would be required to be

posted as margin, which may result in additional funding costs.\389\ On

the other hand, a more conservative approach reflected in the final

rule would result in a greater amount of assets posted, which provides

a greater buffer to cover losses in the event of a default.

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

\387\ The Commission recognizes that these haircuts apply to

certain currencies, under certain circumstances.

\388\ As discussed in Appendix A, the Commission recognizes that

due to certain investment constraints, including regulatory

limitations, not every financial entity is going to be able to

pledge all types of eligible collateral, which will have an effect

on its funding costs of collateral.

\389\ The Commission would expect that under the model based

approach, calculated haircut would be less than the standardized

haircut approach.

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

6. Segregation

Posted collateral must be properly protected in order to avoid

undermining the benefits of the margin requirements. The Commission

understands that, to the extent that the final rule's segregation

requirements diverge from existing industry practices, CSEs may incur

substantial administrative costs.

Under the final rule, required initial margin must be kept in

accordance with the following: (1) All funds collected and posted as

required initial margin must be held by a third-party custodian

(unaffiliated with either counterparty to the swap); (2) the third-

party custodian is prohibited from re-hypothecating, re-using, or re-

pledging (or otherwise transferring) the initial margin; (3) the

initial margin collected or posted may not be reinvested in any asset

that would not qualify as eligible collateral; and 4) the custodial

agreement is legal, valid, binding and enforceable in the event of

bankruptcy, insolvency, or similar proceedings.

While several commenters supported the mandated use of a third-

party custodian, others objected, citing concerns about complexities

that additional parties bring to the relationship, as well as increased

costs arising from the negotiation of custodial contracts and the cost

of developing operational infrastructure as using a third-party

custodian is not the current practice for certain financial

entities.\390\ The Commission is also aware that many custodians are

affiliated with one or more CSE or financial end users; as a result,

the mandated use of a third-party custodian may lead to collateral

assets being held at a limited number of custodians.

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

\390\ See GPC.

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

The Commission believes that it is necessary to require the use of

an independent third-party custodian to safeguard required initial

margin in order to best ensure that those assets would be available to

the non-defaulting counterparty in the event of a counterparty default.

A custodian that is affiliated with either counterparty to a swap

raises the concern that in the event of a default by its affiliate

counterparty, the custodian's affiliation may compromise its ability to

act swiftly to release funds to the non-defaulting counterparty. As to

concerns regarding the high concentration of custodians that could

result from the independence element, the Commission notes that

segregated accounts would be protected--regardless of the concentration

level of custodians--as they would not be part of the estate of the

defaulting custodian under the current bankruptcy regime.

Several commenters recommended lifting the restriction on

rehypothecation and reuse of initial margin collateral, either

generally or on a conditional basis.\391\ The Commission

[[Page 688]]

is not allowing the rehypothecation of initial margin collateral.

Rehypothecation would allow the collateral posted by one counterparty

to be used by the other counterparty as collateral for additional

swaps, resulting in rehypothecation chains and embedded leverage

throughout the financial system. The increased leverage, along with the

additional connections between market participants, resulting from

rehypothecating margin, could have a destabilizing effect on the

financial system.\392\ The Commission understands that prohibition

against rehypothecation will impose significant costs on market

participants as this will increase their funding costs for margin.

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

\391\ See CPFM; CCMR; IFM; ISDA; SIFMA; ABA; CS; and FSR.

\392\ For example, a default or liquidity event that occurs at

one link along the rehypothecation chain may induce further defaults

or liquidity events for other links in the rehypothecation chain as

access to the collateral for other positions may be obstructed by a

default further up the chain. Also, in the event of one default

along the chain, there is an increased chance that each party along

the chain will ask for the rehypothecated collateral to be returned

to them at the same time, leaving just one party with the

collateral. This spiraling event is the result of only one asset

being pledged for all the positions along the rehypothecation chain.

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

The Commission is not allowing cash to be posted as initial margin

collateral without it being converted into other eligible collateral.

As noted above, cash held at a custodian in a deposit account can be

used by the custodial bank and as such, posting of cash as initial

margin would run afoul of the prohibition against rehypothecation. This

requirement may lead to additional funding costs in the form of excess

margin being held at the custodian. However, the Commission expects

that counterparties will post some other form of eligible collateral

and subsequently substitute the cash with other eligible assets,

including a sweep vehicle, which should mitigate the burdens placed by

this requirement.

7. Documentation

Comprehensive documentation of counterparties' rights and

obligations to exchange margin allows each party to manage risks more

effectively throughout the life of the swap and to avoid disputes

regarding the terms of the swap during times of financial turmoil. In

furtherance of that goal, the final rule requires that CSEs enter into

contractual documentation with counterparties addressing, among other

things, how swaps would be valued for purposes of determining margin

amounts, and how valuation disputes would be resolved. To the extent

that other Commission regulations address similar requirements, burdens

on CSEs should be minimal.

8. Non-Financial End Users

The Commission's proposal did not require CSEs to exchange margin

with non-financial end users as the Commission believes that such

entities, which generally are using swaps to hedge commercial risk,

pose less risk to CSEs than financial entities. Instead, the proposal

would have required a CSE, for transactions with non-financial end

users with material swaps exposure to such CSE, each day to calculate

both initial and variation margin as if they were a CSE. These

calculations would serve as risk management tools to assist the CSE in

measuring its exposure and to assist the Commission in conducting

oversight of the CSE. The majority of commenters opposed the

hypothetical margin calculation requirement for non-financial end

users.\393\ Commenters generally noted the significant burdens this

requirement may place on CSEs and the non-financial end user, who must

monitor their swaps exposures to determine if they exceed the material

swaps exposure threshold.

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

\393\ See ISDA; SIFMA; Joint Associations; JBA; FSR; ETA; NGCA/

NCSA; CDEU; COPE; BP; Shell TRM; and CEWG.

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

In response to the comments, the Commission is not adopting the

hypothetical margin calculation requirements concerning non-financial

end users. Although the Commission continues to believe that

hypothetical margin calculation requirements would promote the

financial soundness of CSEs, the Commission recognizes the additional

administrative burdens such measure could impose on CSEs and on non-

financial end users. The Commission has determined that removing the

hypothetical margin calculation is appropriate, particularly in light

of the comprehensive risk management program that all CSEs are required

to establish and maintain under existing Commission regulations.\394\

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

\394\ See, e.g., Sec. 23.600 of the Commission's regulations.

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

The proposal also would have required documentation between a CSE

and a non-financial end user to state whether margin is required to be

exchanged and, if so, the applicable thresholds below which margin is

not required. In response to commenters' concern that the standards are

too burdensome and that other Commission regulations adequately address

the subject, the Commission is not adopting any new documentation

requirement for uncleared swaps with non-financial end users.\395\

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

\395\ See ISDA.

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

9. Inter-Affiliate Swaps

Under the final rule, the Commission is requiring the exchange of

variation margin for swaps between a CSE and its affiliate. Initial

margin is required to be collected from an affiliate if the affiliate

is in a jurisdiction without comparable margin requirements with

respect to the affiliate's outward-facing (i.e., third-party)

transaction. In addition, where the risk is being transferred to the

CSE through a chain of inter-affiliate swaps, with the risk originating

from a third-party transaction, that third-party transaction must be

subject to comparable margin requirements with respect to that

particular transaction; otherwise, the CSE must collect initial margin

from its affiliate counterparty.

The Commission understands that CSEs currently exchange variation

margin when entering into swaps with their affiliates. Therefore, the

Commission expects that CSEs will incur incremental costs associated

with funding variation margin under the final rule. Because the

Commission in most cases is not requiring posting and collection of

initial margin for inter-affiliate swaps, this may result in a CSE, in

the event of a default of an affiliate counterparty (or the default of

any of the affiliates in a chain of inter-affiliate swaps that has a

cascading effect), not having enough margin to cover its losses on an

inter-affiliate swap. However, viewed as a consolidated entity, the

overall risk to the entity and the financial system, in terms of credit

risk and leverage, should not be increased, as a result of the

Commission's requirement, as the affiliate entering into an outward-

facing swap must collect margin or the CSE must collect margin from its

affiliated counterparty. In addition, as these inter-affiliate trades

are typically designed to move risk to the most liquid market (in terms

of breath and depth), this will permit the CSE to efficiently manage

that risk. In addition, by not posting initial margin on their inter-

affiliate swaps, the affected affiliates may compete more effectively

by passing the cost savings to clients.

The Commission believes that the Prudential Regulators' approach,

which requires swap dealers subject to the Prudential Regulators'

margin rules to collect only for initial margin, would be too costly to

the extent that the subject inter-affiliate trade is viewed as shifting

risks within the consolidated group. This difference may make it less

costly

[[Page 689]]

to conduct inter-affiliates swaps for Commission-regulated swap dealers

than prudentially regulated swap dealers and CSEs. As a result of

higher costs in transacting with prudentially regulated swap dealers

than CSEs, the consolidated parent would favor inter-affiliates swaps

with a CSE over a prudentially regulated swap entity.

10. Compliance Schedule

As discussed above, the Commission expects that affected entities

will need to update their current operational infrastructure to comply

with the provisions of the final rule, including potential changes to

internal risk management and other systems, netting agreements, trading

documentation, and collateral arrangements. In addition, the Commission

expects that CSEs that opt to calculate initial margin using an initial

margin model will modify such models and obtain regulatory approval for

their use.\396\ In this regard, the Commission recognizes that CSEs and

other affected counterparties can benefit from additional time to come

into compliance with the new margin regime; at the same time, it is

important that the final rule is implemented without undue delay so as

to protect CSEs and the U.S. financial system as Congress intended.

Accordingly, the Commission has determined to adopt a phase-in schedule

for compliance.\397\ The phase-in schedule is also responsive to

commenters supporting international harmonization of implementation

dates for margin requirement.

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

\396\ The Commission understands that under current practices,

CSEs already use models to calculate initial margin requirements for

certain clients, including hedge funds.

\397\ See Sec. 23.161.

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

Under the phase-in schedule, the largest and most sophisticated

covered swap entities that present the greatest potential risk to the

financial system comply with the requirements first. The Commission

expects that this would be less of a burden on these entities as they

currently have the infrastructure in place to meet the requirements and

would require the least amount of modification.

C. Section 15(a) Factors

1. Protection of Market Participants and the Public

Under the final rule, the market and the public will benefit from

the required collateralization of uncleared swaps. More specifically,

the margin requirements should mitigate the overall credit risk in the

financial system, reduce the probability of financial contagion, and

ultimately reduce systemic risk.

The primary reason for collecting margin from counterparties is to

protect an entity in the event of its counterparty default. That is, in

the event of a default by a counterparty, margin protects the non-

defaulting counterparty by allowing it to use the margin provided by

the defaulting entity to absorb the losses and to continue to meet all

of its obligations. In addition, margin functions as a risk management

tool by limiting the amount of leverage that either counterparty can

incur. Specifically, the requirement to post margin ensures that each

counterparty has adequate collateral to enter into an uncleared swap.

In this way, margin serves as a first line of defense in protecting an

entity from risk arising from uncleared swaps, which ultimately

mitigates the possibility of a systemic event.

Protecting financial entities from the risk of failure has direct

benefit to the public as the failure of these entities could result in

immediate financial loss to its counterparties or customers. Given the

importance of these entities to the financial system, their failure

could spill over to other parts of the broader economy, with

detrimental impact on the general public.

The final rule may also have the effect of promoting centralized

clearing. Specifically, the final rule's robust margin requirements for

uncleared contracts may create incentives for participants to clear

swaps, where available and appropriate for their needs.\398\ Central

clearing can provide systemic benefits by limiting systemic leverage

and aggregating and managing risks by a central counterparty.

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

\398\ As a result of the cost effects on the Commission's final

rule, it is expected that some market participants may change their

practice of using uncleared swaps to alternative instruments.

Futures and cleared swaps, which tend to be more standardized and

liquid than uncleared swaps, typically require less initial margin;

however, this may result in basis risk, as a result of

standardization of these products. A futures contract has a one day

minimum liquidation time. A cleared swap has a three to five day

minimum liquidation time whereas the Commission's margin rules

requires a ten day minimum liquidation time for uncleared swaps.

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

On the other hand, required margin may reduce the availability of

liquid assets for purposes other than posting collateral and therefore

affect the ability of CSEs to engage in swaps activities and financial

end users to manage or hedge the risks arising from their business

activities. In addition, as detailed below in Appendix A, the

Commission's margin requirements will increase the cost of entering

into a swap transaction. The final margin rule incorporates various

cost-mitigating provisions--such as the initial margin thresholds,

expansion of eligible collateral for variation margin for financial end

users, and minimum transfer amount--to contain potentially adverse

impacts on the market and the public.

2. Efficiency, Competitiveness, and Financial Integrity of Swap Markets

In finalizing the rule, the Commission strived to promote

efficiency and financial integrity of the swaps market, and where

possible, mitigate undue competitive disparities. Most notably, the

Commission, in finalizing the margin rule, aligned the rule with that

of the Prudential Regulators to the greatest extent possible. This

should promote greater operational efficiencies for those CSEs that are

part of a bank holding company as they may be able to avoid creating

individualized compliance and operational infrastructures to account

for the final rule and instead, rely on the infrastructure supporting

the bank CSE.

The final rule also provides for built-in flexibilities that should

enhance the efficiency in the application of the rule. For example, the

final rule provides counterparties the flexibility to post a variety of

collateral types to meet the margin requirements which may result in

increased efficiencies for end users and promote the use of swaps to

hedge or manage risks. For initial margin calculation methodology, the

final rule provides CSEs with the choice of two alternatives to allow

them to choose the methodology that is the most cost efficient for

managing their business risks.

Proper documentation of swaps is crucial to reducing risk in the

bilaterally-traded swaps market. Accordingly, the final rule requires

that CSEs enter into contractual documentation with counterparties

addressing, among other things, how swaps would be valued for purposes

of determining margin amounts, and how valuation disputes would be

resolved. Documentation of counterparties' rights and obligations to

exchange margin should allow each party to manage risks more

effectively throughout the life of the swap and to avoid disputes

regarding the terms of the swap during times of financial turmoil.

The safety and soundness of CSEs--given the nature and scope of

their activities--are critical to the financial integrity of markets.

As discussed above, margin serves as a first line of defense to protect

a CSE in the event of a default by its counterparty. It also

[[Page 690]]

helps to reduce the risk of a systemic event by containing the risk of

a cascade of defaults occurring. A cascade occurs when one participant

defaulting causes subsequent defaults by its counterparties, and so on,

resulting in a domino effect and a potential financial crisis.

The Commission also notes that the final margin rule, like other

requirements under the Dodd-Frank Act, could have a substantial impact

on the relative competitive position of market participants operating

within the United States and across various jurisdictions. U.S. or

foreign firms could be advantaged or disadvantaged depending on how the

Commission's margin rule compares with corresponding requirements under

Prudential Regulators' margin regime or in other jurisdictions. To

mitigate undue competitive disparities, the Commission, in developing

the final rule, harmonized the final rule with those of the Prudential

Regulators and the BCBS-IOSCO framework.

3. Price Discovery

The Commission is requiring a ten-day margin period of risk for

uncleared swaps, as compared to a three- to five-day margin period of

risk for cleared swaps. Also, the Commission is only allowing limited

netting for uncleared swaps. Together, these provisions of the final

rule may result in the use of more standardized products.

Increase in the use of standardized products may lead to greater

transparency in the cleared swaps and futures markets. If market

participants migrate to standardized products, price discovery process

for such swaps and futures may improve with higher volumes. Conversely,

lower volumes for uncleared swaps may negatively impact the price

discovery process for such swaps. However, the Commission believes that

since these uncleared swaps are customized, the potential reduction in

the efficacy of the price discovery process for uncleared swaps is less

of a concern.

4. Sound Risk Management Practices

A well-designed risk management system helps to identify, evaluate,

address, and monitor the risks associated with a firm's business. As

discussed above, margin plays an important risk management function.

Initial margin addresses potential future exposure. That is, in the

event of a counterparty default, initial margin protects the non-

defaulting party from the loss that may result from a swap or portfolio

of swaps, during the period of time needed to close out the swap(s).

Initial margin augments variation margin, which secures the current

mark-to-market value of swaps. This, in turn, forces market

participants to recognize losses promptly and to adjust collateral

accordingly and helps to prevent the accumulation of large unrecognized

losses and exposures.

The final rule permits CSEs to calculate initial margin by using

either a risk-based model or standardized table method. The choice of

two alternatives may enhance a CSE's risk management program by

allowing the CSE to choose the methodology that is the most effective

for managing their business risks.

The Commission is also requiring a ten-day margin period of risk

for uncleared swaps and only a five-day margin period of risk for

cleared swaps. Thus, the rule may result in the use of more

standardized cleared swaps at the expense of more customized swaps

which may be harder to evaluate and risk manage; however, this may

encourage market participants to use less ideal hedging techniques, as

noted above, which may result in a different type of risk at a firm.

Finally, the Commission is imposing strong model governance,

oversight and control standards that are designed to ensure the

integrity of the initial margin model and provide margin requirements

that are commensurate with the risk of uncleared swaps. For the

foregoing reasons, the final rule promotes sound risk management

practices by CSEs.

5. Other Public Interest Considerations

The Commission has not identified any additional public interest

considerations related to the costs and benefits of the final rule.

