2020-18222
Federal Register, Volume 85 Issue 184 (Tuesday, September 22, 2020)
[Federal Register Volume 85, Number 184 (Tuesday, September 22, 2020)]
[Proposed Rules]
[Pages 59470-59480]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-18222]
[[Page 59470]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 23
RIN 3038-AF06
Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing to amend the margin requirements for uncleared
swaps for swap dealers (``SD'') and major swap participants (``MSP'')
for which there is no prudential regulator. The proposed amendments
would permit the application of separate minimum transfer amounts
(``MTA'') for initial margin (``IM'') and variation margin (``VM''),
and the application of an MTA of up to $50,000 for separately managed
accounts (``SMA'') (together, ``Proposal'').
DATES: With respect to the proposed amendments, comments must be
received on or before October 22, 2020.
ADDRESSES: You may submit comments, identified by RIN 3038-AE77, by any
of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Center, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods.
Submissions through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
https://comments.cftc.gov. You should submit only information that you
wish to make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act (``FOIA''), a petition for confidential
treatment of the exempt information may be submitted according to the
procedures established in Sec. 145.9 of the Commission's
regulations.\1\
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\1\ 17 CFR 145.9. Commission regulations referred to herein are
found at 17 CFR Chapter I.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from https://comments.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the 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 FOIA.
FOR FURTHER INFORMATION CONTACT: Joshua B. Sterling, Director, 202-418-
6056, [email protected]; Thomas J. Smith, Deputy Director, 202-418-
5495, [email protected]; Warren Gorlick, Associate Director, 202-418-
5195, [email protected]; Liliya Bozhanova, Special Counsel, 202-418-
6232, [email protected]; or Carmen Moncada-Terry, Special Counsel,
202-418-5795, [email protected], Division of Swap Dealer and
Intermediary Oversight, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
A. Statutory and Regulatory Background
In January 2016, the Commission adopted regulations 23.150 through
23.161 (collectively, ``CFTC Margin Rule'') \2\ to implement section
4s(e) of the Commodity Exchange Act (``CEA''),\3\ which requires SDs
and MSPs for which there is not a prudential regulator (``covered swap
entity'' or ``CSE'') to meet minimum IM and VM requirements adopted by
the Commission by rule or regulation.\4\
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\2\ See generally Margin Requirements for Uncleared Swaps for
Swap Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016).
The CFTC Margin Rule, which became effective April 1, 2016, is
codified in part 23 of the Commission's regulations. 17 CFR 23.150--
23.159, 23.161. In May 2016, the Commission amended the CFTC Margin
Rule to add Commission regulation 23.160, 17 CFR 23.160, providing
rules on its cross-border application. See generally Margin
Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants--Cross-Border Application of the Margin Requirements,
81 FR 34818 (May 31, 2016).
\3\ 7 U.S.C. 6s(e) (capital and margin requirements).
\4\ CEA section 1a(39), 7 U.S.C. 1a(39) (defining the term
``prudential regulator'' to include the Board of Governors of the
Federal Reserve System; the Office of the Comptroller of the
Currency; the Federal Deposit Insurance Corporation; the Farm Credit
Administration; and the Federal Housing Finance Agency). The
definition of prudential regulator further specifies the entities
for which these agencies act as prudential regulators.
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Commission regulations 23.152 and 23.153 require CSEs to collect or
post, each business day, VM \5\ for uncleared swap transactions with
each counterparty that is an SD, MSP, or financial end user, and IM \6\
for uncleared swap transactions for each counterparty that is an SD,
MSP, or a financial end user that has material swaps exposure.\7\ IM
posted or collected by a CSE must be held by one or more custodians
that are not affiliated with the CSE or the counterparty.\8\ VM posted
or collected by a CSE is not required to be maintained with a
custodian.\9\
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\5\ VM (or variation margin), as defined in Commission
regulation 23.151, is the 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
the value of such obligations since the trade was executed or the
last time such collateral was provided. 17 CFR 23.151.
\6\ IM (or initial margin) is the collateral (calculated as
provided by Sec. 23.154 of the Commission's regulations) that is
collected or posted in connection with one or more uncleared swaps
pursuant to Sec. 23.152. IM is intended to secure potential future
exposure following default of a counterparty (i.e., adverse changes
in the value of an uncleared swap that may arise during the period
of time when it is being closed out). See CFTC Margin Rule, 81 FR at
683.
\7\ 17 CFR 23.152; 17 CFR 23.153.
\8\ See 17 CFR 23.157(a).
\9\ Commission regulation 23.157 does not require VM to be
maintained in a custodial account. 17 CFR 23.157.
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However, to alleviate the operational burdens associated with
making de minimis margin transfers without resulting in an unacceptable
level of uncollateralized credit risk, Commission regulations
23.152(b)(3) and 23.153(c) provide that a CSE is not required to
collect or post IM or VM with a counterparty until the combined amount
of such IM and VM, as computed under Commission regulations 23.154 and
23.155 respectively, exceeds the MTA of $500,000.\10\ The term MTA (or
minimum transfer amount) is further defined in Commission regulation
23.151 as a combined amount of IM and VM, not exceeding $500,000, under
which no exchange of IM or VM is required.\11\ Once the MTA is
exceeded, the SD or MSP must collect or post the full amount of both
the IM and VM required to be exchanged with the counterparty.\12\
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\10\ 17 CFR 23.152(b)(3); 17 CFR 23.153(c); 81 FR at 653.
\11\ 17 CFR 23.151 (defining the term ``minimum transfer
amount'').
\12\ See 17 CFR 23.152(b)(3); 17 CFR 23.153(c).
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During the implementation of the CFTC Margin Rule, market
participants identified certain operational and
[[Page 59471]]
compliance burdens associated with the application of the MTA. To
mitigate these burdens, the Division of Swap Dealer and Intermediary
Oversight (``DSIO'') staff issued two no-action letters.
B. DSIO No-Action Letter Addressing the Application of MTA to SMAs
In February 2017, DSIO staff issued a no-action letter in response
to a request for relief from the Securities Industry and Financial
Markets Association's Asset Management Group (``SIFMA AMG'').\13\ SIFMA
AMG sought relief on behalf of members that enter into uncleared swaps
with SDs that are registered with the Commission and are subject to the
CFTC Margin Rule.
