Statement of Concurrence of CFTC Commissioner Rostin Behnam Regarding Segregation of Assets Held as Collateral in Uncleared Swap Transactions; Amendments
July 24, 2018
I respectfully concur with the Commodity Futures Trading Commission’s (the Commission or CFTC) approval of its proposed rule (Proposal) regarding amendments to subpart L of the Commission’s Regulations (Segregation of Assets Held as Collateral in Uncleared Swap Transactions” consisting of Regulations 23.700 through 23.704), which implement Section 4s(l) of the Commodity Exchange Act (CEA or the Act). While I have strong reservations about the Commission’s proposed interpretation of CEA Section 4s(l) and its slash and burn approach to “simplify” requirements for swap dealers (SDs) and major swap participants (MSPs) absent meaningful consideration of the impact on swap counterparties, I am hopeful that the Proposal’s solicitation of comments on these key points will produce a balanced record from which to adopt a final rule that more precisely simplifies the current requirements and provides tailored regulatory relief.
Since joining the Commission, I have emphasized both my strong opposition to any rollbacks of Dodd-Frank initiatives and my belief that, while a more principles-based approach may be suitable in certain situations, any changes must be narrowly targeted to ensure that core reforms remain whole and intact. I am concerned that this Proposal forgoes a surgical approach in favor of a blunt, insensitive strike at the purpose of the statute and implementing regulations.
While the preamble purports that the Proposal is supported by Commission experience, in reality the Commission heavily relies on a few comment letters from a limited segment of the market submitted in response to its “Project KISS” initiative. In the absence of corroborative evidence from those most impacted by the Proposal—non-financial end-users and financial end-users without “material swaps exposure,” as defined in the CFTC Margin Rule[1]—I am concerned that the Commission’s proposed amendments take too much of a shoot first, ask questions later tactic. While I am supportive of the Project KISS initiative, I believe that the exercise requires a more diligent approach to evaluating the potential impact of proposing amendments to existing rules.
My greatest concerns with the Proposal relate to the Commission’s proposed interpretation of the notice requirement in CEA section 4s(l)(1) and the proposed removal of all limitations on the investment of margin that is segregated pursuant to an election under Regulation 23.701. As I explain below, I am concerned that the Proposal’s focus on reducing burdens to SDs and MSPs through amending the rules in subpart L may obscure valid issues regarding implementation—matters which may be resolved through more precise amendments with less chance of negatively impacting market participants.
The Commission previously interpreted the language in CEA section 4s(l)(1)(A) “as a segregation right that can be elected or renounced by the SD’s or MSP’s counterparty.”[2] Citing the plain language of the statute, the Commission noted Congress’s emphasis on the importance of the ability of a counterparty to elect to have its collateral segregated by describing segregation as a “right.”[3] Regarding this “right,” the Commission understood that, “the statute does not merely grant counterparties the legal right to segregation; it specifically requires that the existence of this right be communicated to them.”[4] At a minimum, the Commission determined that this requirement is met when an SD or MSP provides notification to a counterparty at least once in each calendar year in which the SD or MSP enters a swap with the counterparty.[5] At the time, the Commission recognized that requiring notification on a transaction-by-transaction basis—e.g., “at the beginning of a swap transaction,”[6] may be overly costly and burdensome, and that annual notification “ensures that the right to segregation is called to the attention of the counterparties reasonably close in time to the point at which they make decisions regarding the handling of collateral for particular swaps transactions.”[7] While the Commission considered requiring only an initial notification, it rejected that approach, noting the importance of the counterparty’s right to elect to have its collateral segregated, and the minimal administrative burden on SDs and MSPs.[8]
The Commission and subpart L are largely silent with regard to content and delivery manner and method of the notice required by CEA section 4s(l)(1)(A) other than provisions in Regulation 23.701(a)(1) and (2) requiring the notification to identify one or more creditworthy, independent custodians and to include information regarding the price of segregation for each custodian, to the extent the SD or MSP has such information.[9] Though not specifically required by CEA section 4s(l)(1)(A), the Commission determined that this limited set of disclosures represents information material to a counterparty’s informed decision making process regarding exercise of the right to segregation and when considering a segregation package offered by an SD or MSP.[10]
The Proposal would amend subpart L, in part, to require a single, one-time notification to a counterparty of their right to require segregation of any initial margin the counterparty provides in connection with all transactions following the first transaction that provides for the exchange of initial margin. The Proposal would also entirely remove Regulations 23.701(a)(2) and (3), generally finding that, since very few counterparties elect to require segregation, the underlying activity of “confirming which custodians are available” is “unnecessarily burdensome” and that pricing for segregation may vary, is normally subject to negotiation, and can be discussed when the counterparty indicates an interest in segregation. Consistent with CEA section 4s(l)(1)(B), the Proposal preserves the ability of a counterparty to change its election upon written notice.
In proposing these amendments, the Commission appears to be taking the view that a counterparty’s decision with regard to segregation is made with respect to a trading relationship with a particular SD or MSP at the relationship’s inception, and that while these types of counterparties are sophisticated enough to elect segregation and negotiate the terms of segregation arrangements, the annual receipt of a notice reminding them that they may change their election at any time is confusing. It also assumes that evidence of minimal uptake of the election to segregate indicates that subpart L is largely superfluous.