Appendix A to the Preamble

In this Appendix, the Commission provides its estimate of the

funding costs related to the final initial and variation margin

requirements and discusses certain key aspects of overall

administrative costs. As noted below, there are a number of

challenges presented in conducting a quantitative analysis of the

costs associated with the final rule. In this exercise, the

Commission looked to data sources that were representative of the

current swaps market and scaled the data to limit its estimate to

CSEs and their uncleared swaps. Given the complexity of this final

rule and its inter-relationship to other rulemakings, the

Commission's estimate is subject to considerable uncertainty. The

Commission's estimates are based on available data and assumptions

set out below.

In the proposal, the Commission requested commenters to provide

data or other information that would be useful in estimation of the

quantifiable costs and benefits of this rulemaking. No commenters,

with the exception of NERA, provided any data; NERA provided its

estimate of the overall costs of the margin requirements under the

Prudential Regulators' and Commission's proposed rules.\399\ The

Commission's estimate of the funding cost of initial margin diverges

from that of NERA, as explained below.

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

\399\ NERA provided recommendations for reducing the costs for

the final rule; these recommendations are discussed above.

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

I. Margin Costs

A. Funding Cost

The Commission reviewed various industry studies estimating the

total cost of initial margin that would be required by the margin

rules, as proposed, by the Prudential Regulators and the CFTC.\400\

These studies rely on a different set of assumptions in calculating

the funding costs of the margin rules, as explained below. The

Commission used this set of industry data, which provides global

estimates of the margin required under such rules, to construct its

own estimates of costs. The cost estimates include two major

components. The first component is an estimate of the amount of

initial margin subject to the Commission's margin regime,

constructed by scaling the global estimates of the margin to the

relevant basis. The second component is an annual funding cost. The

Commission multiplied these two components in order to obtain an

annual cost of funding margin as required by the rules. This

methodology is similar to that used by the Prudential Regulators in

their quantitative analysis in finalizing their margin rules.

Details of the methodology are described in the text that follows.

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

\400\ As discussed below, these studies did not distinguish

between CSEs and prudentially-regulated swap dealers.

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

Table A, below, presents estimated amounts of initial margin

that would be required for CSEs under the final rule.\401\ These

estimates are based on the assumption that the final rule is

effective (i.e., in the post-transitional period).

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

\401\ The Commission is unable to quantify certain swaps that

may fall under the final rule. Specifically, there are swaps entered

into by some non-U.S. swap dealers and foreign counterparties that

would be swept into this rulemaking under a 2(i) analysis (relating

to the Commission's authority to regulate cross-border swaps) that

are not reported. The Commission acknowledges that these costs are

not reflected in the Commission's estimates because the Commission

does not require regulatory reporting of all transaction data on

swaps transacted globally by derivatives dealers covered by the

rule. Hence, the Commission notes the limitation of the estimates

shown in Table A, but is unable to make a reasonable estimate of the

notional amount of derivatives not covered by its estimates.

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

The initial margin estimates in Table A are based on two

different studies that estimate the potential impact of the 2013

international framework: BCBS and IOSCO \402\ and

[[Page 691]]

ISDA \403\ studies. Each study reports an estimate of the global

impact of margin requirements, which is displayed under the column

heading ``Global ($BN).'' Most notably, these studies provide

estimates based on the assumption that margin requirements apply to

all uncleared swaps of all market participants covered by the 2013

international framework.

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

\402\ See Basel Committee on Banking Supervision and the

International Organization of Securities Commissions (2013), Margin

Requirements for Non-Centrally Cleared Derivatives: Second

Consultative Document, report (Basel, Switzerland: Bank for

International Settlements, February).

\403\ Documents on initial margin requirements are available on

the International Swaps and Derivatives Association Web site.

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

To estimate the funding costs of the initial margin requirement,

the Commission modified the ISDA and BCBS IOSCO survey estimates in

two stages. In the first stage, the Commission multiplied the survey

estimates by 57% to align the global estimates better with the

impact of the U.S. rules. The Commission utilized Swap Data

Repository (SDR) data on uncleared interest rate swaps, which

represent the majority of the notional value associated with

uncleared swaps, to compute the 57% scale factor. The 57% scaling is

designed to represent the notional amount of uncleared interest rate

swaps reported to the SDRs as a fraction of the global notional

amount of uncleared interest rate swaps represented in the surveys.

The Commission's Weekly Swaps Report shows $100.9 trillion in

notional outstanding for uncleared interest rate swaps reported to

SDRs as of June 5, 2015, whereas the BCBS-IOSCO survey represents

$175.6 trillion in global notional outstanding of uncleared interest

rate swaps. Hence, the ratio between the two is approximately 57%

(100.9/175.6 = 57.46%). The Commission applied this 57% scale factor

to the global notional amount of margin estimated in each of the

surveys.\404\

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

\404\ The BCBS-IOSCO survey estimate is based on a global

notional amount outstanding of $281.3 trillion of uncleared swaps.

We apply the ratio 100.9/175.6 = 57% to each of the global margin

figures to reduce them to the relevant basis for the rule.

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

These estimates inherit the limitations of the global estimates

provided by the underlying studies, which applied rules that are

similar, but not identical, to the Commission's rules. For example,

the BCBS-IOSCO survey results do not apply the $8 billion material

swaps exposure threshold, and in fact did not apply any such

threshold. It also did not exclude swaps with a non-financial end

user as a counterparty. The results are likely to be conservative

and overstate the actual impact of the U.S. rules.

In a second stage, the Commission multiplied the results

obtained in the first stage by 25%. This 25% scale factor reduces

the estimates to account for the narrower scope of the Commission's

rule as compared to the scope of SDR data. For a variety of reasons,

many of the uncleared swaps reported to the SDRs do not require

margin under the Commission's rule. For example, margin may instead

be required under the Prudential Regulators' rule. Alternatively,

margin would not be required if a covered swap entity's counterparty

to a swap is a non-financial end user. The Commission has used SDR

data to compute this 25% scale factor applied in its cost estimates.

This scale factor is computed by comparing the notional amount of

swaps covered by the Commission's rule to the total notional amount

represented by SDR data.\405\ The Commission believes that 25% is an

appropriate scale factor to adjust the total notional value of

uncleared swaps, reported to the SDR, to the relevant notional

value.

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

\405\ For the purposes of this calculation, the impact of the $8

billion material swaps exposure threshold for financial end users

was approximated in the following manner. Entities estimated to have

had less than $8 billion total notional of open IRS swaps on June 5,

2015 were considered not to have material swaps exposure. The

Commission understands that it is possible that its estimate of the

number of financial end users with material swaps exposure may over-

or underestimate the total number of covered counterparties as

certain instruments that are used in the calculation are not

included in this estimate and certain entities that may be excluded

from the Commission's margin rule may be included.

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

The Commission has estimated this 25% scale factor based on the

uncleared outward-facing open interest rate swaps reported to DTCC

as of June 5, 2015. The scale factor compares the notional value of

swaps covered by the Commission's rule to the total notional value

of all swaps reported to the SDR. Because the identity of both

counterparties to a trade is relevant for the computation, notional

values for each trade side are utilized to construct the ratio

(i.e., notional values are double-counted). If both counterparties

of a swap are subject to the Commission's margin rule, the notional

amount is counted twice (once for each counterparty).If one

counterparty is subject to the Commission's margin rule, but the

other counterparty is subject to the Prudential Regulators' margin

rule, the notional amount is counted once (for the counterparty

covered by the Commission's rule).

Based on the SDR data, the Commission estimates that the total

notional amount of uncleared interest rate swaps subject to the

Commission's initial margin requirement is roughly $42 trillion

(where both trade sides are potentially counted). The total notional

value, reported to the SDR, used in this calculation is $202

trillion (which is twice the $100.9 trillion, one-sided, total

notional value noted earlier). The ratio of these two values is

therefore 21% (which equals 42 divided by 202). To be conservative,

the Commission assumes that the total notional amount between the

CSEs and their covered counterparties account for roughly 25% of the

total notional value of uncleared swaps reported to the SDRs.\406\

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

\406\ The Commission assumed that on June 5, 2015, there were 54

CSEs. The Commission based this number on the number of

provisionally registered swap dealers and major swap participants.

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

The net effect of applying these two scale factors to the survey

estimates is to multiply the raw, survey estimates of initial margin

by approximately 14% (57% x 25% = 14.25%). These estimates are

displayed in Table A under the column heading ``Covered Swap

Entities ($BN).'' \407\

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

\407\ The BCBS-IOSCO impact study discusses the impact of

several different margin regimes, e.g., regimes with and without an

initial margin threshold. In addition, the estimate costs reported

in Table A from the BCBS-IOSCO study reflects an estimate from the

study that is most comparable to the Commission's final rule.

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

Table A presents a range of estimates based on the ISDA and

BCBS-IOSCO studies. Both the ISDA's low estimate and the BCBS-IOSCO

estimate assume that all initial margin requirements are calculated

according to an internal model with parameters consistent with those

required by the final rule. The ISDA's high estimate assumes that

all initial margin requirements are calculated according to a

standardized gross margin approach. Further, the ISDA standardized

approach does not allow for the recognition of any netting

offsets.\408\ The Commission anticipates that most entities will use

internal models to calculate initial margin.

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

\408\ The ISDA study was conducted based on the BCBS-IOSCO

February 2013 consultative document which did not include any

recognition of offsets in the standardized initial margin regime.

Recognition of offsets was included in the final 2013 international

framework.

Applying the standardized approach on SDR data for June 5, 2015,

the Commission estimated total gross initial margin due to the new

margin requirements at $1.174 trillion for IRS and CDS, which is

less than the ISDA-standardized initial margin estimates of $1,454

billion shown in Table A.

[[Page 692]]

Table A--Estimated Initial Margin Requirements for Outward Facing Swaps, Based on Prior Estimates of Global

Margin Required

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

Covered swap

Source Method Global ($BN) entities *

($BN)

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

ISDA.......................................... Standardized.................... 10,200 \409\ 1,454

ISDA.......................................... Model Based..................... 800 \410\ 114

BCBS-IOSCO.................................... Model Based..................... 900 \411\ 128

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

* Assumes uncleared swaps between CSEs and their covered counterparties is approximately 14% of global notional

outstanding, as described in the text.

Table B presents a matrix of the annual cost estimates

associated with the initial margin requirements.\412\

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

\409\ 10,200 x 14.25% = 1,454.

\410\ 800 x 14.25% = 114.

\411\ 900 x 14.25% = 128.

\412\ The cost of funding initial margin for CSEs or covered

counterparties is a function of the entities' business model,

including their financial structure, financial activities and

services, and risk profile. The most direct cost of providing

initial margin is generally the difference between the cost of

funding the required margin, including the opportunity cost on the

use of the margin, less the rate of return on the assets used as

margin. In some cases, for example, certain registered investment

companies will have no additional incremental funding costs, as they

will be able to post assets that they currently hold on their

balance sheet as eligible collateral. Alternatively, certain

entities may have to raise additional funds to purchase eligible

assets, as they may not have any or may need more of eligible

collateral.

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

The three rows of the matrix correspond to the ISDA

Standardized, ISDA Model Based, and BCBS-IOSCO Model Based

approaches for determining initial margin amounts that are presented

and discussed above (in relation to Table A). The matrix includes

four columns, two of which contain final funding-cost estimates for

initial margin required under the final rule. The two funding-cost

columns identify the Commission's estimated lower-end and upper-end

range for funding costs based on three different methods (i.e.,

BCBS-IOSCO, ISDA Model Based, and ISDA Standardized).

For the purposes of this matrix, the Commission assumed that the

opportunity cost of funding initial margin is between 25 basis

points and 160 basis points. The Commission acknowledges that this

opportunity cost range is expansive, but based on the Commission's

experience and understanding of the entities covered by its margin

rule (e.g., swap dealers, insurance companies, collective investment

vehicles), it believes that range addresses the idiosyncrasies of

these entities. As noted above, some entities covered under the

margin rule (e.g., certain registered mutual funds) will be able to

post eligible collateral that are already on their balance sheets

(i.e., investments). Given this possibility, the Commission makes a

conservative assumption that the opportunity cost of pledging

collateral on the lower end is 25 basis points.

For the purposes of determining the higher-end of opportunity

costs, the Commission accepted Duff & Phelps' weighted average cost

of capital of 4.6% for large security brokers and dealers, and then

subtracted the 3% return on 30-year Treasury collateral to arrive at

1.6% of funding costs.\413\ The Commission assumes that the 160

basis points address situations where, for example, a swap dealer

does not have sufficient eligible collateral on its balance sheet.

As a result, the swap dealer would need to raise capital by issuing

debt or equity to purchase eligible collateral, for instance, 30-

year Treasuries to meet the final rule's initial margin

requirements. Under this hypothetical, the swap dealer's opportunity

costs related to posting eligible collateral are increased.\414\

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

\413\ For SIC code 621, Security Brokers, Dealers, Flotation,

the Weighted Average Cost of Capital (``WACC'') is computed to be

4.6% for large firms as of March 31, 2015 by Duff & Phelps, ``2015

Valuation Handbook: Industry Cost of Capital.'' WACC is estimated

over a time horizon that includes a stressed period.

\414\ It should be noted that the entity is also forgoing the

use of the borrowed funds, as an investment asset. Therefore, this

opportunity cost is also imbedded in this cost.

\415\ 1,454 x 0.25% = 3.64.

\416\ 1,454 x 1.6% = 23.26.

\417\ 114 x 0.25% = 0.29.

\418\ 114 x 1.6% =1.82.

\419\ 128 x 0.25% = 0.32.

\420\ 128 x 1.6% =2.05.

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

Each annual funding cost estimate in table B is computed by

multiplying the initial margin amount for CSEs (from Table A)

identified in each row by the opportunity cost of funding initial

margin identified in each column. The amounts presented in Table B

are reported in billions.

Table B--Estimated Annual Cost of Initial Margin Requirements for CSEs and Their Covered Counterparties

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

Final cost ($BN)

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

Opportunity Opportunity

Source Method cost of cost of

funding funding

initial margin initial margin

(at 0.25%) (at 1.6%)

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

ISDA.......................................... Standardized.................... \415\ 3.64 \416\ 23.26

ISDA.......................................... Model........................... \417\ 0.29 \418\ 1.82

BCBS-IOSCO.................................... Model........................... \419\ 0.32 \420\ 2.05

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

The estimated annual cost of the initial margin requirements

depend on the specific initial margin estimate (which depends in

large part on whether the standardized or model approach is used)

and opportunity cost of funding initial margin. As discussed above,

the Commission expects the costs of the final margin rule to be more

consistent with the amounts based on the model approach (both ISDA

and BCBS-IOSCO), rather than the standardized approach for

determining initial margin amounts. Using the estimates based on the

model-based approaches, the Commission therefore, expects that the

costs of the final rule would most likely range from $290 million to

$2.05 billion.

B. Variation Margin

Under the final rule, the Commission is requiring the daily

exchange of variation margin. The requirement is intended to

mitigate the build-up of uncollateralized risk at swap

counterparties. In requiring the exchange of daily variation margin

the Commission acknowledges that there will additional costs to some

market participants,

[[Page 693]]

particularly to those who are not currently exchanging variation

margin daily.\421\

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

\421\ As discussed above, it should be noted that the

Commission's final rule includes a minimum transfer amount, which is

designed to mitigate some of the costs of exchanging variation

margin daily.

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

Presuming that a CSE maintains a relatively flat swap book,\422\

the cost of the cash only requirement is small when the CSEs collect

enough cash to post to other CSEs.\423\ However, when a CSE needs to

convert non-cash collaterals collected from financial end users into

cash to post to their swap dealer and major swap participant

counterparties,\424\ it places additional costs on a CSE.\425\ In

this case, a CSE may use a repurchase agreement to turn non-cash

collaterals into cash. The cost of repo transactions depend on many

factors, including duration and quality of collateral posted. For

example, on September 2, 2015, Bloomberg quotes one week treasury GC

repo rate of 0.24%.\426\ However, in times of severe financial

stress, the repo market may not provide access to market

participants. If this happens, a CSE may not be able to turn non-

cash collateral into cash which might cause technical defaults. In

order to avoid technical defaults, a CSE may elect to pay for a

committed repo agreement that gives them the right to enter into a

repurchase agreement for a fee at a predetermined repo rate

(presumably at a rate significantly above the normal repo

rate).\427\ This additional cost may be priced into a non-cleared

swap agreement and eventually be passed onto financial end users who

post non-cash collaterals.\428\ A CSE might also require financial

end users to only post cash, matching it collateral exposure.\429\

Despite these possibilities, the Commission notes that most of the

variation margin by total volume continues to be in the form of cash

exchanged between swap dealers.\430\

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

\422\ The Commission is assuming this as CSEs are dealers and

typically do not take proprietary long or short positions, in

contrast to other market participants (e.g., hedge funds).

\423\ According to the 2015 ISDA Margin Survey, each of the

largest dealers receives and pays, on average, roughly 6 billion USD

variation margin on a given day. When a swap dealer receives more

cash than it needs to pay, or an equal amount, the cost is minimal.

\424\ As the final rule requires cash to be posted between a CSE

and its swap entity counterparty, while permitting all types of

eligible collateral when it transacts with a financial end user,

this may result in a collateral mismatch.