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\13\ CFTC Letter No. 17-12, Commission Regulations 23.152(b)(3)
and 23.153(c): No-Action Position for Minimum Transfer Amount with
respect to Separately Managed Accounts (Feb. 13, 2017) (``Letter 17-
12''), https://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/17-12.pdf.
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DSIO stated that it would not recommend enforcement action against
an SD that does not comply with the MTA requirements of Commission
regulations 23.152(b)(3) (requiring the exchange of IM when the MTA has
been exceeded) \14\ or 23.153(c) (requiring the exchange of VM when the
MTA has been exceeded),\15\ with respect to the swaps of a legal entity
that is the owner of multiple SMAs, provided that the SD applies an MTA
no greater than $50,000 to each SMA.
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\14\ See 17 CFR 23.152(b)(3).
\15\ See 17 CFR 23.153(c).
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In Letter 17-12, DSIO noted that SIFMA AMG's members are large
institutional investors, such as pension plans and endowments, which
typically hire asset managers to exercise investment discretion over a
portion of their assets for management through separate accounts. Each
separate account is governed by an investment management agreement that
grants asset managers authority over a portion of their clients'
assets. As a swap counterparty, an SD may face the same legal entity--
the owner of the accounts--through multiple separate accounts managed
by multiple asset managers. Each SMA that trades derivatives typically
has its own payment netting set corresponding to each International
Swaps and Derivatives Association (``ISDA'') Master Agreement and
Credit Support Annex (``CSA'') used by the asset manager.\16\
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\16\ The ISDA Master Agreement is a standard contract published
by ISDA commonly used in over-the-counter derivatives transactions
governing the rights and obligations of parties to a derivatives
transaction. A CSA sets forth the terms of the collateral
arrangement for the derivatives transaction.
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SIFMA AMG represented that the application of the MTA at the owner
or legal entity level presented significant practical challenges for
SMAs because the assets for each SMA are held, transferred, and
returned separately at the account level. As a result, it is
impractical for asset managers to collectively calculate the MTA across
the SMAs of a single owner, and, according to SIFMA AMG, asset managers
cannot move collateral in aggregate across the accounts. SIFMA AMG also
stated that SDs cannot dynamically calculate and manage the MTA across
the owner's separate eligible master netting agreements either, for
several reasons, including timing, additional regulatory risk, and
confidentiality requirements.
C. DSIO No-Action Letter Concerning the Application of Separate MTAs
for IM and VM
DSIO staff issued in December 2019 an additional no-action letter
concerning the application of the MTA in response to a request for
relief from ISDA on behalf of its member SDs.\17\ DSIO stated that it
would not recommend enforcement action against an SD or MSP that does
not combine IM and VM amounts for the purposes of Commission
regulations 23.152(b)(3) and 23.153(c). More specifically, the no-
action position covers SDs or MSPs that apply separate MTAs for IM and
VM obligations on uncleared swap transactions with each swap
counterparty, provided that the combined MTA for IM and VM with respect
to that counterparty does not exceed $500,000.
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\17\ CFTC Letter No. 19-25, Commission Regulations 23.151,
23.152, and 23.153--Staff Time-Limited No-Action Position Regarding
Application of Minimum Transfer Amount under the Uncleared Margin
Rules (Dec. 6, 2019) (``Letter 19-25''), https://www.cftc.gov/csl/19-25/download.
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DSIO issued the no-action letter based on ISDA's representations.
ISDA had stated that the MTA for VM and IM for each party to a swap
transaction has, routinely and historically, been included in CSAs to
avoid frequent exchanges of small amounts of collateral between the
parties. ISDA noted that separate MTAs for IM and VM better reflect the
operational requirements and the legal structure of the Commission's
regulations. ISDA further stated that because the CFTC Margin Rule
requires IM to be segregated with an unaffiliated third party and does
not impose similar segregation requirements with respect to VM,
distinct workflows for IM settlement through custodians and tri-party
agents have been established that are completely separate from the VM
settlement process.
D. Market Participant Feedback
Swap market participants, including a subcommittee established by
the CFTC's Global Markets Advisory Committee (``GMAC subcommittee''),
have expressed support for the adoption of regulations consistent with
these no-action letters, noting that Letter 19-25 is time-limited and
that, more generally, codifying no-action positions can be beneficial
for market participants in providing certainty in the application of
the Commission's regulations.\18\ The Commission believes that adopting
regulations in accordance with the terms of no-action letters, under
certain circumstances, is appropriate and could facilitate efforts by
market participants to take the operation of the Commission's
regulations into account in planning their uncleared swap activities.
Based on its implementation experience, and for the reasons provided
below, the Commission preliminarily believes that it would be
appropriate to amend the CFTC Margin Rule consistent with the staff
positions set forth in the no-action letters discussed above.
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\18\ See Recommendations to Improve Scoping and Implementation
of Initial Margin Requirements for Non-Cleared Swaps, Report to the
CFTC's Global Markets Advisory Committee by the Subcommittee on
Margin Requirements for Non-Cleared Swaps (April 2020), https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download
(``GMAC Subcommittee Report''). The Global Markets Advisory
Committee (``GMAC'') established the GMAC subcommittee to consider
issues raised by the implementation of margin requirements for non-
cleared swaps, to identify challenges associated with forthcoming
implementation phases, and to make recommendations through a report.
The GMAC subcommittee issued the GMAC Subcommittee Report
recommending various actions, including the codification of Letters
17-12 and 19-25. The GMAC adopted the Report and recommended to the
Commission that it consider adopting the Report's recommendations.
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II. Proposal
The Commission is proposing to amend Commission regulations 23.151,
23.152(b)(3), 23.153(c) and 23.158(a), consistent with Letters 17-12
and 19-25.\19\ Commission regulation 23.151 defines MTA as a combined
VM and IM amount of $500,000, under which no transfer of funds is
required.\20\ Commission regulations 23.152(b)(3) and 23.153 (c)
describe the application of the MTA in determining whether the
[[Page 59472]]
exchange of IM or VM is required.\21\ Commission regulation 23.158(a)
requires the execution of documentation providing CSEs with contractual
rights and obligations to exchange IM and VM in accordance with the
Commission's regulations.\22\
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\19\ Commission regulations are found at 17 CFR part 1 (2017),
and may be accessed through the Commission's website, https://www.cftc.gov.
