Public Statements & Remarks

Statement of Chairman Timothy G. Massad on Cross Border Margin (Washington, DC)

June 29, 2015

Thank you all for calling in today. Before I begin, I want to let you know that I have CFTC staff members Carlene Kim and John Lawton joining me today on the call.

Today the Commission voted unanimously to issue a proposal on the cross-border application of our previously proposed rules on margin for uncleared swaps. I thank my fellow commissioners for their work and input on this proposal, and I also want to thank our staff for their hard work.

The proposed rule on margin for uncleared swaps, which we issued last fall, is one of the most important rules for the regulation of the over-the-counter swaps market.

That is because there will always be a large part of the swaps market that is not cleared through central counterparties. Although we are mandating clearing for certain swaps, we should not mandate clearing for all swaps. Some products are not appropriate for such a mandate because of their risk or liquidity characteristics.

Margin can be an effective tool for addressing counterparty credit risk arising from uncleared swaps. Our rule will make sure that registered swap dealers post and collect margin in their transactions with other registered swap dealers and financial institutions that are above certain thresholds. That helps lower the risk to the financial system and the overall economy. I also note that the requirements do not apply to commercial end users.

We saw what happened in 2008 when there was a build-up of excessive risk in bilateral swaps. That risk intensified and accelerated the financial crisis like gasoline poured on a fire. And that crisis cost our economy eight million jobs and untold suffering for American families.

Moreover, we saw how that risk could be created offshore, outside our borders, but still jeopardize our financial stability and our economy.

The excessive swap risk taken on by AIG was initiated from its overseas operation. In order to prevent the failure of AIG, our government had to commit over $180 billion.

We got all that money back, but that is a painful example of why the cross-border application of the margin rule is important.

The proposal we are issuing today addresses the possibility that risk created offshore can flow back into the U.S. And so it applies to activities of non-U.S. swap dealers that are registered with us. At the same time, our proposal recognizes the importance of harmonizing rules with other jurisdictions.

If a transaction by an offshore swap dealer is guaranteed by a U.S. person, such as the parent of the dealer, the risk of that transaction can flow back into the U.S. But the same can occur even if the transaction is not guaranteed by the U.S. parent. Our proposal addresses that. By doing so, I believe our proposal is a good way to address the risk that can arise from uncleared swaps in that situation.

The proposal draws a line as to when we should take this offshore risk into account that is both reasonable and clear. The line we are proposing is this: if the financial results and position of the non-U.S. swap dealer are consolidated in the financial statements of the U.S. parent, then we should take that into account, whether or not there is an explicit guarantee.

This is how the proposal works: U.S. swap dealers would be required to comply with the rule in all their transactions, but in their transactions with certain non-U.S. counterparties, they would be entitled to substituted compliance with respect to margin they post, but not the margin they collect. Non-U.S. swap dealers whose swap obligations are guaranteed by a U.S. person would be treated the same way. Substituted compliance would be available in the case of the laws of those jurisdictions which we have deemed comparable.

For non-U.S. swap dealers registered with us, whose obligations are not guaranteed by a U.S. person, they must still comply, but they would be entitled to substituted compliance to a greater extent. Generally, they could avail themselves of full substituted compliance unless the counterparty was a U.S. swap dealer or a swap dealer guaranteed by a U.S. person. And, transactions between a non-U.S. swap dealer (but not conducted through its U.S. branch) and a non-U.S. counterparty would be excluded from the margin rules, if neither party’s obligations under the relevant swap are guaranteed by a U.S. person nor consolidated in the financial statements of its U.S. parent.

Limiting the exclusion from our rule to only those transactions where neither party is guaranteed or consolidated with a U.S. person helps address the concern that there is risk to the U.S. even if there is no explicit guarantee.

Lastly, when foreign banks conduct their swaps business within the U.S. through their branches located in the U.S., in direct competition with U.S. swap dealers, the exclusion would not apply. However, U.S. branches would be eligible for substituted compliance, which would reduce the potential for conflicts with foreign jurisdictions.

The broad scope of substituted compliance recognizes that we must work together with other jurisdictions to regulate this market, and we should design our rules to avoid conflict and duplication as much as possible. And the proposal may reduce competitive disparities that would otherwise result from different sets of rules applying to swap dealers engaged in essentially the same activity.

The proposal we are making today is very similar to the approach proposed last fall by the prudential regulators. That is appropriate, because the law requires us and the prudential regulators to harmonize our margin rules as much as possible. It also makes sense when you look at the composition of the registered swap dealers. There are approximately 100 swap dealers registered with us. Approximately 40 of those will be subject to the margin rules of the prudential regulators, while approximately 60 will be subject to our rules. About two thirds of those 60 swap dealers that will be subject to our margin rule have affiliates who will be subject to the margin rules of the prudential regulators. For example, of the approximately 60 swap dealers subject to our margin rules, over half are subsidiaries of just five major U.S. bank holding companies. Each of those large bank holding companies has other subsidiaries that are, subject to the margin rules of the prudential regulators. Therefore, if our margin rules are substantially different from the margin rules of the prudential regulators, then we have created incentives for firms to move activity from one entity to another solely to take advantage of potential differences in the rules. That is an outcome we should try very hard to avoid.

We also wish to coordinate our rules with the margin rules of other jurisdictions. That is why our proposal today provides for substituted compliance. In addition, at my direction, our staff is actively engaged with their counterparts in other jurisdictions to try to harmonize the rules as much as possible. Although much work remains to be done, and the Commission must take final action, I am hopeful that our final rules will be similar on many critical issues to those currently being developed in other major jurisdictions.

I would also like to say a word about our Cross-Border Guidance, which discussed how the Commission would generally apply Dodd-Frank requirements to cross-border swap activities. In doing so, the Commission recognized that the market is complex and dynamic and that a flexible approach is necessary. As stated in the Guidance, “the Commission will continue to follow developments as foreign regulatory regimes and the global swaps market continue to evolve. In this regard, the Commission will periodically review this Guidance in light of future developments.” That is essentially what we are doing here. With each area of our rules, the implications of cross-border transactions for our policy objectives may vary. Margin for uncleared swaps is intended to protect the safety and soundness of swap dealers and ultimately, to ensure the stability of the U.S. financial system. Therefore, it is appropriate to take into account whether that risk flows back into the United States by virtue of a guarantee by a U.S. person, or financial consolidation with a U.S. person. But the approach we are proposing today for margin may not be appropriate with respect to other areas of regulation – such as swaps reporting or trading.

In conclusion, I believe the approach we are proposing today combines the best elements of the various approaches proposed last fall. It strikes the right balance between the Commission’s supervisory interest in ensuring the safety and soundness of registered swap dealers and the need to recognize principles of international comity and reduce the potential for conflict with foreign regulatory requirements.

Last Updated: June 29, 2015