\425\ For instance, this might happen when a CSE has posted all

the non-cash collateral that it can with financial end users as

variation margin.

\426\ According to the 2015 ISDA Margin Survey, each of the

largest dealers receives and pays, on average, roughly 6 billion USD

variation margin on a given day. If 1 percent of variation margin

received is non-cash collateral which needs to be turned into cash

using a repo agreement, then the daily cost will be roughly $400,

which is calculated as 60 million x 0.24%/360.

\427\ This is similar to a market participant paying a fee to

access to a revolving credit facility.

\428\ To the extent that these predetermined repos are used as a

funding mechanism for the entire operations of the entity, these

costs might not be completely passed on in the price or other aspect

of the relationship between the CSE and the financial end user.

\429\ It should be noted that this requirement may result in

better pricing terms or possibly some other beneficial change in the

relationship with the CSE.

\430\ According to the 2015 ISDA Margin Survey, 77 percent of

variation margin received and 75 percent of variation margin

delivered is in the form of cash. Available at https://www2.isda.org/functional-areas/research/surveys/margin-surveys/.

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

The Commission anticipates that many CSEs will have cheaper

access to liquidity than most financial end users and may be able to

pass along this cost savings to financial end users.\431\ The cash

only variation margin requirement only holds for swaps between a CSE

and another swap entity. The cash only variation margin requirement

does not apply to swaps between a CSE and a financial end user. This

change from the proposal should provide the flexibility to financial

end users to post and to hold the same types of financial

instruments in their portfolios for variation margin, as they did

prior to the final rule, which should result in less performance

drag.\432\ Financial end users may still end up paying for the

liquidity demanded on CSEs, but, overall, the CSEs' costs are likely

to be lower compared to the alternative of requiring cash only

variation margin for financial end users, because CSEs may be able

to pass on their liquidity advantage to financial end users.

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

\431\ The CSE may be able to pool liquidity needs for end users.

Due to CSE liquidity demands, they may need to establish or maintain

relationships with banks that have access to cheaper liquidity

through the payment system and the Federal Reserve System, in

general.

\432\ As suggested by NERA, this change should reduce the

possibility of pro-cyclicality in time of stress.

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

C. Administrative Costs

CSEs and financial end users will face certain startup and

ongoing costs relating to technology and other operational

infrastructure, as well as new or updated legal agreements. These

administrative costs related to margin for uncleared swaps are

difficult to quantify at this time; the Commission will discuss

these costs qualitatively instead.\433\

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

\433\ In the proposal the Commission requested comments

regarding the administrative costs involved in implementing its

proposed margin rule; however, the Commission did not receive any

quantitative data to assist it in its analysis therefore, the

Commission is undertaking a qualitative analysis.

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

The per-entity costs related to changes in technology,

infrastructure, and legal agreements are likely to vary widely,

depending on each market participant's existing technology

infrastructure, legal agreements, and operations, among other

things. As discussed in the preamble and below, the Commission

expects that certain aspects of the final rule--such as minimum

initial margin threshold and expanded list of eligible collaterals--

will have mitigating impact on the overall costs to an affected

entity. Moreover, the higher degree of harmonization between various

regulators and jurisdictions should result in lower administrative

costs.\434\ Longer lead times for industry to build out compliance

systems will lower administrative costs, because it gives industry

more time to plan and execute buildouts, which should result in less

operational errors and costs.

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

\434\ As discussed above, the Commission's final rule is very

similar to the Prudential Regulators' final margin rule and the 2013

International Standards.

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

Examples of the key documents related to administrative costs

include: (1) Certain self-disclosure documents, (2) credit support

annexes; and (3) tri-party segregation of margin collateral that

have to be arranged by the parties involved.\435\

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

\435\ Costs of these requirements are estimated above in the PRA

section.

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

The Commission expects that counterparties will have to make

certain representations regarding their status. These

representations will impose certain costs on CSEs and their swap

entity and financial end user counterparties. There are at least

three types of information when making self-disclosures: (a)

Jurisdictional information, (b) status information, and (c) initial

margin information. Jurisdictional information anticipates possible

multi-jurisdictional counterparties. Status information would

include, among other information, whether a party is a Commission-

registered swap dealer and material swaps exposure information.

Initial margin information includes among other information the

amount of initial margin for the consolidated group.

There may be multiple credit support annexes between

counterparties executing swaps because, among other reasons, the

final rule provides for a separate netting treatment of legacy swaps

and for calculation of initial margin by netting sets of broad asset

classes. Consequently, market participants will need to amend or

enter into new credit support agreements to account for the

differences from the current arrangement(s), resulting in additional

administrative costs.

Tri-party segregation agreements will have to be negotiated as

well.\436\ These arrangements can be costly as they involve multiple

parties and typically customized to the counterparties' needs.\437\

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

\436\ The Commission notes that some of these agreements will

need to be re-negotiated as a result of the final rule.

\437\ The final rule's requirements should provide some level of

standardization.

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

The Commission is aware of certain industry initiatives to

standardize documentation in order to create efficiencies and

mitigate costs. For example, ISDA plans to implement the following:

(1) ISDA Amend Platform, (2) ISDA bookstore for Master Agreements

and CSAs, and (3) Protocols.\438\ The ISDA Amend Platform is

technology that would allow swap contracts between counterparties to

be standardized, but with customized options to reduce costs.

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

\438\ In discussions with ISDA, the Commission understands that

these initiatives are currently in progress.

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

ISDA is also planning to create a database of standardized

Master Agreements and CSAs, updated to reflect the new margin

requirements. This initiative should result in more standardized

agreements and lower the costs to market participants.

Finally, ISDA is considering developing protocols to facilitate

the creation of multilateral agreements based on multiple bilateral

agreements. These protocols should

[[Page 694]]

provide efficiencies and lower the cost of documentation.

Appendix B to the Preamble

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

Seq. Date received Organization

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

1.......................... 11/11/2014 Chris Barnard.

2.......................... 11/21/2014 Japan Financial Markets

Council (JFMC).

3.......................... 11/24/2014 ICI Global.

4.......................... 11/24/2014 Investment Company

Institute.

5.......................... 11/24/2014 Committee on Capital

Markets Regulation.

6.......................... 11/24/2014 Structured Finance Industry

Group.

7.......................... 11/24/2014 ISDA (International Swaps

and derivatives

Association).

8.......................... 11/24/2014 Global FX Division (GFXD)

of the Global Financial

Markets Association

(GFMA).

9.......................... 11/24/2014 Alberta Investment Mgt

Corp; British Columbia

Investment Mgt Corp;

Caisse de

d[eacute]p[ocirc]t et

placement du

Qu[eacute]bec; Canada

Pension Plan Investment

Bd; Healthcare of Ontario

Pension Plan Trust Fund;

OMERS Administration Corp;

Public Sector Pension

Investment Bd.

10......................... 11/24/2014 American Public Gas

Association (APGA).

11......................... 11/24/2014 Securities Industry and

Financial Markets

Association.

12......................... 11/24/2014 State Street Corporation on

behalf of itself, Northern

Trust Corporation and Bank

of New York Mellon

Corporation.

13......................... 11/24/2014 Metropolitan Life Insurance

Company.

14......................... 11/24/2014 SIFMA.

15......................... 11/24/2014 Skadden, Arps, Slate,

Meagher & Flom LLP (on

behalf of the Global

Pension Coalition).

16......................... 11/24/2014 Institute of International

Bankers.

17......................... 11/24/2014 TIAA-CREF.

18......................... 11/25/2014 Securities Industry and

Financial Markets

Association (SIFMA).

19......................... 11/25/2014 American Bankers

Association (ABA).

20......................... 11/25/2014 Credit Suisse.

21......................... 11/25/2014 KfW Bankengruppe.

22......................... 11/26/2014 Credit Suisse.

23......................... 11/27/2014 Instituto de Cr[eacute]dito

Oficial (``ICO'').

24......................... 12/2/2014 Japanese Bankers

Association (JBA).

25......................... 12/2/2014 Alternative Investment

Management Association

(AIMA).

26......................... 12/2/2014 Managed Funds Association.

27......................... 12/2/2014 TriOptima.

28......................... 12/2/2014 MFX Solutions, Inc. (MFX).

29......................... 12/2/2014 The Financial Services

Roundtable.

30......................... 12/2/2014 White & Case LLP.

31......................... 12/2/2014 FMS Wertmanagement.

32......................... 12/2/2014 MasterCard International

Incorporated First Data

Corporation Vantiv, Inc.

33......................... 12/2/2014 Public Citizen.

34......................... 12/2/2014 American Gas Association

American Public Power

Association Edison

Electric Institute

Electric Power Supply

Association Large Public

Power Council National

Rural Electric Cooperative

Association.

35......................... 12/2/2014 National Corn Growers

Association & Natural Gas

Supply Association.

36......................... 12/2/2014 Freddie Mac.

37......................... 12/2/2014 National Rural Utilities

Cooperative Finance

Corporation.

38......................... 12/2/2014 CME Group.

39......................... 12/2/2014 Coalition of Physical

Energy Companies (COPE).

40......................... 12/2/2014 Sutherland Asbill & Brennan

LLP on behalf of the

Federal Home Loan Banks.

41......................... 12/2/2014 National Economic Research

Associates, Inc.

42......................... 12/2/2014 American Council of Life

Insurers.

43......................... 12/2/2014 International Energy Credit

Association.

44......................... 12/2/2014 Coalition for Derivatives

End users.

45......................... 12/2/2014 BP Energy Company.

46......................... 12/2/2014 Shell Trading Risk

Management.

47......................... 12/2/2014 Sutherland Asbill & Brennan

LLP on behalf of The

Commercial Energy Working

Group.

48......................... 12/2/2014 Better Markets.

49......................... 12/9/2014 Vanguard.

50......................... 12/2/2014 National Rural Electric

Cooperative Association

(NRECA).

51......................... 12/2/2014 Americans for Financial

Reform (AFR).

52......................... 12/3/2014 INTL FCStone Inc.

53......................... 12/18/2014 KfW Bankengruppe.

54......................... 12/11/2014 Australia and New Zealand

Banking Group Commonwealth

Bank of Australia

Macquarie Bank Ltd

National Australia Bank

Ltd Westpac Banking Corp.

55......................... 3/12/2015 Global Pension Coalition.

56......................... 5/15/2015 Managed Funds Association.

57......................... 6/1/2015 The Clearing House

Association L.L.C. (TCH);

American Bankers

Association (ABA); ABA

Securities Association

(ABASA), and the

Securities Industry and

Financial Markets

Association (SIFMA).

58......................... 6/9/2015 William J Harrington.

59......................... 8/7/2015 ISDA (International Swaps

and Derivatives

Association).

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

[[Page 695]]

List of Subjects

17 CFR Part 23

Swaps, Swap dealers, Major swap participants, Capital and margin

requirements.

17 CFR Part 140

Authority delegations (Government agencies), Organization and

functions (Government agencies).

For the reasons discussed in the preamble, the Commodity Futures

Trading Commission amends 17 CFR chapter I as set forth below:

PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

0

1. The authority citation for part 23 continues to read as follows:

Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,

9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.

0

2. Add subpart E to part 23 to read as follows:

Subpart E--Capital and Margin Requirements for Swap Dealers and

Major Swap Participants

Sec.

23.100-23.149 [Reserved]

23.150 Scope.

23.151 Definitions applicable to margin requirements.

23.152 Collection and posting of initial margin.

23.153 Collection and posting of variation margin.

23.154 Calculation of initial margin.

23.155 Calculation of variation margin.

23.156 Forms of margin.

23.157 Custodial arrangements.

23.158 Margin documentation.

23.159 Special rules for affiliates.

23.160 [Reserved]

23.161 Compliance dates.

23.162-23.199 [Reserved]

Subpart E--Capital and Margin Requirements for Swap Dealers and

Major Swap Participants

Sec. Sec. 23.100-23.149 [Reserved]

Sec. 23.150 Scope.

(a) The margin requirements set forth in Sec. Sec. 23.150 through

23.161 shall apply to uncleared swaps, as defined in Sec. 23.151, that

are executed after the applicable compliance dates set forth in Sec.

23.161.

(b) The requirements set forth in Sec. Sec. 23.150 through 23.161

shall not apply to a swap if the counterparty:

(1) Qualifies for an exception from clearing under section

2(h)(7)(A) of the Act and implementing regulations;

(2) Qualifies for an exemption from clearing under a rule,

regulation, or order issued by the Commission pursuant to section

4(c)(1) of the Act concerning cooperative entities that would otherwise

be subject to the requirements of section 2(h)(1)(A) of the Act; or

(3) Satisfies the criteria in section 2(h)(7)(D) of the Act and

implementing regulations.

Sec. 23.151 Definitions applicable to margin requirements.

For the purposes of Sec. Sec. 23.150 through 23.161:

Bank holding company has the meaning specified in section 2 of the

Bank Holding Company Act of 1956 (12 U.S.C. 1841).

Broker has the meaning specified in section 3(a)(4) the Securities

Exchange Act of 1934 (15 U.S.C. 78c(a)(4)).

Business day means any day other than a Saturday, Sunday, or legal

holiday.

Company means a corporation, partnership, limited liability

company, business trust, special purpose entity, association, or

similar organization.

Counterparty means the other party to a swap to which a covered

swap entity is a party.

Covered counterparty means a financial end user with material swaps

exposure or a swap entity that enters into a swap with a covered swap

entity.

Covered swap entity means a swap dealer or major swap participant

for which there is no prudential regulator.

Cross-currency swap means a swap in which one party exchanges with

another party principal and interest rate payments in one currency for

principal and interest rate payments in another currency, and the

exchange of principal occurs on the date the swap is entered into, with

a reversal of the exchange of principal at a later date that is agreed

upon when the swap is entered into.

Currency of Settlement means a currency in which a party has agreed

to discharge payment obligations related to an uncleared swap or a

group of uncleared swaps subject to a master netting agreement at the

regularly occurring dates on which such payments are due in the

ordinary course.

Day of execution means the calendar day at the time the parties

enter into an uncleared swap, provided:

(1) If each party is in a different calendar day at the time the

parties enter into the uncleared swap, the day of execution is deemed

the latter of the two dates; and

(2) If an uncleared swap is--

(i) Entered into after 4:00 p.m. in the location of a party; or

(ii) Entered into on a day that is not a business day in the

location of a party, then the uncleared swap is deemed to have been

entered into on the immediately succeeding day that is a business day

for both parties, and both parties shall determine the day of execution

with reference to that business day.

Data source means an entity and/or method from which or by which a

covered swap entity obtains prices for swaps or values for other inputs

used in a margin calculation.

Dealer has the meaning specified in section 3(a)(5) of the

Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(5)).

Depository institution has the meaning specified in section 3(c) of

the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).

Eligible collateral means collateral described in Sec. 23.156.

Eligible master netting agreement means a written, legally

enforceable agreement provided that:

(1) The agreement creates a single legal obligation for all

individual transactions covered by the agreement upon an event of

default following any stay permitted by paragraph (2) of this

definition, including upon an event of receivership, conservatorship,

insolvency, liquidation, or similar proceeding, of the counterparty;

(2) The agreement provides the covered swap entity the right to

accelerate, terminate, and close-out on a net basis all transactions

under the agreement and to liquidate or set off collateral promptly

upon an event of default, including upon an event of receivership,

conservatorship, insolvency, liquidation, or similar proceeding, of the

counterparty, provided that, in any such case, any exercise of rights

under the agreement will not be stayed or avoided under applicable law

in the relevant jurisdictions, other than:

(i) In receivership, conservatorship, or resolution under the

Federal Deposit Insurance Act (12 U.S.C. 1811 et seq.), Title II of the

Dodd-Frank Wall Street Reform and Consumer Protection Act (12 U.S.C.

5381 et seq.), the Federal Housing Enterprises Financial Safety and

Soundness Act of 1992, as amended (12 U.S.C. 4617), or the Farm Credit

Act of 1971, as amended (12 U.S.C. 2183 and 2279cc), or laws of foreign

jurisdictions that are substantially similar to the U.S. laws

referenced in this paragraph (2)(i) in order to facilitate the orderly

resolution of the defaulting counterparty; or

(ii) Where the agreement is subject by its terms to, or

incorporates, any of the laws referenced in paragraph (2)(i) of this

definition;

[[Page 696]]

(3) The agreement does not contain a walkaway clause (that is, a

provision that permits a non-defaulting counterparty to make a lower

payment than it otherwise would make under the agreement, or no payment

at all, to a defaulter or the estate of a defaulter, even if the

defaulter or the estate of the defaulter is a net creditor under the

agreement); and

(4) A covered swap entity that relies on the agreement for purposes

of calculating the margin required by this part must:

(i) Conduct sufficient legal review to conclude with a well-founded

basis (and maintain sufficient written documentation of that legal

review) that:

(A) The agreement meets the requirements of paragraph (2) of this

definition; and

(B) In the event of a legal challenge (including one resulting from

default or from receivership, conservatorship, insolvency, liquidation,

or similar proceeding) the relevant court and administrative

authorities would find the agreement to be legal, valid, binding, and

enforceable under the law of the relevant jurisdictions; and

(ii) Establish and maintain written procedures to monitor possible

changes in relevant law and to ensure that the agreement continues to

satisfy the requirements of this definition.