\20\ 17 CFR 23.151.
\21\ 17 CFR 23.152(b)(3); 17 CFR 23.153(c).
\22\ 17 CFR 23.158(a) (setting forth margin documentation
requirements).
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A. Application of MTA to SMAs
The Commission proposes to amend the definition of MTA in
Commission regulation 23.151 to allow a CSE to apply an MTA of up to
$50,000 to each SMA owned by a counterparty with which the CSE enters
into uncleared swaps. The proposed amendment is consistent with the
terms of Letter 17-12, which provides that DSIO would not recommend
enforcement action if an SD applies an MTA no greater than $50,000 to
each SMA of a legal entity, subject to certain conditions.
When the Commission adopted the CFTC Margin Rule, it rejected the
notion that SMAs of a legal entity should be treated separately from
each other in applying certain aspects of the margin requirements for
uncleared swaps.\23\ However, after implementing the margin
requirements for several years, the Commission preliminarily believes
that separately treating SMAs, at least with respect to the application
of the MTA, may be necessary from an operational perspective.
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\23\ See 81 FR at 653 (rejecting commenters' request to extend
to each separate account of a fund or plan its own initial margin
threshold, while acknowledging that separate managers acting for the
same fund or plan may not take steps to inform the fund or plan of
their uncleared swap exposures on behalf of their principal on a
frequent basis).
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The GMAC subcommittee, in the GMAC Subcommittee Report recently
submitted to the Commission for its consideration, stated that while
the owner of the SMAs may be the same across the ISDA master agreements
and credit support documents entered into with each CSE, the SMAs
managed by each asset manager on behalf of the same SMA owner are
contractually treated as distinct counterparties in uncleared swap
transactions.\24\ Given the separation between SMAs existing
independently from each other, and the resulting lack of coordination,
the management of collateral, and more specifically the calculation of
the MTA, across the SMAs may be impractical for each asset manager,
hindering efforts to comply with the CFTC Margin Rule.
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\24\ GMAC Subcommittee Report at 16. However, it should be noted
that for credit risk purposes, the beneficial owner of the SMA is
the counterparty and the SD has credit exposure to the beneficial
owner and not the asset manager.
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The Commission acknowledges that certain owners of SMAs, such as
pension funds, in administering investments for beneficiaries, may
engage in collateral management exercises and may have the capability
to aggregate collateral across SMAs that trade uncleared swaps with the
same CSE. These beneficial owners of the SMA may be able to aggregate
the MTA across each of their SMAs and centralize the management of
collateral for all of their SMAs, which may result in increased netting
among the SMAs and the CSE, and more efficient collateral management.
Other SMA owners, however, do not have the capability to manage the
calculation and aggregation of MTA across their SMAs. In the GMAC
Subcommittee Report, the GMAC subcommittee stated that SMA owners are
not in a position to coordinate the trading activity across their SMAs,
as they typically grant full investment discretion to their asset
managers and do not employ a centralized collateral manager in-
house.\25\ Therefore, these SMA owners are not able to perform
collateral management across their accounts.
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\25\ Id.
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In theory, asset managers could coordinate with each other the
calculation of the MTA across SMAs under their management. However, the
Report stated that owners of SMAs typically prohibit information
sharing among their SMAs and require asset managers to keep trading
information confidential. The Report noted that asset managers lack
transparency and control over any assets of the SMA owner other than
the specific assets under their management.
The Report also stated that, while a CSE may face the same legal
entity--the owner of the accounts--through multiple SMAs managed by
different asset managers, a duty of confidentiality to the legal entity
prevents the CSE from sharing information with each asset manager
concerning the overall legal entity's trading activity.\26\ As a
result, while each of the SMAs of an owner may contribute to reaching
the MTA limit, asset managers for the SMAs only know the amounts of IM
and VM being contributed by SMAs under their management.
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\26\ The Commission notes that Commission regulation
23.410(c)(1)(i) prohibits disclosure by an SD or MSP, including a
CSE, of confidential information provided by or on behalf of a
counterparty to the SD or MSP. Nevertheless, Commission regulation
23.410(c)(2) provides that the SD or MSP may disclose the
counterparty's confidential information if the disclosure is
authorized in writing by the counterparty.
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In light of the practical challenges that the calculation of the
MTA across SMAs poses, as described above, the Commission proposes to
amend Commission regulation 23.151 to allow CSEs to apply an MTA of up
to $50,000 for each SMA of a counterparty. The Commission notes,
however, that under the proposed application of the MTA to SMAs, an MTA
of up to $50,000 could be applied to an indefinite number of SMAs. This
application of the MTA could effectively result in the replacement of
the aggregate limit of $500,000 on a particular counterparty's
uncollateralized risk for uncleared swaps with an individual limit of
$50,000 on each SMA of such counterparty. In turn, the counterparty
could have an aggregate amount of uncollateralized margin in excess of
$500,000.
While the proposed approach to the application of the MTA for SMAs
could provide an incentive for owners of SMAs to create separate
accounts or formulate their trading strategies to reduce or avoid
margin transfers, the Commission believes that an owner's inability to
net collateral across separate accounts may serve as a disincentive to
the fragmentation of investments across many SMAs.\27\ This is
particularly so because the MTA for SMAs, as proposed, would be set at
a low level (i.e., $50,000).
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\27\ As further discussed below, the proposed application of the
MTA would only be available for separate accounts of an owner that,
consistent with the proposed definition of SMA, are not subject to
collateral agreements that provide for netting across the separate
accounts.
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The Commission further notes that there are other provisions in the
CEA and the Commission's regulations that would mitigate the increase
in uncollateralized credit risk resulting from the absence of an
aggregate limit on the amount of uncollateralized margin and the use of
multiple SMAs by a single counterparty. Specifically, section 4s(j)(2)
of the CEA requires CSEs to adopt a robust and professional risk
management system adequate for the management of their swap
activities,\28\ and Commission regulation 23.600 \29\ mandates that
CSEs establish a risk management program to monitor and manage risks
associated with their swap activities that includes, among other
things, a description of risk tolerance limits.
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\28\ See 7 U.S.C. 6s(j).
\29\ 17 CFR 23.600.