While it may be true that swap counterparties have not elected segregation in droves, CEA section 4s(l) and subpart L are not intended to advance any particular outcome. Rather they concern the rights of counterparties to SDs and MSPs and aim to increase the safety in the market for uncleared swaps by creating a self-effectuating requirement for the segregation of counterparty initial margin in an entity legally separate from the SD or MSP.[11] As previously noted by the Commission in proposing subpart L, a goal of the regulation was to “increase the likelihood that any lack of use of segregated collateral accounts by uncleared swaps counterparties is the result of genuine choices by counterparties and reduce the likelihood that it is the result of inertia, market power, or other market imperfections.”[12] Indeed, based on some of the preamble discussion, it may be that we should consider the possibility that swap counterparties are not electing segregation specifically because the current system of annual notification does not provide them adequate notice of their ongoing right to segregation. If that is the case, the appropriate Commission response may be more (or clearer) notification, rather than the reduction in notification proposed today.
I am concerned that the Commission’s proposal could undermine the right to segregation as well as Congressional intent by removing the periodic notification and minimal disclosures currently required by subpart L. I believe there are prescriptive elements of subpart L that can be removed with little impact to counterparties.[13] However, I am concerned by the Proposal’s reliance on representations by SDs and unverified assumptions regarding counterparty behavior to justify regulatory rollbacks in the absence of further examination of whether and how the manner in which the annual notice requirement is currently implemented has contributed to claims of confusion and burden. I am also concerned that the Proposal may discourage commenters from suggesting alternative means of complying with the current language in Regulation 23.701(a) which may better preserve Congressional intent.[14]
I am similarly concerned that the Proposal’s removal of the requirement in Regulation 23.703 that limits the investment of initial margin segregated pursuant to subpart L to be invested consistent with Commission Regulation 1.25 is a knee-jerk response to a single Project KISS comment letter that ignores current practice and presupposes that the rollback will encourage more counterparties to elect to segregate pursuant to subpart L, which, as stated above, is not the goal of the statute or implementing regulation. While I am not opposed to permitting greater flexibility with regard to the investment of initial margin, I would have preferred that the Commission seek additional information regarding whether and how the current limitations in Regulation 23.703 have impacted counterparties and their decision making under subpart L before proposing alternative regulatory language.
I commend the Commission and its staff for engaging through Project KISS in efforts to identify and reduce unnecessary burdens in the Commission regulations. I appreciate staff’s consideration and inclusion of several of my suggested edits to this Proposal. To be clear, I believe the Proposal provides for many sound improvements to subpart L that respond to ongoing concerns and confusion created by the finalization of the CFTC and Prudential Regulator Margin Rules and CFTC interpretive guidance.[15] However, where the Proposal aims to strip out regulatory provisions that the Commission previously determined were essential to effectuating the language and purpose of CEA section 4s(l), I believe the Commission may be engaging in shortsighted and unnecessary rollbacks to the detriment of the swap counterparties subpart L is intended to protect.
[1] 17 CFR 23.150-159, 161.
[2] Protection of Collateral of Counterparties to Uncleared Swaps; Treatment of Securities in a Portfolio Margining Account in a Commodity Broker Bankruptcy, 78 FR 66621, 66623 (Nov. 6, 2013).
[3] Id. at 66623 and 66625.
[4] Id. at 66625.
[5] Id.; 17 CFR 23.701(e).
[6] 7 U.S.C. 6s(l)(1)(A) (emphasis added).
[7] 78 FR at 66635 (emphasis added); see also 78 FR at 66633 (adding that annual notice offers this benefit “without requiring excessive or repetitive notification in cases where a counterparty engages in multiple swaps with a particular SD or MSP over the course of a year.”).
[8] 78 FR at 66633 (“The Commission believes that the cost of requiring SDs and MSPs to deliver one notification per year to each counterparty is not overly burdensome, particularly when one considers the importance of the counterparty’s decision to require segregation and the large dollar volume of business that is typically done by SDs and MSPs.”).
[9] 17 CFR 23.701(a)(2) and (3). While Commission Regulation 23.701(d) requires the SD or MSP to obtain confirmation of receipt of the segregation notification, since 2014, the Commission has permitted SDs and MSPs to rely on negative consent for purposes of Regulation 23.701(d), provided that the notice under Regulation 23.701(a) includes a prominent and unambiguous statement to that effect. See CFTC Staff Letter No. 14-132 (Oct. 31, 2014) at 7, available at https://www.cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/14-132.pdf.; See also Transcript of the NFA Swap Dealer Examinations Webinar at 6 ( Jan. 18, 2018), available at https://www.nfa.futures.org/members/member-resources/files/transcripts/sdexamswebinartranscriptjan2018.pdf.
[10] See 78 FR at 66624.
[11] Id. at 66621 and 66632.
[12] Protection of Collateral of Counterparties to Uncleared Swaps; Treatment of Securities in a Portfolio Margining Account in a Commodity Broker Bankruptcy, 75 FR 75432, 75437 (proposed Dec. 3, 2010).
[13] I also believe that the Commission can respond to specific burdens identified by SDs and MSPs by, for example, codifying staff interpretive guidance. See, e.g. Letter from the Financial Services Roundtable at 56 (Sept. 30, 2017) (urging the Commission to codify its interpretation in CFTC Staff Letter No. 14-132 with respect to SDs’ ability to rely on negative consent), https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61427&SearchText=.
[14] For example, through the use of additional clauses in customer onboarding or relationship documentation as a means to append the required notification and disclosures to each new swap confirmation thereby ensuring and simultaneously documenting that the counterparty is notified of their right to require segregation at least at the beginning of each swap transaction.
[15] See CFTC Staff Letter No. 14-132, supra note 9.