Financial end user means--

(1) A counterparty that is not a swap entity and that is:

(i) A bank holding company or a margin affiliate thereof; a savings

and loan holding company; a U.S. intermediate holding company

established or designated for purposes of compliance with 12 CFR

252.153; or a nonbank financial institution supervised by the Board of

Governors of the Federal Reserve System under Title I of the Dodd-Frank

Wall Street Reform and Consumer Protection Act (12 U.S.C. 5323);

(ii) A depository institution; a foreign bank; a Federal credit

union or State credit union as defined in section 2 of the Federal

Credit Union Act (12 U.S.C. 1752(1) and (6)); an institution that

functions solely in a trust or fiduciary capacity as described in

section 2(c)(2)(D) of the Bank Holding Company Act (12 U.S.C.

1841(c)(2)(D)); an industrial loan company, an industrial bank, or

other similar institution described in section 2(c)(2)(H) of the Bank

Holding Company Act (12 U.S.C. 1841(c)(2)(H));

(iii) An entity that is state-licensed or registered as:

(A) A credit or lending entity, including a finance company; money

lender; installment lender; consumer lender or lending company;

mortgage lender, broker, or bank; motor vehicle title pledge lender;

payday or deferred deposit lender; premium finance company; commercial

finance or lending company; or commercial mortgage company; except

entities registered or licensed solely on account of financing the

entity's direct sales of goods or services to customers;

(B) A money services business, including a check casher; money

transmitter; currency dealer or exchange; or money order or traveler's

check issuer;

(iv) A regulated entity as defined in section 1303(20) of the

Federal Housing Enterprises Financial Safety and Soundness Act of 1992

(12 U.S.C. 4502(20)) or any entity for which the Federal Housing

Finance Agency or its successor is the primary federal regulator;

(v) Any institution chartered in accordance with the Farm Credit

Act of 1971, as amended, 12 U.S.C. 2001 et seq. that is regulated by

the Farm Credit Administration;

(vi) A securities holding company; a broker or dealer; an

investment adviser as defined in section 202(a) of the Investment

Advisers Act of 1940 (15 U.S.C. 80b-2(a)); an investment company

registered with the Securities and Exchange Commission under the

Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.), a company

that has elected to be regulated as a business development company

pursuant to section 54(a) of the Investment Company Act of 1940 (15

U.S.C. 80a-53(a)), or a person that is registered with the U.S.

Securities and Exchange Commission as a security-based swap dealer or a

major security-based swap participant pursuant to the Securities

Exchange Act of 1934 (15 U.S.C. 78a et seq.).

(vii) A private fund as defined in section 202(a) of the Investment

Advisers Act of 1940 (15 U.S.C. 80-b-2(a)); an entity that would be an

investment company under section 3 of the Investment Company Act of

1940 (15 U.S.C. 80a-3) but for section 3(c)(5)(C); or an entity that is

deemed not to be an investment company under section 3 of the

Investment Company Act of 1940 pursuant to Investment Company Act Rule

3a-7 (Sec. 270.3a-7 of this title) of the Securities and Exchange

Commission;

(viii) A commodity pool, a commodity pool operator, a commodity

trading advisor, a floor broker, a floor trader, an introducing broker

or a futures commission merchant;

(ix) An employee benefit plan as defined in paragraphs (3) and (32)

of section 3 of the Employee Retirement Income and Security Act of 1974

(29 U.S.C. 1002);

(x) An entity that is organized as an insurance company, primarily

engaged in writing insurance or reinsuring risks underwritten by

insurance companies, or is subject to supervision as such by a State

insurance regulator or foreign insurance regulator;

(xi) An entity, person, or arrangement that is, or holds itself out

as being, an entity, person, or arrangement that raises money from

investors, accepts money from clients, or uses its own money primarily

for investing or trading or facilitating the investing or trading in

loans, securities, swaps, funds, or other assets; or

(xii) An entity that would be a financial end user described in

paragraph (1) of this definition or a swap entity if it were organized

under the laws of the United States or any State thereof.

(2) The term ``financial end user'' does not include any

counterparty that is:

(i) A sovereign entity;

(ii) A multilateral development bank;

(iii) The Bank for International Settlements;

(iv) An entity that is exempt from the definition of financial

entity pursuant to section 2(h)(7)(C)(iii) of the Act and implementing

regulations;

(v) An affiliate that qualifies for the exemption from clearing

pursuant to section 2(h)(7)(D) of the Act; or

(vi) An eligible treasury affiliate that the Commission exempts

from the requirements of Sec. Sec. 23.150 through 23.161 by rule.

Foreign bank means an organization that is organized under the laws

of a foreign country and that engages directly in the business of

banking outside the United States.

Foreign exchange forward has the meaning specified in section

1a(24) of the Act.

Foreign exchange swap has the meaning specified in section 1a(25)

of the Act.

Initial margin means the collateral, as calculated in accordance

with Sec. 23.154 that is collected or posted in connection with one or

more uncleared swaps.

Initial margin model means an internal risk management model that:

(1) Has been developed and designed to identify an appropriate,

risk-based amount of initial margin that the covered swap entity must

collect with respect to one or more non-cleared swaps to which the

covered swap entity is a party; and

(2) Has been approved by the Commission or a registered futures

association pursuant to Sec. 23.154(b).

[[Page 697]]

Initial margin threshold amount means an aggregate credit exposure

of $50 million resulting from all uncleared swaps between a covered

swap entity and its margin affiliates on the one hand, and a covered

counterparty and its margin affiliates on the other. For purposes of

this calculation, an entity shall not count a swap that is exempt

pursuant to Sec. 23.150(b).

Major currencies means--

(1) United States Dollar (USD);

(2) Canadian Dollar (CAD);

(3) Euro (EUR);

(4) United Kingdom Pound (GBP);

(5) Japanese Yen (JPY);

(6) Swiss Franc (CHF);

(7) New Zealand Dollar (NZD);

(8) Australian Dollar (AUD);

(9) Swedish Kronor (SEK);

(10) Danish Kroner (DKK);

(11) Norwegian Krone (NOK); and

(12) Any other currency designated by the Commission.

Margin affiliate. A company is a margin affiliate of another

company if:

(1) Either company consolidates the other on a financial statement

prepared in accordance with U.S. Generally Accepted Accounting

Principles, the International Financial Reporting Standards, or other

similar standards,

(2) Both companies are consolidated with a third company on a

financial statement prepared in accordance with such principles or

standards, or

(3) For a company that is not subject to such principles or

standards, if consolidation as described in paragraph (1) or (2) of

this definition would have occurred if such principles or standards had

applied.

Market intermediary means--

(1) A securities holding company;

(2) A broker or dealer;

(3) A futures commission merchant;

(4) A swap dealer; or

(5) A security-based swap dealer.

Material swaps exposure for an entity means that the entity and its

margin affiliates have an average daily aggregate notional amount of

uncleared swaps, uncleared security-based swaps, foreign exchange

forwards, and foreign exchange swaps with all counterparties for June,

July and August of the previous calendar year that exceeds $8 billion,

where such amount is calculated only for business days. An entity shall

count the average daily aggregate notional amount of an uncleared swap,

an uncleared security-based swap, a foreign exchange forward, or a

foreign exchange swap between the entity and a margin affiliate only

one time. For purposes of this calculation, an entity shall not count a

swap that is exempt pursuant to Sec. 23.150(b) or a security-based

swap that qualifies for an exemption under section 3C(g)(10) of the

Securities Exchange Act of 1934 (15 U.S.C. 78c-3(g)(4)) and

implementing regulations or that satisfies the criteria in section

3C(g)(1) of the Securities Exchange Act of 1934 (15 U.S.C. 78-c3(g)(4))

and implementing regulations.

Minimum transfer amount means a combined initial and variation

margin amount under which no actual transfer of funds is required. The

minimum transfer amount shall be $500,000.

Multilateral development bank means:

(1) The International Bank for Reconstruction and Development;

(2) The Multilateral Investment Guarantee Agency;

(3) The International Finance Corporation;

(4) The Inter-American Development Bank;

(5) The Asian Development Bank;

(6) The African Development Bank;

(7) The European Bank for Reconstruction and Development;

(8) The European Investment Bank;

(9) The European Investment Fund;

(10) The Nordic Investment Bank;

(11) The Caribbean Development Bank;

(12) The Islamic Development Bank;

(13) The Council of Europe Development Bank; and

(14) Any other entity that provides financing for national or

regional development in which the U.S. government is a shareholder or

contributing member or which the Commission determines poses comparable

credit risk.

Non-financial end user means a counterparty that is not a swap

dealer, a major swap participant, or a financial end user.

Prudential regulator has the meaning specified in section 1a(39) of

the Act.

Savings and loan holding company has the meaning specified in

section 10(n) of the Home Owners' Loan Act (12 U.S.C. 1467a(n)).

Securities holding company has the meaning specified in section 618

of the Dodd-Frank Wall Street Reform and Consumer Protection Act (12

U.S.C. 1850a).

Security-based swap has the meaning specified in section 3(a)(68)

of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(68)).

Sovereign entity means a central government (including the U.S.

government) or an agency, department, ministry, or central bank of a

central government.

State means any State, commonwealth, territory, or possession of

the United States, the District of Columbia, the Commonwealth of Puerto

Rico, the Commonwealth of the Northern Mariana Islands, American Samoa,

Guam, or the United States Virgin Islands.

Swap entity means a person that is registered with the Commission

as a swap dealer or major swap participant pursuant to the Act.

Uncleared security-based swap means a security-based swap that is

not, directly or indirectly, submitted to and cleared by a clearing

agency registered with the Securities and Exchange Commission pursuant

to section 17A of the Securities Exchange Act of 1934 (15 U.S.C. 78a-1)

or by a clearing agency that the U.S. Securities and Exchange

Commission has exempted from registration by rule or order pursuant to

section 17A of the Securities Exchange Act of 1934 (15 U.S.C. 78a-1).

Uncleared swap means a swap that is not cleared by a registered

derivatives clearing organization, or by a clearing organization that

the Commission has exempted from registration by rule or order pursuant

to section 5b(h) of the Act.

U.S. Government-sponsored enterprise means an entity established or

chartered by the U.S. government to serve public purposes specified by

federal statute but whose debt obligations are not explicitly

guaranteed by the full faith and credit of the U.S. government.

Variation margin means collateral provided by a party to its

counterparty to meet the performance of its obligation under one or

more uncleared swaps between the parties as a result of a change in

value of such obligations since the trade was executed or the last time

such collateral was provided.

Variation margin amount means the cumulative mark-to-market change

in value to a covered swap entity of an uncleared swap, as measured

from the date it is entered into (or in the case of an uncleared swap

that has a positive or negative value to a covered swap entity on the

date it is entered into, such positive or negative value plus any

cumulative mark-to-market change in value to the covered swap entity of

an uncleared swap after such date), less the value of all variation

margin previously collected, plus the value of all variation margin

previously posted with respect to such uncleared swap.

Sec. 23.152 Collection and posting of initial margin.

(a) Collection--(1) Initial obligation. On or before the business

day after execution of an uncleared swap between a covered swap entity

and a covered counterparty, the covered swap entity shall collect

initial margin from the

[[Page 698]]

covered counterparty in an amount equal to or greater than an amount

calculated pursuant to Sec. 23.154, in a form that complies with Sec.

23.156, and pursuant to custodial arrangements that comply with Sec.

23.157.

(2) Continuing obligation. The covered swap entity shall continue

to hold initial margin from the covered counterparty in an amount equal

to or greater than an amount calculated each business day pursuant to

Sec. 23.154, in a form that complies with Sec. 23.156, and pursuant

to custodial arrangements that comply with Sec. 23.157, until such

uncleared swap is terminated or expires.

(b) Posting--(1) Initial obligation. On or before the business day

after execution of an uncleared swap between a covered swap entity and

a financial end user with material swaps exposure, the covered swap

entity shall post initial margin with the counterparty in an amount

equal to or greater than an amount calculated pursuant to Sec. 23.154,

in a form that complies with Sec. 23.156, and pursuant to custodial

arrangements that comply with Sec. 23.157.

(2) Continuing obligation. The covered swap entity shall continue

to post initial margin with the counterparty in an amount equal to or

greater than an amount calculated each business day pursuant to Sec.

23.154, in a form that complies with Sec. 23.156, and pursuant to

custodial arrangements that comply with Sec. 23.157, until such

uncleared swap is terminated or expires.

(3) Minimum transfer amount. A covered swap entity is not required

to collect or to post initial margin pursuant to Sec. Sec. 23.150

through 23.161 with respect to a particular counterparty unless and

until the combined amount of initial margin and variation margin that

is required pursuant to Sec. Sec. 23.150 through 23.161 to be

collected or posted and that has not been collected or posted with

respect to the counterparty is greater than $500,000.

(c) Netting. (1) To the extent that one or more uncleared swaps are

executed pursuant to an eligible master netting agreement between a

covered swap entity and covered counterparty, a covered swap entity may

calculate and comply with the applicable initial margin requirements of

Sec. Sec. 23.150 through 23.161 on an aggregate net basis with respect

to all uncleared swaps governed by such agreement, subject to paragraph

(c)(2) of this section.

(2)(i) Except as permitted in paragraph (c)(2)(ii) of this section,

if an eligible master netting agreement covers uncleared swaps entered

into on or after the applicable compliance date set forth in Sec.

23.161, all the uncleared swaps covered by that agreement are subject

to the requirements of Sec. Sec. 23.150 through 23.161 and included in

the aggregate netting portfolio for the purposes of calculating and

complying with the margin requirements of Sec. Sec. 23.150 through

23.161.

(ii) An eligible master netting agreement may identify one or more

separate netting portfolios that independently meet the requirements in

paragraph (1) of the definition of ``eligible master netting

agreement'' in Sec. 23.151 and to which collection and posting of

margin applies on an aggregate net basis separate from and exclusive of

any other uncleared swaps covered by the eligible master netting

agreement. Any such netting portfolio that contains any uncleared swap

entered into on or after the applicable compliance date set forth in

Sec. 23.161 is subject to the requirements of Sec. Sec. 23.150

through 23.161. Any such netting portfolio that contains only uncleared

swaps entered into before the applicable compliance date is not subject

to the requirements of Sec. Sec. 23.150 through 23.161.

(d) Satisfaction of collection and posting requirements. A covered

swap entity shall not be deemed to have violated its obligation to

collect or to post initial margin from a covered counterparty if:

(1) The covered counterparty has refused or otherwise failed to

provide, or to accept, the required initial margin to, or from, the

covered swap entity; and

(2) The covered swap entity has:

(i) Made the necessary efforts to collect or to post the required

initial margin, including the timely initiation and continued pursuit

of formal dispute resolution mechanisms, including pursuant to Sec.

23.504(b)(4), if applicable, or has otherwise demonstrated upon request

to the satisfaction of the Commission that it has made appropriate

efforts to collect or to post the required initial margin; or

(ii) Commenced termination of the uncleared swap with the covered

counterparty promptly following the applicable cure period and

notification requirements.

Sec. 23.153 Collection and posting of variation margin.

(a) Initial obligation. On or before the business day after the day

of execution of an uncleared swap between a covered swap entity and a

counterparty that is a swap entity or a financial end user, the covered

swap entity shall collect the variation margin amount from the

counterparty when the amount is positive, or post the variation margin

amount with the counterparty when the amount is negative as calculated

pursuant to Sec. 23.155 and in a form that complies with Sec. 23.156.

(b) Continuing obligation. The covered swap entity shall continue

to collect the variation margin amount from, or to post the variation

margin amount with, the counterparty as calculated each business day

pursuant to Sec. 23.155 and in a form that complies with Sec. 23.156

each business day until such uncleared swap is terminated or expires.

(c) Minimum transfer amount. A covered swap entity is not required

to collect or to post variation margin pursuant to Sec. Sec. 23.150

through 23.161 with respect to a particular counterparty unless and

until the combined amount of initial margin and variation margin that

is required pursuant to Sec. Sec. 23.150 through 23.161 to be

collected or posted and that has not been collected or posted with

respect to the counterparty is greater than $500,000.

(d) Netting. (1) To the extent that more than one uncleared swap is

executed pursuant to an eligible master netting agreement between a

covered swap entity and a counterparty, a covered swap entity may

calculate and comply with the applicable variation margin requirements

of this section on an aggregate basis with respect to all uncleared

swaps governed by such agreement subject to paragraph (d)(2) of this

section.

(2)(i) Except as permitted in paragraph (d)(2)(ii) of this section,

if an eligible master netting agreement covers uncleared swaps entered

into on or after the applicable compliance date set forth in Sec.

23.161, all the uncleared swaps covered by that agreement are subject

to the requirements of Sec. Sec. 23.150 through 23.161 and included in

the aggregate netting portfolio for the purposes of calculating and

complying with the margin requirements of Sec. Sec. 23.150 through

23.161.

(ii) An eligible master netting agreement may identify one or more

separate netting portfolios that independently meet the requirements in

paragraph (1) of the definition of ``eligible master netting

agreement'' in Sec. 23.151 and to which collection and posting of

margin applies on an aggregate net basis separate from and exclusive of

any other uncleared swaps covered by the eligible master netting

agreement. Any such netting portfolio that contains any uncleared swap

entered into on or after the applicable compliance date set forth in

Sec. 23.161 is subject to the requirements of Sec. Sec. 23.150

through 23.161. Any such netting portfolio that contains only uncleared

swaps entered into before the applicable compliance date is not subject

to the

[[Page 699]]

requirements of Sec. Sec. 23.150 through 23.161.