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In addition to amending the definition of MTA, the Commission
proposes to define the term SMA in Commission
[[Page 59473]]
regulation 23.151. The term was defined in Letter 17-12 as an account
managed by an asset manager and governed by an investment management
agreement that grants the asset manager authority with respect to a
portion of a legal entity's assets.
The proposed definition of SMA would include the definition of the
term as well as certain conditions set forth in Letter 17-12.
Specifically, Letter 17-12 provides that the no-action position would
only apply with respect to swaps of an SMA of a legal entity that (i)
are entered into by an asset manager on behalf of the SMA pursuant to
authority granted under an investment management agreement, and (ii)
are subject to a master netting agreement that does not permit the
netting of IM or VM obligations across SMAs.
DSIO staff included these conditions in the no-action letter
because SIFMA AMG stated, in seeking relief, that the authority of
asset managers under their investment management agreements with the
owners of the SMAs is limited to assets under their management. SIFMA
AMG also stated that each SMA that trades uncleared swaps typically has
its own payment netting set corresponding to each ISDA master agreement
and CSA that is used by an asset manager. These conditions reflect
DSIO's recognition that asset managers' limited authority over the
assets of a legal entity and the practical inability to net collateral
payments across SMAs pose obstacles in the calculation and aggregation
of the MTA across SMAs.
As proposed, the term SMA would be defined as an account of a
counterparty to a CSE that is managed by an asset manager pursuant to a
specific grant of authority to such asset manager under an investment
management agreement between the counterparty and the asset manager,
with respect to a specified portion of the counterparty's assets.\30\
In addition, the definition would require that the swaps of the SMA be:
(i) Entered into between the counterparty and the CSE by the asset
manager pursuant to authority granted by the counterparty to the asset
manager through an investment management agreement, and (ii) subject to
a master netting agreement that does not provide for the netting of IM
or VM obligations across all SMAs of the counterparty that have swaps
outstanding with the CSE.
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\30\ The proposed definition of the term SMA would refer to the
aggregate account of a counterparty managed by an asset manager
under the investment management agreement, and not to fund or pool
sleeves overseen by sub-advisers.
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Request for comment: The Commission requests comment regarding the
proposed amendments to Commission regulation 23.151. The Commission
specifically requests comment on the following questions:
The proposed amendments to Commission regulation 23.151
would allow a CSE to apply up to $50,000 of MTA for each SMA of a
counterparty with multiple SMAs. The aggregate MTA for the counterparty
could thus exceed the $500,000 MTA threshold, which could result in
delaying the exchange of IM and VM, as neither IM nor VM would need to
be exchanged until the threshold has been exceeded. As such, less
margin may be collected and posted than would be permitted under the
current requirements. In light of the resulting potential
uncollateralized swap risk, should the Commission consider an
alternative to the proposed amendments? Should the Commission impose
any additional limits or conditions? Would the proposed amendments to
Commission regulation 23.151 incentivize SMA owners to create
additional separate accounts to potentially benefit from a higher MTA
limit, or otherwise alter their trading strategies, thus increasing the
amount of uncollateralized swap risk? What measures could the
Commission take to mitigate any such risk? Please provide data on the
current average number of separate accounts per counterparty and the
current average amount of daily collateral movements between CSEs and
counterparties who own SMAs. Has there been a change in the number of
SMAs per counterparty following the adoption of Letter 17-12?
Market participants have indicated that the aggregation of
the MTA across SMAs may not be practicable because SMA owners generally
grant full investment discretion to asset managers and do not employ a
centralized collateral manager in-house to coordinate swap activity and
manage collateral payments across their SMAs. Nevertheless, as an
alternative to the proposed rule, the Commission seeks comments on
whether it is feasible and desirable to maintain the CFTC's existing
requirements, which would therefore necessitate that owners of SMAs and
their asset managers address these challenges through coordination and
arrangements between themselves, so that they are able to manage the
relationship with the CSE with whom the SMAs enter into uncleared swaps
and are able to meet margin obligations as they arise. Do the practical
challenges posed by the status quo outweigh any potential concerns
raised by this Proposal?
Should the Commission proceed to adopt the proposed
amendments to Commission regulation 23.151 if the prudential regulators
do not adopt similar regulatory changes? Is there a potential for
confusion if that were to be the case?
B. Application of Separate MTAs for IM and VM
The Commission proposes to revise the margin documentation
requirements outlined in Commission regulation 23.158(a) in recognition
that, consistent with Letter 19-25, a CSE may apply separate MTAs for
IM and VM with each counterparty, provided that the MTAs corresponding
to IM and VM are specified in the margin documentation required by
Commission regulation 23.158 and that the MTAs, on a combined basis, do
not exceed the MTA specified in Commission regulation 23.151.
Letter 19-25 provides that CSEs can apply separate MTAs for IM and
VM for determining whether IM and VM must be exchanged under Commission
regulations 23.152(b)(2) and 23.153(c), provided that the MTAs set out
for IM and VM for a counterparty, on a combined basis, do not exceed
$500,000. In issuing Letter 19-25, DSIO acknowledged that applying
separate MTAs for IM and VM may result in the exchange of less total
margin than the amount that would be exchanged if the MTA were computed
on an aggregate basis.\31\ However, in DSIO's view, given that the
total amount of combined IM and VM that would not be exchanged would
never exceed $500,000, differences in the total margin exchanged would
not be material and would not result in an unacceptable level of credit
risk.\32\
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\31\ Letter 19-25 provides the following example to illustrate
the effect of the no-action relief. An SD and a counterparty agree
to a $300,000 IM MTA and a $200,000 VM MTA. If the margin
calculations set forth in Commission regulations 23.154 (for IM) and
23.155 (for VM) require the SD to post $400,000 of IM with the
counterparty and $150,000 of VM with the counterparty, the SD will
be required to post $400,000 of IM with the counterparty (assuming
that the $50 million IM threshold amount, defined in Commission
regulation 23.151, for the counterparty has been exceeded). The SD,
however, will not be obligated to post any VM with the counterparty
as the $150,000 requirement is less than the $200,000 MTA. By
contrast, in the absence of relief, the SD would have been required
to post $550,000 (the full amount of both IM and VM), given that the
combined amount of IM and VM exceeds the MTA of $500,000.
\32\ The Commission acknowledges, however, that if the
application of MTAs of up to $50,000 for SMAs is adopted as set
forth in this Proposal, the amounts of margin that would not be
exchanged may in some cases exceed the $500,000 limit. Specifically,
this may be the case if the CSE enters into swaps with more than ten
SMAs belonging to the same counterparty. If each SMA is allocated an
MTA of $50,000, the amount of margin not exchanged between the
counterparties may exceed $500,000, even if the sum of the separate
IM and VM MTAs applied to each SMA does not exceed the $50,000 MTA
threshold applicable to SMAs.
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[[Page 59474]]
The Commission preliminarily believes that adopting regulations
consistent with the terms of Letter 19-25 would accommodate a
widespread market practice that facilitates the implementation of the
CFTC margin requirements. The Commission notes that CSEs and their
counterparties maintain separate settlement workflows for IM and VM to
reflect, from an operational perspective, the different regulatory
requirements applicable to IM and VM. IM posted or collected by a CSE
must be held by one or more custodians that are not affiliated with the
CSE or the counterparty.\33\ VM posted or collected by a CSE is not
required to be segregated with an independent custodian.\34\
---------------------------------------------------------------------------
\33\ See 17 CFR 23.157(a).
\34\ See supra note 9.
---------------------------------------------------------------------------
DSIO, in taking a no-action position, stated its belief that the
application of separate MTAs for IM and VM, subject to certain
conditions, is consistent with the Commission's objective of requiring
swap counterparties to mitigate credit and market risks, while reducing
the cost and burdens associated with the transfer of small margin
balances. The Commission preliminarily agrees with that view and
requests public comment.
The Commission also notes that similar applications of the MTA are
permitted in certain foreign jurisdictions, including the European
Union.\35\ The proposed amendment to Commission regulation 23.158(a)
would therefore promote consistent regulatory standards across
jurisdictions, in line with the statutory mandate set forth in the
Dodd-Frank Act \36\ and reduce the need for market participants to
create and implement IM and VM settlement flows tailored to different
jurisdictions.
---------------------------------------------------------------------------
\35\ See Commission Delegated Regulation (EU) 2016/2251
Supplementing Regulation (EU) No. 648/2012 of the European
Parliament and of the Council of July 4, 2012 on OTC Derivatives,
Central Counterparties and Trade Repositories with Regard to
Regulatory Technical Standards for Risk-Mitigation Techniques for
OTC Derivative Contracts Not Cleared by a Central Counterparty (Oct.
4, 2016), Article 25(4), https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R2251&from=EN.
\36\ See section 752 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010),
calling on the CFTC to consult and coordinate on the establishment
of consistent international standards with respect to the regulation
of swaps.
---------------------------------------------------------------------------
The proposed amendment to Commission regulation 23.158(a) would
incorporate the conditions set forth in Letter 19-25. To that effect,
the Commission would require that the separate MTAs to be applied for
IM and VM be specified in the margin documentation required by
Commission regulation 23.158(a). Consistent with Letter 19-25 and the
proposed definition of MTA, Commission regulation 23.158(a), as
proposed, would further specify that, on a combined basis, the MTAs to
be applied for IM and VM must not exceed the MTA as the term is defined
in Commission regulation 23.151.
In imposing these conditions, the Commission seeks to ensure
maximum margin coverage for uncleared swaps, while recognizing that
swap counterparties may apply separate MTAs for IM and VM, thus
facilitating the implementation and administration of the uncleared
margin requirements.
Request for comment: The Commission requests comment regarding the
proposed amendment to Commission regulation 23.158(a). The Commission
specifically requests comment on the following questions:
Is the proposed amendment to Commission regulation
23.158(a) appropriate in light of the CFTC's overall approach to margin
requirements for uncleared swaps? Should the Commission impose any
additional limits or conditions?
The application of separate MTAs for IM and VM may result
in less margin being exchanged as compared to the amounts that would be
exchanged if separate MTAs are not permitted, increasing the amount of
uncleared swap uncollateralized risk. Should the Commission consider
any alternative to the proposed amendment that more fully addresses the
risk of uncleared swaps?
Should the application of separate MTAs for IM and VM be
extended to SMAs of a counterparty, for each of which an MTA of up to
$50,000 would be applied under the proposed amendment to Commission
regulation 23.151?
Should the Commission proceed to adopt the proposed
amendment to Commission regulation 23.158(a) if the prudential
regulators do not adopt similar regulatory changes? Is there a
potential for confusion if that were to be the case?
C. Conforming Changes
Consistent with the proposed amendment to the definition of MTA in
Commission regulation 23.151, the Commission proposes to make
conforming changes to Commission regulations 23.152(b)(3) and 23.153(c)
by replacing ``$500,000'' with ``the minimum transfer amount, as the
term is defined in 23.151.'' The proposed changes would replace the
reference to $500,000 in current Commission regulations 23.152(b)(3)
and 23.153(c), which effectively limits the MTA to $500,000, with a
reference to the revised definition of MTA, incorporating the proposed
definition of MTA, which would allow for the application of an MTA of
up to $50,000 for each SMA.
III. Administrative Compliance
The Regulatory Flexibility Act (``RFA'') requires Federal agencies
to consider whether the rules they propose will have a significant
economic impact on a substantial number of small entities and, if so,
provide a regulatory flexibility analysis respecting the impact.\37\
Whenever an agency publishes a general notice of proposed rulemaking
for any rule, pursuant to the notice-and-comment provisions of the
Administrative Procedure Act,\38\ a regulatory flexibility analysis or
certification typically is required.\39\ The Commission previously has
established certain definitions of ``small entities'' to be used in
evaluating the impact of its regulations on small entities in
accordance with the RFA.\40\ The proposed amendments only affect
certain SDs and MSPs and their counterparties, which must be eligible
contract participants (``ECPs'').\41\ The Commission has previously
established that SDs, MSPs and ECPs are not small entities for purposes
of the RFA.\42\
---------------------------------------------------------------------------
\37\ 5 U.S.C. 601 et seq.
\38\ 5 U.S.C. 553. The Administrative Procedure Act is found at
5 U.S.C. 500 et seq.
\39\ See 5 U.S.C. 601(2), 603, 604, and 605.