(e) Satisfaction of collection and payment requirements. A covered

swap entity shall not be deemed to have violated its obligation to

collect or to pay variation margin from a counterparty if:

(1) The counterparty has refused or otherwise failed to provide or

to accept the required variation margin to or from the covered swap

entity; and

(2) The covered swap entity has:

(i) Made the necessary efforts to collect or to post the required

variation margin, including the timely initiation and continued pursuit

of formal dispute resolution mechanisms, including pursuant to Sec.

23.504(b)(4), if applicable, or has otherwise demonstrated upon request

to the satisfaction of the Commission that it has made appropriate

efforts to collect or to post the required variation margin; or

(ii) Commenced termination of the uncleared swap with the

counterparty promptly following the applicable cure period and

notification requirements.

Sec. 23.154 Calculation of initial margin.

(a) Means of calculation. (1) Each business day each covered swap

entity shall calculate an initial margin amount to be collected from

each covered counterparty using:

(i) A risk-based model that meets the requirements of paragraph (b)

of this section; or

(ii) The table-based method set forth in paragraph (c) of this

section.

(2) Each business day each covered swap entity shall calculate an

initial margin amount to be posted with each financial end user with

material swaps exposure using:

(i) A risk-based model that meets the requirements of paragraph (b)

of this section; or

(ii) The table-based method set forth in paragraph (c) of this

section.

(3) Each covered swap entity may reduce the amounts calculated

pursuant to paragraphs (a)(1) and (2) of this section by the initial

margin threshold amount provided that the reduction does not include

any portion of the initial margin threshold amount already applied by

the covered swap entity or its margin affiliates in connection with

other uncleared swaps with the counterparty or its margin affiliates.

(4) The amounts calculated pursuant to paragraph (a)(3) of this

section shall not be less than zero.

(b) Risk-based models--(1) Commission or registered futures

association approval. (i) A covered swap entity shall obtain the

written approval of the Commission or a registered futures association

to use a model to calculate the initial margin required in Sec. Sec.

23.150 through 23.161.

(ii) A covered swap entity shall demonstrate that the model

satisfies all of the requirements of this section on an ongoing basis.

(iii) A covered swap entity shall notify the Commission and the

registered futures association in writing 60 days prior to:

(A) Extending the use of an initial margin model that has been

approved to an additional product type;

(B) Making any change to any initial margin model that has been

approved that would result in a material change in the covered swap

entity's assessment of initial margin requirements; or

(C) Making any material change to modeling assumptions used by the

initial margin model.

(iv) The Commission or the registered futures association may

rescind approval of the use of any initial margin model, in whole or in

part, or may impose additional conditions or requirements if the

Commission or the registered futures association determines, in its

discretion, that the model no longer complies with this section.

(2) Elements of the model. (i) The initial margin model shall

calculate an amount of initial margin that is equal to the potential

future exposure of the uncleared swap or netting portfolio of uncleared

swaps covered by an eligible master netting agreement. Potential future

exposure is an estimate of the one-tailed 99 percent confidence

interval for an increase in the value of the uncleared swap or netting

portfolio of uncleared swaps due to an instantaneous price shock that

is equivalent to a movement in all material underlying risk factors,

including prices, rates, and spreads, over a holding period equal to

the shorter of ten business days or the maturity of the swap or netting

portfolio.

(ii) All data used to calibrate the initial margin model shall be

based on an equally weighted historical observation period of at least

one year and not more than five years and must incorporate a period of

significant financial stress for each broad asset class that is

appropriate to the uncleared swaps to which the initial margin model is

applied.

(iii) The initial margin model shall use risk factors sufficient to

measure all material price risks inherent in the transactions for which

initial margin is being calculated. The risk categories shall include,

but should not be limited to, foreign exchange or interest rate risk,

credit risk, equity risk, and commodity risk, as appropriate. For

material exposures in significant currencies and markets, modeling

techniques shall capture spread and basis risk and shall incorporate a

sufficient number of segments of the yield curve to capture differences

in volatility and imperfect correlation of rates along the yield curve.

(iv) In the case of an uncleared cross-currency swap, the initial

margin model need not recognize any risks or risk factors associated

with the fixed, physically-settled foreign exchange transactions

associated with the exchange of principal embedded in the uncleared

cross-currency swap. The initial margin model must recognize all

material risks and risk factors associated with all other payments and

cash flows that occur during the life of the uncleared cross-currency

swap.

(v) The initial margin model may calculate initial margin for an

uncleared swap or netting portfolio of uncleared swaps covered by an

eligible master netting agreement. It may reflect offsetting exposures,

diversification, and other hedging benefits for uncleared swaps that

are governed by the same eligible master netting agreement by

incorporating empirical correlations within the following broad risk

categories, provided the covered swap entity validates and demonstrates

the reasonableness of its process for modeling and measuring hedging

benefits: Commodity, credit, equity, and foreign exchange or interest

rate. Empirical correlations under an eligible master netting agreement

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

across broad risk categories.

(vi) If the initial margin model does not explicitly reflect

offsetting exposures, diversification, and hedging benefits between

subsets of uncleared swaps within a broad risk category, the covered

swap entity shall calculate an amount of initial margin separately for

each subset of uncleared swaps for which such relationships are

explicitly recognized by the model. The sum of the initial margin

amounts calculated for each subset of uncleared swaps within a broad

risk category will be used to determine the aggregate initial margin

due from the counterparty for the portfolio of uncleared swaps within

the broad risk category.

(vii) The sum of the initial margin calculated for each broad risk

category shall be used to determine the aggregate initial margin due

from the counterparty.

(viii) The initial margin model shall not permit the calculation of

any initial margin to be offset by, or otherwise take

[[Page 700]]

into account, any initial margin that may be owed or otherwise payable

by the covered swap entity to the counterparty.

(ix) The initial margin model shall include all material risks

arising from the nonlinear price characteristics of option positions or

positions with embedded optionality and the sensitivity of the market

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

rates, prices, or other material risk factors.

(x) The covered swap entity shall not omit any risk factor from the

calculation of its initial margin that the covered swap entity uses in

its model unless it has first demonstrated to the satisfaction of the

Commission or the registered futures association that such omission is

appropriate.

(xi) The covered swap entity shall not incorporate any proxy or

approximation used to capture the risks of the covered swap entity's

uncleared swaps unless it has first demonstrated to the satisfaction of

the Commission or the registered futures association that such proxy or

approximation is appropriate.

(xii) The covered swap entity shall have a rigorous and well-

defined process for re-estimating, re-evaluating, and updating its

internal margin models to ensure continued applicability and relevance.

(xiii) The covered swap entity shall review and, as necessary,

revise the data used to calibrate the initial margin model at least

annually, and more frequently as market conditions warrant, to ensure

that the data incorporate a period of significant financial stress

appropriate to the uncleared swaps to which the initial margin model is

applied.

(xiv) The level of sophistication of the initial margin model shall

be commensurate with the complexity of the swaps to which it is

applied. In calculating an initial margin amount, the initial margin

model may make use of any of the generally accepted approaches for

modeling the risk of a single instrument or portfolio of instruments.

(xv) The Commission or the registered futures association may in

its discretion require a covered swap entity using an initial margin

model to collect a greater amount of initial margin than that

determined by the covered swap entity's initial margin model if the

Commission or the registered futures association determines that the

additional collateral is appropriate due to the nature, structure, or

characteristics of the covered swap entity's transaction(s) or is

commensurate with the risks associated with the transaction(s).

(3) [Reserved]

(4) Periodic review. A covered swap entity shall periodically, but

no less frequently than annually, review its initial margin model in

light of developments in financial markets and modeling technologies,

and enhance the initial margin model as appropriate to ensure that it

continues to meet the requirements for approval in this section.

(5) Control, oversight, and validation mechanisms. (i) The covered

swap entity shall maintain a risk management unit in accordance with

Sec. 23.600(c)(4)(i) that is independent from the business trading

unit (as defined in Sec. 23.600).

(ii) The covered swap entity's risk control unit shall validate its

initial margin model prior to implementation and on an ongoing basis.

The covered swap entity's validation process shall be independent of

the development, implementation, and operation of the initial margin

model, or the validation process shall be subject to an independent

review of its adequacy and effectiveness. The validation process shall

include:

(A) An evaluation of the conceptual soundness of (including

developmental evidence supporting) the initial margin model;

(B) An ongoing monitoring process that includes verification of

processes and benchmarking by comparing the covered swap entity's

initial margin model outputs (estimation of initial margin) with

relevant alternative internal and external data sources or estimation

techniques. The benchmark(s) must address the model's limitations. When

applicable the covered swap entity should consider benchmarks that

allow for non-normal distributions such as historical and Monte Carlo

simulations. When applicable validation shall include benchmarking

against observable margin standards to ensure that the initial margin

required is not less than what a derivatives clearing organization

would require for similar cleared transactions; and

(C) An outcomes analysis process that includes back testing the

model. This analysis shall recognize and compensate for the challenges

inherent in back testing over periods that do not contain significant

financial stress.

(iii) If the validation process reveals any material problems with

the model, the covered swap entity must promptly notify the Commission

and the registered futures association of the problems, describe to the

Commission and the registered futures association any remedial actions

being taken, and adjust the model to ensure an appropriately

conservative amount of required initial margin is being calculated.

(iv) In accordance with Sec. 23.600(e)(2), the covered swap entity

shall have an internal audit function independent of the business

trading unit and the risk management unit that at least annually

assesses the effectiveness of the controls supporting the initial

margin model measurement systems, including the activities of the

business trading units and risk control unit, compliance with policies

and procedures, and calculation of the covered swap entity's initial

margin requirements under this part. At least annually, the internal

audit function shall report its findings to the covered swap entity's

governing body, senior management, and chief compliance officer.

(6) Documentation. The covered swap entity shall adequately

document all material aspects of its model, including management and

valuation of uncleared swaps to which it applies, the control,

oversight, and validation of the initial margin model, any review

processes and the results of such processes.

(7) Escalation procedures. The covered swap entity must adequately

document--

(i) Internal authorization procedures, including escalation

procedures, that require review and approval of any change to the

initial margin calculation under the initial margin model;

(ii) Demonstrable analysis that any basis for any such change is

consistent with the requirements of this section; and

(iii) Independent review of such demonstrable analysis and

approval.

(c) Table-based method. If a model meeting the standards set forth

in paragraph (b) of this section is not used, initial margin shall be

calculated in accordance with this paragraph.

(1) Standardized initial margin schedule.

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

Gross initial

margin (% of

Asset class notional

exposure)

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

Credit: 0-2 year duration............................... 2

Credit: 2-5 year duration............................... 5

Credit: 5+ year duration................................ 10

Commodity............................................... 15

Equity.................................................. 15

Foreign Exchange/Currency............................... 6

Cross Currency Swaps: 0-2 year duration................. 1

Cross Currency Swaps: 2-5 year duration................. 2

Cross Currency Swaps: 5+ year duration.................. 4

Interest Rate: 0-2 year duration........................ 1

[[Page 701]]

 

Interest Rate: 2-5 year duration........................ 2

Interest Rate: 5+ year duration......................... 4

Other................................................... 15

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

(2) Net to gross ratio adjustment. (i) For multiple uncleared swaps

subject to an eligible master netting agreement, the initial margin

amount under the standardized table shall be computed according to this

paragraph.

(ii) Initial Margin = 0.4 x Gross Initial Margin + 0.6 x Net-to-

Gross Ratio x Gross Initial Margin, where:

(A) Gross Initial Margin = the sum of the product of each uncleared

swap's effective notional amount and the gross initial margin

requirement for all uncleared swaps subject to the eligible master

netting agreement;

(B) Net-to-Gross Ratio = the ratio of the net current replacement

cost to the gross current replacement cost;

(C) Gross Current Replacement cost = the sum of the replacement

cost for each uncleared swap subject to the eligible master netting

agreement for which the cost is positive; and

(D) Net Current Replacement Cost = the total replacement cost for

all uncleared swaps subject to the eligible master netting agreement.

(E) In cases where the gross replacement cost is zero, the Net-to-

Gross Ratio shall be set to 1.0.

Sec. 23.155 Calculation of variation margin.

(a) Means of calculation. (1) Each business day each covered swap

entity shall calculate variation margin for itself and for each

counterparty that is a swap entity or a financial end user using

methods, procedures, rules, and inputs that to the maximum extent

practicable rely on recently-executed transactions, valuations provided

by independent third parties, or other objective criteria.

(2) Each covered swap entity shall have in place alternative

methods for determining the value of an uncleared swap in the event of

the unavailability or other failure of any input required to value a

swap.

(b) Control mechanisms. (1) Each covered swap entity shall create

and maintain documentation setting forth the variation methodology with

sufficient specificity to allow the counterparty, the Commission, the

registered futures association, and any applicable prudential regulator

to calculate a reasonable approximation of the margin requirement

independently.

(2) Each covered swap entity shall evaluate the reliability of its

data sources at least annually, and make adjustments, as appropriate.

(3) The Commission or the registered futures association at any

time may require a covered swap entity to provide further data or

analysis concerning the methodology or a data source, including:

(i) An explanation of the manner in which the methodology meets the

requirements of this section;

(ii) A description of the mechanics of the methodology;

(iii) The conceptual basis of the methodology;

(iv) The empirical support for the methodology; and

(v) The empirical support for the assessment of the data sources.

Sec. 23.156 Forms of margin.

(a) Initial margin--(1) Eligible collateral. A covered swap entity

shall collect and post as initial margin for trades with a covered

counterparty only the following types of collateral:

(i) Immediately available cash funds denominated in:

(A) U.S. dollars;

(B) A major currency;

(C) A currency of settlement for the uncleared swap;

(ii) A security that is issued by, or unconditionally guaranteed as

to the timely payment of principal and interest by, the U.S. Department

of Treasury;

(iii) A security that is issued by, or unconditionally guaranteed

as to the timely payment of principal and interest by, a U.S.

government agency (other than the U.S. Department of Treasury) whose

obligations are fully guaranteed by the full faith and credit of the

U.S. government;

(iv) A security that is issued by, or fully guaranteed as to the

payment of principal and interest by, the European Central Bank or a

sovereign entity that is assigned no higher than a 20 percent risk

weight under the capital rules applicable to swap dealers subject to

regulation by a prudential regulator;

(v) A publicly traded debt security issued by, or an asset-backed

security fully guaranteed as to the timely payment of principal and

interest by, a U.S. Government-sponsored enterprise that is operating

with capital support or another form of direct financial assistance

received from the U.S. government that enables the repayments of the

U.S. Government-sponsored enterprise's eligible securities;

(vi) A security that is issued by, or fully guaranteed as to the

payment of principal and interest by, the Bank for International

Settlements, the International Monetary Fund, or a multilateral

development bank;

(vii) Other publicly-traded debt that has been deemed acceptable as

initial margin by a prudential regulator;

(viii) A publicly traded common equity security that is included

in:

(A) The Standard & Poor's Composite 1500 Index or any other similar

index of liquid and readily marketable equity securities as determined

by the Commission; or

(B) An index that a covered swap entity's supervisor in a foreign

jurisdiction recognizes for purposes of including publicly traded

common equity as initial margin under applicable regulatory policy, if

held in that foreign jurisdiction;

(ix) Securities in the form of redeemable securities in a pooled

investment fund representing the security-holder's proportional

interest in the fund's net assets and that are issued and redeemed only

on the basis of the market value of the fund's net assets prepared each

business day after the security-holder makes its investment commitment

or redemption request to the fund, if the fund's investments are

limited to the following:

(A) Securities that are issued by, or unconditionally guaranteed as

to the timely payment of principal and interest by, the U.S. Department

of the Treasury, and immediately-available cash funds denominated in

U.S. dollars; or

(B) Securities denominated in a common currency and issued by, or

fully guaranteed as to the payment of principal and interest by, the

European Central Bank or a sovereign entity that is assigned no higher

than a 20 percent risk weight under the capital rules applicable to

swap dealers subject to regulation by a prudential regulator, and

immediately-available cash funds denominated in the same currency; and

(C) Assets of the fund may not be transferred through securities

lending, securities borrowing, repurchase agreements, reverse

repurchase agreements, or other means that involve the fund having

rights to acquire the same or similar assets from the transferee, or

(x) Gold.

(2) Prohibition of certain assets. A covered swap entity may not

collect or post as initial margin any asset that is a security issued

by:

(i) The covered swap entity or a margin affiliate of the covered

swap entity (in the case of posting) or the counterparty or any margin

affiliate of the counterparty (in the case of collection);

(ii) A bank holding company, a savings and loan holding company, a

[[Page 702]]

U.S. intermediate holding company established or designated for

purposes of compliance with 12 CFR 252.153, a foreign bank, a

depository institution, a market intermediary, a company that would be

any of the foregoing if it were organized under the laws of the United

States or any State, or a margin affiliate of any of the foregoing

institutions, or

(iii) A nonbank financial institution supervised by the Board of

Governors of the Federal Reserve System under Title I of the Dodd-Frank

Wall Street Reform and Consumer Protection Act (12 U.S.C. 5323).