\40\ See Registration of Swap Dealers and Major Swap
Participants, 77 FR 2613 (Jan. 19, 2012).
\41\ Pursuant to section 2(e) of the CEA, 7 U.S.C. 2(e), each
counterparty to an uncleared swap must be an ECP, as defined in
section 1a(18) of the CEA, 7 U.S.C. 1a(18).
\42\ See Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based
Swap Participant'' and ``Eligible Contract Participant,'' 77 FR
30596, 30701 (May 23, 2012).
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Accordingly, the Chairman, on behalf of the Commission, hereby
certifies pursuant to 5 U.S.C. 605(b) that the proposed amendments will
not have a significant economic impact on a substantial number of small
entities.
A. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \43\ 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. The Commission may not conduct or
sponsor, and a person is not required to respond to, a collection of
information unless it displays a currently valid
[[Page 59475]]
Office of Management and Budget control number. The proposed rules
contain no requirements subject to the PRA.
---------------------------------------------------------------------------
\43\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
B. Cost-Benefit Considerations
Section 15(a) of the CEA \44\ requires the Commission to consider
the costs and benefits of its actions before promulgating a regulation
under the CEA. Section 15(a) further specifies that the costs and
benefits shall be evaluated in light of the following five broad areas
of market and public concern: (1) Protection of market participants and
the public; (2) efficiency, competitiveness, and financial integrity of
futures markets; (3) price discovery; (4) sound risk management
practices; and (5) other public interest considerations. The Commission
considers the costs and benefits resulting from its discretionary
determinations with respect to the section 15(a) considerations.
---------------------------------------------------------------------------
\44\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
The Commission is proposing to amend Commission regulation 23.151
consistent with Letter 17-12. The Commission proposes to revise the
definition of MTA in Commission regulation 23.151 to permit CSEs to
apply an MTA of up to $50,000 for each SMA of a counterparty that
enters into uncleared swaps with a CSE. The Commission also proposes to
amend Commission regulation 23.151 to add a definition for the term SMA
(or separately managed account). The Commission is also proposing to
revise Commission regulation 23.158(a) consistent with Letter 19-25 to
state that if a CSE and its counterparty agree to have separate MTAs
for IM and VM, the respective amounts of MTA must be reflected in the
margin documentation required by Commission regulation 23.158(a).
Finally, the Commission proposes conforming changes to Commission
regulations 23.152(b)(3) and 23.153(c) to incorporate the proposed
change to the definition of MTA in Commission regulation 23.151.
The baseline for the Commission's consideration of the costs and
benefits of this Proposal is the CFTC Margin Rule. The Commission
recognizes that to the extent market participants have relied on
Letters 17-12 and 19-25, the actual costs and benefits of the proposed
amendments, as realized in the market, may not be as significant.
The Commission notes that the consideration of costs and benefits
below is based on the understanding that the markets function
internationally, with many transactions involving U.S. firms taking
place across international boundaries; with some Commission registrants
being organized outside of the United States; with leading industry
members typically conducting operations both within and outside the
United States; and with industry members commonly following
substantially similar business practices wherever located. Where the
Commission does not specifically refer to matters of location, the
below discussion of costs and benefits refers to the effects of the
proposed amendments on all activity subject to the amended regulations,
whether by virtue of the activity's physical location in the United
States or by virtue of the activity's connection with or effect on U.S.
commerce under section 2(i) of the CEA.\45\
---------------------------------------------------------------------------
\45\ 7 U.S.C. 2(i).
---------------------------------------------------------------------------
1. Benefits
The proposed amendments to Commission regulation 23.151 would allow
CSEs to apply an MTA of up to $50,000 to SMAs of a counterparty. Under
the current requirements, a CSE must apply the MTA with respect to each
counterparty to an uncleared transaction. As a result, in the context
of a counterparty that has multiple SMAs through which uncleared swaps
are traded, with each SMA potentially giving rise to IM and VM
obligations, the amounts of IM and VM attributable to the SMAs of the
counterparty must be aggregated to determine whether the MTA has been
exceeded, which would require the exchange of IM or VM.
As previously discussed, because the assets of SMAs are separately
held, transferred, and returned at the account level, and CSEs and SMA
asset managers do not share trading information across SMAs,
aggregation of IM and VM obligations across SMAs for the purpose of
determining whether the MTA has been exceeded may be impractical,
hindering efforts to comply with the CFTC Margin Rule. The Commission
acknowledges, however, the possibility that, in certain contexts, an
owner of SMAs, such as a pension fund that administers investments for
beneficiaries, may be set up to and may perform collateral management
exercises, and may have the capability to aggregate collateral across
SMAs. Nevertheless, according to preliminary industry feedback, the
only practical alternative to fully ensure compliance with the margin
requirements is to set the MTA for each SMA at zero, so that trading by
a given SMA does not result in an inadvertent breach of the aggregate
MTA threshold without the exchange of the required margin.
The proposed amendments to Commission regulation 23.151, by
allowing the application of an MTA of up to $50,000 for each SMA of a
counterparty, would ease the operational burdens and transactional
costs associated with managing frequent transfers of small amounts of
collateral that counterparties would incur if the MTA for SMAs were to
be set at zero. In addition, the proposed amendments give flexibility
to CSEs, owners of SMAs, and asset managers to negotiate MTA levels
within the regulatory limits that match the risks of the SMAs and their
investment strategies, and the uncleared swaps being traded.
Furthermore, because the proposed amendments to Commission 23.151
would simplify the application of the MTA in the SMA context, thereby
reducing the operational burden, market participants may be encouraged
to participate in the uncleared swap markets through managed accounts,
and account managers may also make their services more readily
available to clients. As a result, trading in the uncleared swap
markets may increase, promoting competition and liquidity.
The amendment of Commission regulation 23.158(a) would likewise
lead to efficiencies in the application of the MTA. The proposed
amendment would state that if a CSE and its counterparty agree to have
separate MTAs for IM and VM, the respective amounts of MTA must be
reflected in the margin documentation required by Commission regulation
23.158(a). CSEs would thus be able to maintain separate margin
settlement workflows for IM and VM to address the differing segregation
treatments for IM and VM under the CFTC Margin Rule.