(3) Haircuts. (i) The value of any eligible collateral collected or

posted to satisfy initial margin requirements shall be subject to the

sum of the following discounts, as applicable:

(A) An 8 percent discount for initial margin collateral denominated

in a currency that is not the currency of settlement for the uncleared

swap, except for eligible types of collateral denominated in a single

termination currency designated as payable to the non-posting

counterparty as part of the eligible master netting agreement; and

(B) The discounts set forth in the following table:

Standardized Haircut Schedule

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

 

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

Cash in same currency as swap obligation....................... 0.0

Eligible government and related debt (e.g., central bank, 0.5

multilateral development bank, GSE securities identified in

paragraph (a)(1)(iv) of this section): Residual maturity less

than one-year.................................................

Eligible government and related debt (e.g., central bank, 2.0

multilateral development bank, GSE securities identified in

paragraph (a)(1)(iv) of this section): Residual maturity

between one and five years....................................

Eligible government and related debt (e.g., central bank, 4.0

multilateral development bank, GSE securities identified in

paragraph (a)(1)(iv) of this section): Residual maturity

greater than five years.......................................

Eligible corporate debt (including eligible GSE debt securities 1.0

not identified in paragraph (a)(1)(iv) of this section):

Residual maturity less than one-year..........................

Eligible corporate debt (including eligible GSE debt securities 4.0

not identified in paragraph (a)(1)(iv) of this section):

Residual maturity between one and five years..................

Eligible corporate debt (including eligible GSE debt securities 8.0

not identified in paragraph (a)(1)(iv) of this section):

Residual maturity greater than five years.....................

Equities included in S&P 500 or related index.................. 15.0

Equities included in S&P 1500 Composite or related index but 25.0

not S&P 500 or related index..................................

Gold........................................................... 15.0

Additional (additive) haircut on asset in which the currency of 8.0

the swap obligation differs from that of the collateral asset.

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

(ii) The value of initial margin collateral shall be computed as

the product of the cash or market value of the eligible collateral

asset times one minus the applicable haircut expressed in percentage

terms. The total value of all initial margin collateral is calculated

as the sum of those values for each eligible collateral asset.

(b) Variation margin--(1) Eligible collateral--(i) Swaps with a

swap entity. (A) A covered swap entity shall post and collect as

variation margin to or from a counterparty that is a swap entity only

immediately available cash funds that are denominated in: U.S. dollars;

(B) Another major currency; or

(C) The currency of settlement of the uncleared swap.

(ii) Swaps with a financial end user. A covered swap entity may

post and collect as variation margin to or from a counterparty that is

a financial end user any asset that is eligible to be posted or

collected as initial margin under paragraphs (a)(1) and (2) of this

section.

(2) Haircuts. (i) The value of any eligible collateral collected or

posted to satisfy variation margin requirements shall be subject to the

sum of the following discounts, as applicable:

(A) An 8% discount for variation margin collateral denominated in a

currency that is not the currency of settlement for the uncleared swap

except for immediately available cash funds denominated in U.S. cash

funds or another major currency; and

(B) The discounts for initial margin set forth in the table in

paragraph (a)(3)(i)(B) of this section.

(ii) The value of variation margin collateral shall be computed as

the product of the cash or market value of the eligible collateral

asset times one minus the applicable haircut expressed in percentage

terms. The total value of all variation margin collateral shall be

calculated as the sum of those values of each eligible collateral

asset.

(c) Monitoring obligation. A covered swap entity shall monitor the

market value and eligibility of all collateral collected and posted to

satisfy the margin requirements of Sec. Sec. 23.150 through 23.161. To

the extent that the market value of such collateral has declined, the

covered swap entity shall promptly collect or post such additional

eligible collateral as is necessary to maintain compliance with the

margin requirements of Sec. Sec. 23.150 through 23.161. To the extent

that the collateral is no longer eligible, the covered swap entity

shall promptly collect or post sufficient eligible replacement

collateral to comply with the margin requirements of Sec. Sec. 23.150

through 23.161.

(d) Excess margin. A covered swap entity may collect or post

initial margin or variation margin that is not required pursuant to

Sec. Sec. 23.150 through 23.161 in any form of collateral.

Sec. 23.157 Custodial arrangements.

(a) Initial margin posted by covered swap entities. Each covered

swap entity that posts initial margin with respect to an uncleared swap

shall require that all funds or other property that the covered swap

entity provides as initial margin be held by one or more custodians

that are not the covered swap entity, the counterparty, or margin

affiliates of the covered swap entity or the counterparty.

(b) Initial margin collected by covered swap entities. Each covered

swap entity that collects initial margin required by Sec. 23.152 with

respect to an uncleared swap shall require that such initial margin be

held by one or more custodians that are not the covered swap entity,

the counterparty, or margin affiliates of the covered swap entity or

the counterparty.

(c) Custodial agreement. Each covered swap entity shall enter into

an agreement with each custodian that holds funds pursuant to

paragraphs (a) or (b) of this section that:

(1) Prohibits the custodian from rehypothecating, repledging,

reusing, or otherwise transferring (through securities lending,

securities borrowing, repurchase agreement, reverse repurchase

agreement or other means) the collateral held by the custodian except

that cash collateral may be held in a general deposit account with the

custodian if the funds in the account are used to purchase an asset

described in

[[Page 703]]

Sec. 23.156(a)(1)(iv) through (xii), such asset is held in compliance

with this section, and such purchase takes place within a time period

reasonably necessary to consummate such purchase after the cash

collateral is posted as initial margin; and

(2) Is a legal, valid, binding, and enforceable agreement under the

laws of all relevant jurisdictions including in the event of

bankruptcy, insolvency, or a similar proceeding.

(3) Notwithstanding paragraph (c)(1) of this section, a custody

agreement may permit the posting party to substitute or direct any

reinvestment of posted collateral held by the custodian, provided that,

with respect to collateral posted or collected pursuant to Sec.

23.152, the agreement requires the posting party, when it substitutes

or directs the reinvestment of posted collateral held by the custodian.

(i) To substitute only funds or other property that would qualify

as eligible collateral under Sec. 23.156, and for which the amount net

of applicable discounts described in Sec. 23.156 would be sufficient

to meet the requirements of Sec. 23.152; and

(ii) To direct reinvestment of funds only in assets that would

qualify as eligible collateral under Sec. 23.156, and for which the

amount net of applicable discounts described in Sec. 23.156 would be

sufficient to meet the requirements of Sec. 23.152.

Sec. 23.158 Margin documentation.

(a) General requirement. Each covered swap entity shall execute

documentation with each counterparty that complies with the

requirements of Sec. 23.504 and that complies with this section, as

applicable. For uncleared swaps between a covered swap entity and a

counterparty that is a swap entity or a financial end user, the

documentation shall provide the covered swap entity with the

contractual right and obligation to exchange initial margin and

variation margin in such amounts, in such form, and under such

circumstances as are required by Sec. Sec. 23.150 through 23.161.

(b) Contents of the documentation. The margin documentation shall:

(1) Specify the methods, procedures, rules, inputs, and data

sources to be used for determining the value of uncleared swaps for

purposes of calculating variation margin;

(2) Describe the methods, procedures, rules, inputs, and data

sources to be used to calculate initial margin for uncleared swaps

entered into between the covered swap entity and the counterparty; and

(3) Specify the procedures by which any disputes concerning the

valuation of uncleared swaps, or the valuation of assets collected or

posted as initial margin or variation margin may be resolved.

Sec. 23.159 Special rules for affiliates.

(a) Initial margin. (1) Except as provided in paragraph (c) of this

section, a covered swap entity shall not be required to collect initial

margin from a margin affiliate provided that the covered swap entity

meets the following conditions:

(i) The swaps are subject to a centralized risk management program

that is reasonably designed to monitor and to manage the risks

associated with the inter-affiliate swaps; and

(ii) The covered swap entity exchanges variation margin with the

margin affiliate in accordance with paragraph (b) of this section.

(2)(i) A covered swap entity shall post initial margin to any

margin affiliate that is a swap entity subject to the rules of a

Prudential Regulator in an amount equal to the amount that the swap

entity is required to collect from the covered swap entity pursuant to

the rules of the Prudential Regulator.

(ii) A covered swap entity shall not be required to post initial

margin to any other margin affiliate pursuant to Sec. Sec. 23.150

through 23.161.

(b) Variation margin. Each covered swap entity shall post and

collect variation margin with each margin affiliate that is a swap

entity or a financial end user in accordance with all applicable

provisions of Sec. Sec. 23.150 through 23.161.

(c) Foreign margin affiliates. (1) For purposes of this section,

the term outward facing margin affiliate means a margin affiliate that

enters into swaps with third parties.

(2) Except as provided in paragraph (c)(3) of this section, each

covered swap entity shall collect initial margin in accordance with all

applicable provisions of Sec. Sec. 23.150 through 23.161 from each

margin affiliate that meets the following criteria:

(i) The margin affiliate is a financial end user;

(ii) The margin affiliate enters into swaps with third parties, or

enters into swaps with any other margin affiliate that, directly or

indirectly (including through a series of transactions), enters into

swaps with third parties, for which the provisions of Sec. Sec. 23.150

through 23.161 would apply if any such margin affiliate were a swap

entity; and

(iii) Any such outward facing margin affiliate is located in a

jurisdiction that the Commission has not found to be eligible for

substituted compliance with regard to the provisions of Sec. Sec.

23.150 through 23.161 and does not collect initial margin for such

swaps in a manner that would comply with the provisions of Sec. Sec.

23.150 through 23.161.

(3) The custodian for initial margin collected pursuant to

paragraph (c)(1) of this section may be the covered swap entity or a

margin affiliate of the covered swap entity.

Sec. 23.160 [Reserved]

Sec. 23.161 Compliance dates.

(a) Covered swap entities shall comply with the minimum margin

requirements for uncleared swaps on or before the following dates for

uncleared swaps entered into on or after the following dates:

(1) September 1, 2016 for the requirements in Sec. 23.152 for

initial margin and in Sec. 23.153 for variation margin for any

uncleared swaps where both--

(i) The covered swap entity combined with all its margin

affiliates; and

(ii) Its counterparty combined with all its margin affiliates, have

an average daily aggregate notional amount of uncleared swaps,

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

exchange swaps in March, April, and May 2016 that exceeds $3 trillion,

where such amounts are calculated only for business days; and where

(iii) In calculating the amounts in paragraphs (a)(1)(i) and (ii)

of this section, an entity shall count the average daily notional

amount of an uncleared swap, an uncleared security-based swap, a

foreign-exchange forward, or a foreign exchange swap between an entity

or a margin affiliate only one time and shall not count a swap or a

security-based swap that is exempt pursuant to Sec. 23.150(b) or a

security-based swap that is exempt pursuant to section 15F(e) of the

Securities Exchange Act of 1934 (15 U.S.C. 78o-10(e)).

(2) March 1, 2017 for the requirements in Sec. 23.153 for

variation margin for any other covered swap entity for uncleared swaps

entered into with any other counterparty.

(3) September 1, 2017 for the requirements in Sec. 23.152 for

initial margin for any uncleared swaps where both--

(i) The covered swap entity combined with all its margin

affiliates; and

(ii) Its counterparty combined with all its margin affiliates, have

an average daily aggregate notional amount of uncleared swaps,

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

exchange swaps in March,

[[Page 704]]

April, and May 2017 that exceeds $2.25 trillion, where such amounts are

calculated only for business days; and where

(iii) In calculating the amounts in paragraphs (a)(3)(i) and (ii)

of this section, an entity shall count the average daily notional

amount of an uncleared swap, an uncleared security-based swap, a

foreign-exchange forward, or a foreign exchange swap between an entity

or a margin affiliate only one time and shall not count a swap or a

security-based swap that is exempt pursuant to Sec. 23.150(b) or a

security-based swap that is exempt pursuant to section 15F(e) of the

Securities Exchange Act of 1934 (15 U.S.C. 78o-10(e)).

(4) September 1, 2018, for the requirements in Sec. 23.152 for

initial margin for any uncleared swaps where both--

(i) The covered swap entity combined with all its margin

affiliates; and

(ii) Its counterparty combined with all its margin affiliates have

an average daily aggregate notional amount of uncleared swaps,

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

exchange swaps in March, April, and May 2018 that exceeds $1.5

trillion, where such amounts are calculated only for business days; and

where

(iii) In calculating the amounts in paragraphs (a)(4)(i) and (ii)

of this section, an entity shall count the average daily notional

amount of an uncleared swap, an uncleared security-based swap, a

foreign-exchange forward, or a foreign exchange swap between an entity

or a margin affiliate only one time and shall not count a swap or a

security-based swap that is exempt pursuant to Sec. 23.150(b) or a

security-based swap that is exempt pursuant to section 15F(e) of the

Securities Exchange Act of 1934 (15 U.S.C. 78o-10(e)).

(5) September 1, 2019 for the requirements in Sec. 23.152 for

initial margin for any uncleared swaps where both--

(i) The covered swap entity combined with all its margin

affiliates; and

(ii) Its counterparty combined with all its margin affiliates have

an average daily aggregate notional amount of uncleared swaps,

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

exchange swaps in March, April, and May 2019 that exceeds $0.75

trillion, where such amounts are calculated only for business days; and

where

(iii) In calculating the amounts in paragraphs (a)(5)(i) and (ii)

of this section, an entity shall count the average daily notional

amount of an uncleared swap, an uncleared security-based swap, a

foreign-exchange forward, or a foreign exchange swap between an entity

or a margin affiliate only one time and shall not count a swap or a

security-based swap that is exempt pursuant to Sec. 23.150(b) or a

security-based swap that is exempt pursuant to section 15F(e) of the

Securities Exchange Act of 1934 (15 U.S.C. 78o-10(e)).

(6) September 1, 2020 for the requirements in Sec. 23.152 for

initial margin for any other covered swap entity with respect to

uncleared swaps entered into with any other counterparty.

(b) Once a covered swap entity and its counterparty must comply

with the margin requirements for uncleared swaps based on the

compliance dates in paragraph (a) of this section, the covered swap

entity and its counterparty shall remain subject to the requirements of

Sec. Sec. 23.150 through 23.161 with respect to that counterparty.

(c)(1) If a covered swap entity's counterparty changes its status

such that an uncleared swap with that counterparty becomes subject to a

stricter margin requirement under Sec. Sec. 23.150 through 23.161 (for

example, if the counterparty's status changes from a financial end user

without material swaps exposure to a financial end user with material

swaps exposure), then the covered swap entity shall comply with the

stricter margin requirements for any uncleared swaps entered into with

that counterparty after the counterparty changes its status.

(2) If a covered swap entity's counterparty changes its status such

that an uncleared swap with that counterparty becomes subject to less

strict margin requirement under Sec. Sec. 23.150 through 23.161 (for

example, if the counterparty's status changes from a financial end user

with material swaps exposure to a financial end user without material

swaps exposure), then the covered swap entity may comply with the less

strict margin requirements for any uncleared swaps entered into with

that counterparty after the counterparty changes its status as well as

for any outstanding uncleared swap entered into after the applicable

compliance date under paragraph (a) of this section and before the

counterparty changed its status.

Sec. Sec. 23.162-23.199 [Reserved]

0

3. In Sec. 23.701 revise paragraphs (a)(1), (d), and (f) to read as

follows:

Sec. 23.701 Notification of right to segregation.

(a) * * *

(1) Notify each counterparty to such transaction that the

counterparty has the right to require that any Initial Margin the

counterparty provides in connection with such transaction be segregated

in accordance with Sec. Sec. 23.702 and 23.703 except in those

circumstances where segregation is mandatory pursuant to Sec. 23.157;

* * * * *

(d) Prior to confirming the terms of any such swap, the swap dealer

or major swap participant shall obtain from the counterparty

confirmation of receipt by the person specified in paragraph (c) of

this section of the notification specified in paragraph (a) of this

section, and an election, if applicable, to require such segregation or

not. The swap dealer or major swap participant shall maintain such

confirmation and such election as business records pursuant to Sec.

1.31 of this chapter.

* * * * *

(f) A counterparty's election, if applicable, to require

segregation of Initial Margin or not to require such segregation, may

be changed at the discretion of the counterparty upon written notice

delivered to the swap dealer or major swap participant, which changed

election shall be applicable to all swaps entered into between the

parties after such delivery.

PART 140--ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION

0

4. The authority citation for part 140 continues to read as follows:

Authority: 7 U.S.C. 2(a)(12), 12a, 13(c), 13(d), 13(e), and

16(b).

0

5. In Sec. 140.93, add paragraph (a)(6) to read as follows:

Sec. 140.93 Delegation of authority to the Director of the Division

of Swap Dealer and Intermediary Oversight.

(a) * * *

(6) All functions reserved to the Commission in Sec. Sec. 23.150

through 23.161 of this chapter.

* * * * *

Issued in Washington, DC, on December 18, 2015, by the

Commission.

Christopher J. Kirkpatrick,

Secretary of the Commission.

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

Federal Regulations.

Appendices to Margin Requirements for Uncleared Swaps for Swap Dealers

and Major Swap Participants--Commission Voting Summary, Chairman's

Statement, and Commissioners' Statements

[[Page 705]]

Appendix 1--Commission Voting Summary

On this matter, Chairman Massad and Commissioner Giancarlo voted

in the affirmative. Commissioner Bowen voted in the negative.