The Commission notes that the application of separate MTAs for IM
and VM has been adopted in other jurisdictions, including the European
Union, and the practice is widespread. The proposed amendment, in
aligning the CFTC with other jurisdictions with respect to the
application of the MTA, would advance the CFTC's efforts in promoting
consistent international standards, in line with the statutory mandate
set forth in the Dodd-Frank Act.
Finally, the proposed amendments would provide certainty to market
participants who may have relied on Letters 17-12 and 19-25, and could
thereby facilitate their efforts to take the operation of the
Commission's regulations into account in the planning of their
uncleared swap activities.
[[Page 59476]]
2. Costs
The proposed amendments to Commission regulation 23.151 could
result in a CSE applying an MTA that exceeds, in the aggregate, the
current MTA limit of $500,000. That is because the proposed amendments
would permit the application of an MTA of up to $50,000 for each SMA of
a counterparty, without limiting the number of SMAs to which the
$50,000 threshold may be applied. The amendments may even incentivize
SMA owners to increase the number of separate accounts in order to
benefit from the higher MTA limit. As a result, the collection and
posting of margin for some SMAs may be delayed, since margin would not
need to be exchanged until the MTA threshold is exceeded, which could
result in the exchange of less collateral to mitigate the risk of
uncleared swaps.
The proposed amendment to Commission regulation 23.158(a) would
state that if a CSE and its counterparty agree to have separate MTAs
for IM and VM, the respective amounts of MTA must be reflected in the
margin documentation required by Commission regulation 23.158(a). The
proposed amendment would recognize that CSEs can apply separate MTAs
for IM and VM for determining whether Commission regulations
23.152(b)(3) and 23.153(c) require the exchange of IM or VM. The
Commission acknowledges that the application of separate IM and VM MTAs
may result in the exchange of a lower amount of total margin between a
CSE and its counterparty to mitigate the risk of their uncleared swaps
than the amount that would be exchanged if the IM and VM MTA were
computed on an aggregate basis.\46\ The Commission notes that this cost
may be mitigated because the application of separate IM and VM MTAs
could also result in the exchange of higher rather than lower amounts
of margin.\47\
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\46\ Supra note 31 (explaining how the application of separate
MTAs for IM and VM could result in the exchange of lower amounts of
margin than if IM and VM MTA were computed on an aggregate basis).
\47\ The following illustration explains how the application of
separate MTAs for IM and VM could result in the exchange of higher
amounts of margin than if IM and VM MTA were computed on an
aggregate basis: An SD and a counterparty agree to $300,000 IM MTA,
and $200,000 VM MTA. If the margin calculations set forth in
Commission regulations 23.154 (for IM), and 23.155 (for VM) require
the SD to post $200,000 of IM with the counterparty and $250,000 of
VM with the counterparty, the SD would not be required to post IM
with the counterparty as the $200,000 requirement is less than the
$300,000 MTA. However, the SD would be required to post $250,000 in
VM as the VM required exceeds the $200,000 VM MTA, even though the
total amount of margin owed is below the $500,000 MTA set forth in
Commission regulations 23.152(b)(3) and 23.153(c). Letter 19-25 at
4.
---------------------------------------------------------------------------
While the Commission recognizes that the uncollateralized exposure
that may result from amending Commission regulations 23.151 and
23.158(a) in line with Letters 17-12 and 19-25 could increase credit
risk associated with uncleared swaps, the Commission believes that a
number of safeguards exist to mitigate this risk. The Commission notes
that the proposed amendments set the MTA at low levels. When the MTA is
applied to a counterparty, the sum of the IM and VM MTAs must not
exceed $500,000. When the MTA is applied to an SMA of a counterparty,
the sum of the IM and VM MTAs must not exceed $50,000. Even if the
aggregate MTA applied to a counterparty that owns multiple SMAs may
exceed $500,000, the total amount of margin that is permitted to remain
unexchanged is expected to be low, because other regulatory safeguards
exist to limit the credit exposure, including section 4s(j)(2) of the
CEA,\48\ which mandates that CSEs adopt a robust and professional risk
management system adequate for the management of day-to-day swap
activities, and Commission regulation 23.600,\49\ which requires CSEs,
in establishing a risk management program for the monitoring and
management of risk related to their swap activities, to account for
credit risk and to set risk tolerance limits.
---------------------------------------------------------------------------
\48\ 7 U.S.C. 6s(j)(2).
\49\ 17 CFR 23.600.
---------------------------------------------------------------------------
3. Section 15(a) Considerations
In light of the foregoing, the CFTC has evaluated the costs and
benefits of the Proposal pursuant to the five considerations identified
in section 15(a) of the CEA as follows:
a. Protection of Market Participants and Public
As discussed above, the proposed amendments to Commission
regulations 23.151 and 23.158(a), which address the application of the
MTA to SMAs and the application of separate MTAs for IM and VM, would
remove practical burdens in the application of the MTA, facilitating
the implementation of the CFTC Margin Rule, with minimal impact on the
protection of market participants and the public in general. Although
the proposed amendments could result in larger amounts of MTA being
applied to uncleared swaps, potentially resulting in the exchange of
reduced margin to offset the risk of uncleared swaps, the impact is
likely to be negligible relative to the size of the uncleared swap
positions. The Commission notes that the MTA thresholds are set at low
levels. In addition, CSEs are required to monitor and manage risk
associated with their swaps, in particular credit risk, and to set
tolerance levels as part of the risk management program mandated by
Commission regulation 23.600. To meet the risk tolerance levels, CSEs
may contractually limit the MTA or the number of SMAs with which they
enter into transactions.
b. Efficiency, Competitiveness, and Financial Integrity of Markets
By amending Commission regulation 23.151 to allow CSEs to apply an
MTA of up to $50,000 for each SMA of a counterparty, the Commission
would eliminate burdens and practical challenges associated with the
computation and aggregation of the MTA across multiple SMAs. In
addition, the new MTA threshold for SMAs could have the effect of
delaying how soon margin would be exchanged, as the aggregate MTA for
SMAs would no longer be limited to $500,000.
The simplification of the process for applying the MTA to SMAs and
the reduced cost that may be realized from the deferral of margin
obligations may encourage market participants to enter into uncleared
swaps through accounts managed by asset managers and also encourage
asset managers to accept more clients. The proposed amendments to
Commission regulation 23.151 could therefore foster competitiveness by
encouraging increased participation in the uncleared swap markets.