Appendix 2--Statement of Chairman Timothy G. Massad

The rule this Commission is adopting today is one of the most

important elements of swaps market regulation set forth in the Dodd-

Frank Act. Although we have mandated clearing for standardized

swaps, there will always be a large part of the market that is not

cleared. This is entirely appropriate, as many swaps are not

suitable for central clearing because of limited liquidity or other

characteristics. Our clearinghouses will be stronger if we exercise

care in what is required to be cleared. However, we must take steps

to protect against such activity posing excessive risk to the

system. That is why margin requirements for uncleared swaps are

important.

The rule we are adopting today is strong and sensible. It

requires swap dealers and major swap participants (``covered swap

entities'' or ``CSEs'') to post and collect margin with financial

entities with whom they have significant exposures. It requires

initial margin, which is designed to protect against potential

future loss on a default, as well as variation margin, which serves

as mark-to-market protection. It allows for the use of a broad range

of types of collateral, but only with appropriate haircuts. It

requires a greater level of margin than for cleared swaps, given

that uncleared swaps are likely to be less liquid. It requires

segregation of margin with third party custodians, and prohibits

rehypothecation.

While there are costs to this rule, they are justified in light

of the potential risks that uncleared swaps can pose. We learned

this firsthand in the global financial crisis, which resulted in

dramatic suffering and loss for American families.

The swap activities of commercial end-users were not a source of

significant risk in the financial crisis, and we must make sure that

they can continue using the derivatives markets effectively and

efficiently. Accordingly, an important feature of our rule is that

these margin requirements do not apply to swaps with commercial end-

users. This was an element of our proposed rule and is in accordance

with the intent of Congress. Instead, our rule focuses on those

entities that create the greatest risks to our system through

uncleared swaps: The large financial institutions with the greatest

amount of swap activity.

Our rule is practically identical to the rules of the United

States banking regulators, and substantially similar to

international rules. Harmonization is critical to creating a sound

international framework for regulation. Shortly after I took office,

I committed to doing all we could to achieve such harmonization, and

we have succeeded. For example, a year ago there were significant

differences between proposals by the CFTC as well as the prudential

regulators on the one hand, and international regulators on the

other. But today, all these rules are substantially similar. This is

true with respect to a number of provisions, including a two-way

``post and collect'' obligation; the material swaps threshold that

determines when the requirements apply; the minimum transfer amount;

the types of permissible collateral; the haircuts used in valuing

types of collateral; the general provisions on models for

calculating margin; segregation requirements; and the use of

different currencies for collateral. We have also taken into account

concerns related to the timing of when margin must be posted and

made changes to address the complexities of cross-border

transactions.

Today's rule is designed to address the potential risks that can

arise if a CSE or large financial entity defaults on transactions

with another CSE or large financial entity. We are particularly

seeking to reduce the risk that such a default leads to further

defaults by those counterparties, given the interconnectedness of

our financial system. We became all too familiar with that risk in

2008. Margin is designed to reduce the risk of cascading defaults by

enabling the non-defaulting party to recover its loss. Some will

characterize this as expensive insurance, as both parties must post

initial margin as protection against potential future loss, even

though in default, only one would actually recover against the

margin. But we need only remember the costs of the crisis to our

economy to recognize that this is, on the contrary, quite sensible.

The issue of how our rule should apply to inter-affiliate

transactions has received a lot of attention. I believe we should

look at this issue in terms of the goals of the rule, which are

first and foremost to avoid the potential for the buildup of

excessive risk from bilateral transactions between unaffiliated

parties. Inter-affiliate transactions are not outward-facing and

thus do not increase the overall risk exposure of the consolidated

enterprise to third parties. Instead, they are typically a means for

the consolidated enterprise to centrally manage risk related to the

activities of multiple subsidiaries. Imposing the same third-party

transaction standards on these internal activities of consolidated

entities is likely to significantly increase costs to end-users

without any commensurate benefit. Nevertheless, we have imposed some

protections and requirements.

First, we must make sure that inter-affiliate transactions are

not used as a loophole or as a means to escape the obligation to

collect margin from third parties. This could occur, for example, if

an affiliate in a jurisdiction that does not have comparable margin

requirements enters into a swap with a third party without

collecting margin, and then enters into an affiliate swap to

transfer that risk. Our rule imposes a strong anti-evasion standard.

A CSE is required to collect margin from an affiliate if that

affiliate is, directly or indirectly, engaging in an outward facing

swap in a situation where it should be, but is not, collecting

margin. In addition, our proposal on the cross-border application of

our margin rule, which is the subject of a separate rulemaking, also

addresses this. The proposal provides that any affiliate that is

consolidated with a U.S. parent is subject to requirements to

collect margin from third parties no matter where the affiliate is

located and whether or not it is guaranteed by the U.S. parent.

We have seen how global financial institutions have changed

their business models to ``deguarantee'' the transactions of their

overseas swap dealers so as to circumvent certain U.S. requirements.

Whether guaranteed or not, swap risk created by an affiliate abroad

could harm our financial system. That is why we have a strong anti-

evasion standard in this rule and why we are addressing this through

the cross-border aspects of the rule. I hope that we can finalize

that part of the rule early next year.

In addition, our rule requires segregation of margin and

prohibits rehypothecation, which prevents the affiliate that created

the outward exposure from using the margin for something else, thus

leaving itself more vulnerable to a default.

Second, we have required that variation margin be exchanged for

all inter-affiliate swaps. This provides mark-to-market protection

to either side, and prevents the potential buildup of a liability

owed by one affiliate to another.

Third, we have required that inter-affiliate swaps be subject to

a centralized risk management program that is reasonably designed to

monitor and to manage the risks associated with such transactions.

Some have suggested that, even if inter-affiliate swaps do not

increase exposure to third parties, we should require initial margin

for all inter-affiliate swaps to enhance that internal risk

management. But that would be a very costly and not very effective

way for us as a regulator to enhance such risk management. For

example, it would not make sense to have a rule that required

initial margin on, say, a $100 million inter-affiliate swap, when

one affiliate could loan the other $100 million and not collect any

margin. Similarly, a CSE could collect Treasury securities (or other

non-cash collateral) from an affiliate as initial margin, but then

loan the same amount of other securities back to the affiliate in a

separate transaction which is not subject to requirements. The point

is, if the concern is the adequacy of central risk management, then

we should focus on that subject more generally. We should not

attempt to address it by imposing on all inter-affiliate trades an

initial margin requirement that is designed to address default risk

on trading relationships between unaffiliated parties.

It is also important to remember that the definition of

``affiliate'' in our rule is limited to consolidated entities. This

means that any swap with an affiliate that is not consolidated would

be subject to the same margin requirements as third party swaps.

This would be the case, for example, if a swap dealer enters into a

swap with a mutual fund managed by an affiliate.

The fact that we are not generally requiring an exchange of

initial margin in inter-affiliate transactions is also consistent

with the rule this Commission adopted in 2013, which provided an

exception to the clearing mandate for inter-affiliate transactions.

In that rulemaking, the Commission considered,

[[Page 706]]

but decided against, requiring the exchange of initial margin or

variation margin as a condition for electing the exemption. It did

so out of a concern that such requirements ``would limit the ability

of U.S. companies to efficiently allocate risk among affiliates and

manage risk centrally.'' A requirement to exchange initial margin on

all uncleared inter-affiliate transactions would effectively

contravene the inter-affiliate clearing exemption, as it would

likely be cheaper to clear the inter-affiliate swap. However, I

think the case for variation margin is different, and that is why I

support imposing a general requirement for exchange of variation

margin for inter-affiliate swaps. While this goes further than what

the Commission did in 2013, I believe it is a necessary and

reasonable addition to the overall protections of the rule.

In addition to the goal of minimizing systemic risk, I also

considered our desire to harmonize with the prudential regulators

and international standards as much as possible, so that we do not

create inconsistencies in the regulatory framework or incentives for

regulatory arbitrage. The prudential regulators' rules require the

exchange of variation margin in inter-affiliate transactions, as

ours do. They did not require the two-way exchange of initial

margin; instead they required a ``collect only'' approach. This is

similar to what federal law already requires, as Section 23 A and B

of the Federal Reserve Act imposes requirements on inter-affiliate

transactions by insured depositary institutions designed to protect

the insured depository institutions. Those requirements do not apply

to CSEs subject to our rule. In addition, if we were to adopt a

collect only approach to initial margin, it would result in the two-

way approach for transactions between the CFTC's CSEs and the CSEs

subject to the prudential regulators' rules that the prudential

regulators did not adopt. Instead, we have required the posting of

initial margin to affiliated CSEs regulated by the prudential

regulators to ensure consistency with the requirements of the

prudential regulators' rules. By doing so, we can help enforce the

prudential regulators' goal and the existing Section 23 framework.

With respect to international harmonization, we expect the rules

to be adopted soon by Europe and Japan to not require initial or

variation margin for inter-affiliate swaps. Similarly, the joint

Basel Committee on Banking Supervision and the International

Organization of Securities Commissions standards agreed upon in 2013

stated that the exchange of initial or variation margin for inter-

affiliate swaps is ``not customary'' and expressed concern that

imposing such requirements would result in ``additional liquidity

demands.'' Our rule is somewhat more conservative than the

international standards, but I believe the differences are not so

great as to create significant international disparities.

In conclusion, the differences in our views on inter-affiliate

margin do not reflect differences in the level of concern about the

safety of the system or avoiding the problems of the past. They

reflect differences in our analysis of what is accomplished by

inter-affiliate initial margin. I believe the rule we are adopting

today is a strong and sensible approach that will contribute to the

strength and resiliency of our financial system.

Appendix 3--Dissenting Statement of Commissioner Sharon Y. Bowen

I commend the staff, the Chairman, and Commissioner Giancarlo

for their work on this final rule. This rule has many benefits for

the American public and is an important step towards further girding

the financial system. Unfortunately, as compared to our September,

2014 proposal and the rule passed by the prudential regulators, this

final rule fails to meet statutory intent and it puts swap dealers

we regulate at greater risk in times of financial stress because of

its treatment of interaffiliate margin.

In 2008, our financial system was brought to its knees as a

tidal wave of financial risk washed away the savings of many,

destroyed confidence in the financial system, and swept away

platitudes about large, sophisticated, financial players' ability to

manage their own credit risks. This crisis was considerably

compounded by derivatives transactions that were unregulated and

woefully under-collateralized.

While these large players were bailed out by taxpayers, today

they have returned to record profits. Many of those same taxpayers

had no similar help. No recourse to the financial institutions that

harmed them. No help to pick up the pieces and rebuild a financial

future.

In the aftermath, the international regulatory community

recognized that margin requirements for uncleared swaps are a

critical safeguard against repeating these mistakes. They provide

covered entities with protections against counterparty default.

Crucially, initial margin is a protection paid by the ``defaulter.''

These defaulter-paid protections help entities recognize the risk

they take and impose on others. Variation margin, on the other hand,

force entities to recognize losses they have already incurred.

Together, variation margin and initial margin reduce systemic risk

and excess leverage. They help ensure the parties have the capacity

to perform on the swap over time.

In 2010, the Dodd Frank Wall Street Reform and Consumer

Protection Act (``Dodd Frank'') recognized the higher risk swap

dealers faced from using uncleared swaps. Dodd Frank mandated margin

requirements to protect the safety and soundness of swap dealers

using uncleared swaps.

In 2011, the Group of Twenty (G20) added margin requirements on

uncleared derivatives to the global financial reform agenda.

In September, 2013, following the G20 agenda, the Basel

Committee on Banking Supervision (``BCBS'') and International

Organization for Securities Commissions (``IOSCO'') released a

framework for margin requirements for uncleared derivatives (the

``BCBS/IOSCO Framework'').\1\ This framework highlighted the

increased risk posed by uncleared derivatives as the ``same type of

systemic contagion and spillover risks'' \2\ involved in the 2008

financial crisis. The Framework also found that margin requirements

for uncleared derivatives would promote central clearing.\3\

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

\1\ BCBS/IOSCO, Margin requirements for non-centrally cleared

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

\2\ Id. at 2.

\3\ Ibid.

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

In September, 2014, the Commission re-proposed its 2011 rule on

uncleared margin, updating it to reflect the Framework and working

with the prudential regulators to develop a proposal that was

consistent with theirs.

Unfortunately, the rule before us is a considerable retreat from

the September proposal. This final rule provides an exemption for

swap dealers, excusing them from collecting initial margin when

entering into transactions with most affiliated parties including

prudentially regulated swap dealers, i.e., swap dealers that are

also banks. It also includes, in most cases, under-capitalized

affiliates, foreign affiliates, and even unregulated affiliates.

As the prudential regulators noted in their recently released

final rule, these swaps ``may be significant in number and notional

amount.'' \4\ As I understand from our staff, interaffiliate

transactions likely make up nearly half of all uncleared

transactions by notional volume.

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

\4\ 80 FR 74840 (November 30, 2015) at 74889.

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

Initial margin functions like a performance bond. Collected from

your counterparty, it helps ensure that even as one party defaults

on you, you will be able to perform on your obligations to others.

Posted and collected across the financial system, it is a critical

shock absorber for the bumps and potholes of our financial markets

and for the risk of contagion and spillovers.

The large financial institutions that benefit from this

exemption have tremendously complicated organizational structures,

webs of hundreds, sometimes thousands, of affiliates spread across

the globe. These complicated structures allow these banks to shift

risk across the globe through different legal entities in their

quest to earn higher returns on capital.

The difference in political, financial, and legal systems across

these interconnected, international affiliate webs makes it

difficult, likely impossible, to fully predict how risk unfolds

across the global entity in a period of severe financial stress.

Think of immunizations. We have them to protect our population

against the risk of infectious disease, not just for us as

individuals, but to keep disease from spreading across our

communities. Immunizations are not always enough, people still get

sick, but they are a vital protective measure. People do forgo them,

perhaps hoping that they either are not going to get sick, or if

they do, that they can be treated. But, we know, hope is not enough.

The whole point of immunizations is protecting against dangerous,

but preventable, risks.

Initial margin fulfills a similar role. Legally, the affiliates

we are talking about here are separate entities, even if they are

part of a larger company structure. If their transactions across

affiliates create risk, that risk should be addressed. For uncleared

[[Page 707]]

swaps, initial margin helps immunize individuals, institutions and

ultimately the whole financial system from financial disease and

contagion.

In November of this year, the prudential regulators decided to

allow, subject to conditions, dealers to collect but not post

initial margin with affiliates. The prudential regulators noted this

accommodation would meet the twin goals of ``protect[ing] the safety

and soundness of covered swap entities in the event of an affiliated

counterparty default'' while not ``permit[ting] such inter-affiliate

swaps . . . to remain unmargined and thus to pose a risk to systemic

stability.'' According to the statute, our rules are to be

comparable, ``to the maximum practicable'' to those of our fellow

prudential regulators.\5\

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

\5\ 7 U.S.C. 6s(e)(3)(D)(ii).

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

While this rule today is, in many respects consistent with that

of the prudential regulators, regarding interaffiliate initial

margin it is neither comparable to that of the prudential

regulators, nor does it protect safety and soundness of swap dealers

we oversee. It places the swap dealers we regulate, and thus, their

customers, at unnecessary risk in times of financial stress.

The situation of a CFTC-regulated swap dealer transacting with a

prudentially regulated swap dealer is particularly problematic. Not

only does the CFTC-regulated swap dealer not have the benefit of

collecting initial margin, it has to post initial margin to the

prudentially-regulated swap dealer. For entities with high volumes

of affiliate transactions, this can leave these CFTC-regulated swap

dealers in a huge hole in the case of default. By not collecting

initial margin, this rule places the swap dealers we regulate at

greater risk in times of severe financial stress. That cannot be

consistent with the intent of a statute mandating us to protect the

``safety and soundness'' of our swap dealers.

By not requiring the collection of interaffiliate initial margin

for this significant number of trades, we lose a vital financial

shock absorber that is intended to help immunize institutions and

the system against the risk of default.

We should not minimize the risk of this action. One could say

that having our swap dealers collect initial margin is not necessary

because a large financial institution is never going to let one of

its affiliates go under. Do we want to risk the health of our

economy on that bet? Especially since, relying on financial entities

to properly risk manage, without regulatory limitations, did not

work in 2008?

The rationale noted in this rule for allowing this loophole

seems to be in order to reduce the margin amount collected by the

overall enterprise. But, we are charged with protecting the ``safety

and soundness'' of swap dealers.\6\ We need to address the risks

that cause a particular swap dealer to fail. Especially, those risks

that might cause a swap dealer to fail to meet its obligations to

its customers or protect its customers' funds.

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

\6\ 7 U.S.C. 6s(e)(3)(A)(i).

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

I do not know, for a particular swap dealer, what circumstances

might arise that would send it careening towards another financial

crash. I cannot predict whether collecting interaffiliate initial

margin will be enough to protect the swap dealer and ultimately its

customers. I do know that having collateral in the form of initial

margin makes it more likely the swap dealer will meet its

obligations than not having it.

This decision seems to reflect a forgetfulness about how we, as

a country, allowed the last financial crisis to happen. It is easy

to believe that large, complex financial institutions can manage

their risks. They are smart people. They make a lot of money. They

have to know what they are doing.

However, the risks we are dealing with are hard to quantify.

They are the kinds of risks that humans have shown, throughout

history, they are quite poor at managing.

Most institutions for whom these transactions are relevant,

failed in 2008 to manage the risk of these transactions. This action

today seems to be a return to blindly trusting in large financial

institutions' ability and willpower to manage their risks

adequately. Are we really willing to make that bet again?

I am not.

Our prudential colleagues have agreed that initial margin is the

correct tool to manage the risks of transactions across affiliates.

We should not be trying to guess whether a large, complex financial

institution's global risk controls will be sufficient to protect the

swap dealers we regulate. Our failure to provide comparable

protection for our swap dealers is inexplicable to me.

I have been responsible for dealing with customers who have lost

their life savings when complex financial entities collapse. I

cannot vote for a rule that places the swap dealers we regulate, and

most importantly, their customers, at risk. Accordingly, I vote no.

Appendix 4--Statement of Commissioner J. Christopher Giancarlo

Today's final rule regarding margin requirements for uncleared

swaps is far from perfect. The Commission had the unenviable task of

harmonizing its rule with the prudential regulators' rules and with

standards issued by the Basel Committee on Banking Supervision and

the International Organization of Securities Commissions (BCBS/

IOSCO). While there are particular provisions of the final rule that

I do not support, I think the final rule is far better balanced than

the previous proposal.

Much of the discussion in finalizing this rule has been focused

on margin requirements for inter-affiliate swaps. That discussion

must begin with the recognition that inter-affiliate swaps

transactions do not involve transactions between distinct financial

institutions that was at issue in the 2008 financial crisis and do

not pose the systemic risk that the Dodd-Frank Act \1\ was

ostensibly designed to address. Congress expressed no particular

intention to subject inter-affiliate transactions to clearing or

inter-affiliate margin.

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

\1\ Dodd-Frank Wall Street Reform and Consumer Protection Act,

Pub. L. 111-203, 124 Stat. 1376 (2010).

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

Accordingly, the CFTC adopted a rule in April 2013 to exempt

certain inter-affiliate swaps from mandatory clearing.\2\ That

rulemaking, supported by former Chairman Gensler and Commissioners

Wetjen, Chilton and O'Malia, recognized that inter-affiliate swaps

provide an important risk management role within corporate groups.

They enable use of a single conduit on behalf of multiple affiliates

to net affiliates' trades, which reduces the overall risk of the

corporate group and the number of outward-facing swaps into which

the affiliates might otherwise enter. This, in turn, reduces

operational, market, counterparty credit and settlement risk.\3\

Rather than increasing risk, inter-affiliate swaps allow entities

within a corporate group to transfer risk to the group entity best

positioned to manage it.

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

\2\ Clearing Exemption for Swaps Between Certain Affiliated

Entities, 78 FR 21750 (Apr. 11, 2013); 17 CFR 50.52.

\3\ Id. at 21753.

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

Moreover, in exercising its authority under Section 4(c) of the

Commodity Exchange Act to exempt qualifying inter-affiliate swaps

from the mandatory clearing requirement, the Commission found that

the exemption promotes responsible financial innovation, fair

competition and is consistent with the public interest.\4\ It

further found that the exemption, which was conditioned on having

certain risk mitigating measures in place,\5\ would not have a

material effect on the Commission's ability to discharge its

regulatory responsibilities.\6\

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

\4\ Id. at 21754.

\5\ For example, the clearing exemption may be elected only if

the affiliates' financial statements are consolidated, which

increases the likelihood that the affiliates will be mutually

obligated to meet the group's swap obligations; the affiliates must

be subject to a centralized risk management program; and outward-

facing swaps must be cleared or subject to an exemption or exception

from clearing. Id. at 21753.

\6\ Id. at 21754.

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

When the CFTC issued its proposed rule in September 2014, I

noted that subjecting inter-affiliate swaps to the higher costs of

uncleared margin \7\ could not be logically or prudentially

justified with the clearing exemption for inter-affiliate swaps that

the Commission adopted in 2013.\8\ The

[[Page 708]]

Commission's 2013 findings remain valid on this issue. I am aware of

no facts that have come to light that would change the original

assessment made by our predecessor Commission.

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

\7\ The costs of posting margin for uncleared swaps will likely

be substantially higher than the costs associated with clearing. For

example, the minimum liquidation time for cleared agricultural,

energy and metals swaps is one-day for purposes of calculating

initial margin, and five days for cleared interest rate and credit

default swaps. Commission Regulation 39.13(g)(2). Under the final

rule, initial margin for uncleared swaps may be calculated under

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

Under the table-based method, initial margin for commodity swaps

must equal 15 percent of gross notional exposure. The model-based

method requires a ten-day close out period for all swaps regardless

of the underlying liquidity characteristics.

\8\ Margin Requirements for Uncleared Swaps for Swap Dealers and

Major Swap Participants; Proposed Rule, 79 FR 59898, 59936 (Oct. 3,

2014) (Statement of Commissioner J. Christopher Giancarlo),

available at http://www.cftc.gov/idc/groups/public/@lrfederalregister/documents/file/2014-22962a.pdf.

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

In fact, since issuing the proposed rule for notice and comment,

an independent cost-benefit analysis of the rule recommended, among

other things, exempting inter-affiliate swaps from initial margin

requirements as a means to reduce the ``excessively onerous'' impact

of the rule on competition, price discovery and overall market

efficiency without allowing additional systemic risk.\9\ I concur

with that recommendation.

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

\9\ Cost-Benefit Analysis of the CFTC's Proposed Margin

Requirements for Uncleared Swaps, NERA Economic Consulting (Dec. 2,

2014), available at http://www.nera.com/content/dam/nera/publications/2014/NERA_Margin_Requirements_Uncleared_Swaps.pdf.

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

Earlier this year, I testified before the U.S. House of

Representatives Committee on Agriculture Subcommittee on Commodity

Exchanges, Energy, and Credit. In response to a question, I

explained that the cost of any requirement to impose initial margin

in inter-affiliate transactions would have two likely impacts:

first, it would raise the cost of commercial risk hedging for

American end-users; and second, it would encapsulate risk in the

U.S. marketplace and thus increase the risk of systemic hazard in

American financial markets.\10\

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

\10\ Hearing before the Subcommittee on Commodity Exchanges,

Energy, and Credit of the Committee on Agriculture, House of

Representatives, 114th Congress, First Session, Serial No. 114-7,

Transcript at 193-194 (Apr. 14, 2015), available at http://agriculture.house.gov/uploadedfiles/114-07_-_93966.pdf.

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

The final rule before us today is not na[iuml]ve or reckless

concerning inter-affiliate swaps transactions. It recognizes that

they are not without risk and sets appropriate safeguards. First,

the rule requires operation of a centralized risk management program

for such swaps. Second, variation margin will be required. Third,

the rule requires covered swap entities to collect initial margin

from non-U.S. affiliates that are not subject to comparable initial

margin collection requirements for their own outward-facing swaps

with financial entities. These measures appropriately address the

risks associated with uncleared inter-affiliate swaps.\11\

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

\11\ AIG often did not post initial margin or pay variation

margin on its outward facing swaps. See Opening Statement of

Commissioner Michael V. Dunn, Public Meeting on Proposed Rules Under

Dodd-Frank Act (Apr. 12, 2011). Both are required under today's

rule.

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

In other regards, I am satisfied that the threshold for

measuring material swaps exposure has been raised from $3 billion to

$8 billion, which brings our requirement roughly in line with the

BSBS/IOSCO standard of [euro]8 billion.\12\ I am also pleased that

the swaps of commercial end-users, agricultural and energy

cooperatives that are classified as financial institutions and small

banks will not be subject to the margin requirements if they qualify

for an exclusion or exemption. That is one small assist to America's

remaining small banks to get their heads back above water in the

toppling wake of the Dodd-Frank Act.

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

\12\ I note an inconsistency between the $8 billion de minimis

threshold for purposes of determining who must register as a swap

dealer or major swap participant and the $8 billion threshold for

measuring material swaps exposure. Foreign exchange swaps, foreign

exchange forwards and hedging swaps must be included in the

calculation of material swaps exposure; they are not included in

calculating the de minimis threshold.

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

I disagree, however, with the definition of ``financial end

user,'' which is overly broad. It includes entities that are

unlikely to act as counterparties to swaps such as floor brokers,

introducing brokers and futures commission merchants acting on

behalf of customers, among others. These entities may not ultimately

be captured by the rule because they are unlikely to have material

swaps exposure triggering application of the rule, but I question

the logic behind their inclusion. Good regulation means precisely

crafted rules, not ones that are deliberately overly-broad.

I also continue to object to the ten-day liquidation horizon

that must be incorporated into initial margin models for all types

of uncleared swaps. The ten-day requirement is a made up number that

is not tailored to the true liquidity profile of the underlying swap

instruments. I call upon my fellow regulators to revisit this issue

as we gain more experience with initial margin models.

Another item that requires further Commission action is to

codify by rule the no-action letters providing clearing relief to

certain Treasury affiliates acting as principal.\13\ The prudential

regulators were unwilling to recognize the no-action relief in their

final rules, but have indicated that if the Commission acts to

exclude these entities by rule, they would also be excluded from the

prudential regulators' rules. The Commission should act to issue a

rule without delay.

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

\13\ See CFTC No-Action Letter No. 13-22 (Jun. 4, 2013); CFTC

No-Action Letter No. 14-144 (Nov. 26, 2014).

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

In addition, I remain concerned about the cross-border

implications for this rule, which remain unfinished because they

were proposed separately from the rule finalized today.\14\ As I

stated at the time of the cross-border rule proposal, I have many

concerns and questions surrounding that rulemaking, including: (1)

The shift away from the transaction-level approach set forth in the

July 2013 Cross-Border Interpretive Guidance and Policy Statement;

(2) the revised definitions of ``U.S. person'' (defined for the

first time in an actual Commission rule) and ``guarantee'' and how

these new terms will be interpreted and applied by market

participants across their entire global operations; (3) the scope of

when substituted compliance is allowed; and (4) the practical

implications of permitting substituted compliance, but disallowing

the exclusion from CFTC margin requirements for certain non-U.S.

covered swap entities.\15\

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

\14\ See Margin Requirements for Uncleared Swaps for Swap

Dealers and Major Swap Participants--Cross-Border Application of the

Margin Requirements; Proposed Rule, 80 FR 41376 (Jul. 14, 2015),

available at http://www.cftc.gov/idc/groups/public/@lrfederalregister/documents/file/2015-16718a.pdf.

\15\ Id. at 41407.

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

An appropriate framework for the cross-border application of

margin requirements for uncleared swaps is essential if we are to

preserve the global nature of the swaps market. I reiterate a few of

my concerns with the yet-to-be-finished cross-border element of the

margin for uncleared swaps regime because that proposal and this

final rule must work in harmony. We must avoid further fragmenting

the global swaps markets by imposing another regulatory framework

that is inconsistent, confusing or burdensome. Doing so will only

result in yet another competitive disadvantage between American

institutions and their international counterparts.

I am disappointed that the Commission decided to treat the

results of portfolio compression of legacy swaps as new swaps

subject to the margin rule at this time. In 2013 the Division of

Clearing and Risk (DCR) determined that it would not recommend

enforcement action for the failure of market participants to submit

to clearing amended or replacement swaps that are generated as part

of a multilateral portfolio compression exercise and are subject to

required clearing, provided that certain conditions are met.\16\

Staff recognized in issuing the no-action relief that ``multilateral

portfolio compression allows swap market participants to net down

the size and/or number of outstanding swaps, and decrease the number

of outstanding swaps or the aggregate notional value of such swaps,

thereby reducing operational risk and, in some instances, reducing

counterparty credit risk.'' \17\

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

\16\ CFTC Letter No. 13-01.

\17\ Id. at 2.

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

Portfolio compression is of great benefit to the safety and

soundness of the market. It should be incentivized, not penalized.

Treating swaps created by compressing legacy swaps as new swaps

subject to margin requirements may well discourage portfolio

compression. Moreover, it is inconsistent with the DCR staff no-

action relief. This is a missed opportunity. I urge the Commission

to revisit this issue prior to implementation of the margin

requirements.

From my perspective, the most objectionable aspect of today's

rule is its foundation in the superficial logic that, if the cost of

margining uncleared swaps is forced high enough, then market

participants will use more cleared instruments.\18\ That foundation

is not supported by either reason or experience. If no clearinghouse

is willing to clear a particular swap, then no amount of punitive

cost will enable it to be cleared.

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

\18\ See Chair Janet L. Yellen, Opening Statement on the Long-

Term Debt and Total Loss-Absorbing Capacity Proposal and the Final

Rule for Margin and Capital Requirements for Uncleared Swaps, Board

of Governors of the Federal Reserve System, Oct. 30, 2015, available

at http://www.federalreserve.gov/newsevents/press/bcreg/yellen-statement-20151030a.htm; see also Madigan, Peter, US Margin Rules

Threaten Clearing Bottleneck, Risk.net, Dec. 14, 2015.

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

I know this because I was involved before the financial crisis

in one of the first

[[Page 709]]

independent efforts by non-Wall Street banks to develop a central

clearing house for credit default swaps.\19\ For years, I have

expressed my support for increased central counterparty clearing of

swaps \20\ and continue to support it where appropriate. Yet, I also

recognize that central counterparty clearing is not a panacea for

counterparty credit risk.\21\ As regulators, we must be

intellectually honest and acknowledge that there are legitimate and

vital needs for both cleared and uncleared swaps markets in a

modern, complex economy.

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

\19\ See, e.g., GFI Group Inc. and ICAP plc To Acquire Ownership

Stakes In The Clearing Corporation, PRNewswire, Dec. 21, 2006,

available at http://www.prnewswire.com/news-releases/gfi-group-inc-and-icap-plc-to-acquire-ownership-stakes-in-the-clearing-corporation-57223742.html; see also, Testimony Before the H.

Committee on Financial Services on Implementation of the Dodd-Frank

Wall Street Reform and Consumer Protection Act, 112th Cong. 8 (2011)

(statement of J. Christopher Giancarlo) (``In 2005, GFI Group and

ICAP Plc, a wholesale broker and fellow member of the WMBAA, took

minority stakes in the Clearing Corp and worked together to develop

a clearing facility for credit default swaps. That initiative

ultimately led to greater dealer participation and the sale of the

Clearing Corp to the Intercontinental Exchange and the creation of

ICE Trust, a leading clearer of credit derivative products.'').

\20\ See Testimony Before the H. Committee on Financial Services

on Implementation of the Dodd-Frank Wall Street Reform and Consumer

Protection Act, 112th Cong. 8 (Feb. 21, 2011), available at dia/pdf/

021511giancarlo.pdf; see also WMBAA Press Release, WMBAA Commends

Historic US Financial Legislation, Jul. 21, 2010, available at

http://www.wmbaa.com/wp-content/uploads/2012/01/WMBAA-Dodd-Frank-Law-press-release-final123.pdf.

\21\ See CFTC Commissioner J. Christopher Giancarlo, Pro-Reform

Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-

Frank (Jan. 29, 2015), available at http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/sefwhitepaper012915.pdf.

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

As I have previously said,\22\ uncleared swaps allow businesses

to avoid basis risk and obtain hedge accounting treatment for more

complex, non-standardized exposures. Uncleared swaps are an

unmatched tool for customized risk management by businesses,

governments, asset managers and other institutions whose operations

are essential to American economic growth. Their precise risk

transfer utility generally cannot be replicated with standardized

cleared derivatives without resulting in improper or imperfect

hedges or hedges that fail hedge accounting treatment under U.S.

GAAP.

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

\22\ See Opening Statement of Commissioner J. Christopher

Giancarlo, Open Meeting on Proposed Rule on Margin Requirements for

Uncleared Swaps and Final Rule on Utility Special Entities, Sept.

17, 2014, available at http://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement091714.

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

Today's rule also reflects a disingenuous reading of the Dodd-

Frank Act to favor cleared derivatives over uncleared swaps. In

fact, there is no provision in the law directing regulators to set

punitive levels of margin to drive hedging market participants

toward cleared products. Imposing punitive margin levels will hazard

a range of adverse consequences from raising the commercial cost of

risk hedging to reducing trading liquidity in uncleared swaps

markets and incentivizing movement of products otherwise unsuitable

for clearing into clearinghouses into which counterparty risk is

already increasingly concentrated. More critically, punitive margin

on uncleared swaps will increase the amount of inadequately hedged

risk exposure on America's corporate balance sheets exacerbating

volatility in earnings and share prices.

Yet, I know that my voice alone cannot reverse the course of the

present prevalence of ``macro-prudential'' regulation that

prioritizes systemic stability over investment opportunity, market

vibrancy and economic growth. Only time will show that systemic risk

cannot be managed through centralized economic planning. In fact,

rather than being managed, systemic risk is being transformed today

from counterparty credit exposure to jarring volatility spikes and

liquidity risk across the breadth of financial markets, with

ramifications that will be even harder to manage in the future.

Unfortunately, today's rule will not reverse these trends. I

will vote for the rule, not because it is the right prescription for

uncertain markets, but because it is much better than originally

proposed and less harmful than likely alternatives.

I commend the CFTC staff for their hard work, thoughtfulness

and, ultimately, the generally improved rulemaking that is before us

today.

[FR Doc. 2015-32320 Filed 1-5-16; 8:45 am]

BILLING CODE 6351-01-P

 

Last Updated: January 6, 2016