The proposed amendment to Commission 23.158(a) would state that if
a CSE and its counterparty agree to have separate MTAs for IM and VM,
the respective amounts of MTA must be reflected in the margin
documentation required by Commission regulation 23.158(a). The proposed
amendment would recognize that CSEs can apply separate MTAs for IM and
VM, enabling CSEs to accommodate the different segregation treatments
for IM and VM under the CFTC's margin requirements and to more
efficiently comply with the CFTC Margin Rule.
The proposed amendments to Commission regulations 23.151 and
23.158(a) could have the overall effect of permitting larger amounts of
MTA being applied to uncleared swaps, resulting in the collection and
posting of less collateral to offset the risk of uncleared swaps, which
could undermine the integrity of the markets. The Commission, however,
believes that the
[[Page 59477]]
uncollateralized swap exposure would be limited given that the MTA
thresholds are set at low levels, and there are other built-in
regulatory safeguards, such as the requirement that CSEs establish a
risk management program under Commission regulation 23.600 that
provides for the implementation of internal risk parameters for the
monitoring and management of swap risk.
The Commission also notes that the proposed amendments would
provide certainty to market participants who may have relied on Letters
17-12 and 19-25, and thereby facilitate their efforts to take the
operation of the Commission's regulations into account in planning
their uncleared swap activities.
c. Price Discovery
The proposed amendments to Commission regulations 23.151 and
23.158(a) would simplify the process for applying the MTA, reducing the
burden and cost of implementation. Given these cost savings, CSEs and
other market participants may be encouraged to increase their
participation in the uncleared swap markets. As a result, trading in
uncleared swaps may increase, leading to increased liquidity and
enhanced price discovery.
d. Sound Risk Management
Because the proposed amendments to Commission regulations 23.151
and 23.158(a) may permit the application of larger amounts of MTA, less
margin may be collected and posted to offset the risk of uncleared
swaps. Nevertheless, the Commission believes that the risk would be
mitigated because the regulatory MTA thresholds are set at low levels,
and CSEs are required to have a risk management program that provides
for the implementation of internal risk management parameters for the
monitoring and management of swap risk.
The Commission also notes that the proposed amendments would
simplify the application of the MTA, reducing the burden and cost of
implementation, without leading to an unacceptable level of
uncollateralized credit risk. Such reduced burden and cost could
encourage market participants to increase their participation in the
uncleared swap markets, potentially facilitating improved risk
management for counterparties using uncleared swaps to hedge risks.
Moreover, by facilitating compliance with certain aspects of the
Commission's regulations, the Commission would allow market
participants to focus their efforts on monitoring and ensuring
compliance with other substantive aspects of the CFTC Margin Rule, thus
promoting balanced and sound risk management.
e. Other Public Interest Considerations
The proposed amendment to Commission regulation 23.158(a) would
address the application of separate MTAs for IM and VM, contributing to
the CFTC's alignment with other jurisdictions, such as the European
Union, which would advance the CFTC's efforts to achieve consistent
international standards. The CFTC's alignment with other jurisdictions
with respect to the application of the MTA will benefit CSEs that are
global market participants by eliminating the need to establish
different settlement workflows tailored to each jurisdiction in which
they operate.
Request for Comment. The Commission invites comment on its
preliminary consideration of the costs and benefits associated with the
proposed amendments to Commission regulations 23.151, 23.152(b)(3),
23.153(c) and 23.158(a), especially with respect to the five factors
the Commission is required to consider under section 15(a) of the CEA.
In addressing these areas and any other aspect of the Commission's
preliminary cost-benefit considerations, the Commission encourages
commenters to submit any data or other information they may have
quantifying and/or qualifying the costs and benefits of the Proposal.
The Commission also specifically requests comment on the following
questions:
Has the Commission accurately identified the benefits of
this Proposal? Are there other benefits to the Commission, market
participants, and/or the public that may result from the adoption of
this Proposal that the Commission should consider? Please provide
specific examples and explanations of any such benefits.
Has the Commission accurately identified the costs of this
Proposal? Are there additional costs to the Commission, market
participants, and/or the public that may result from the adoption of
this Proposal that the Commission should consider? Please provide
specific examples and explanations of any such costs.
Does this Proposal impact the section 15(a) factors in any
way that is not described above? Please provide specific examples and
explanations of any such impact.
Whether, and the extent to which, any specific foreign
requirement(s) may affect the costs and benefits of the Proposal. If
so, please identify the relevant foreign requirement(s) and any
monetary or other quantitative estimates of the potential magnitude of
those costs and benefits.
What are the benefits and costs if the Commission, as an
alternative to this Proposal, were to maintain the status quo with
respect to SMAs, which would therefore necessitate that the owners of
SMAs and their asset managers address the practical challenges in the
calculation of the MTA across SMAs through coordination and
arrangements between the parties, in conjunction with the CSE that
executes the swap trades? Would such an approach impose an undue burden
on either the CSE or the SMA owner? Would the potential benefit of
maintaining the existing $500,000 MTA threshold outweigh any potential
costs?
C. Antitrust Considerations
Section 15(b) of the CEA requires the Commission to ``take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the CEA, in issuing any order or adopting any Commission
rule or regulation (including any exemption under section 4(c) or
4c(b)), or in requiring or approving any bylaw, rule, or regulation of
a contract market or registered futures association established
pursuant to section 17 of the CEA.\50\
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\50\ 7 U.S.C. 19(b).
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The Commission believes that the public interest to be protected by
the antitrust laws is generally to protect competition. The Commission
requests comment on whether the Proposal implicates any other specific
public interest to be protected by the antitrust laws.
The Commission has considered the Proposal to determine whether it
is anticompetitive and has preliminarily identified no anticompetitive
effects. The Commission requests comment on whether the Proposal is
anticompetitive and, if it is, what the anticompetitive effects are.
Because the Commission has preliminarily determined that the
Proposal is not anticompetitive and has no anticompetitive effects, the
Commission has not identified any less anticompetitive means of
achieving the purposes of the CEA. The Commission requests comment on
whether there are less anticompetitive means of achieving the relevant
purposes of the CEA that would otherwise be served by adopting the
Proposal.
[[Page 59478]]
List of Subjects in 17 CFR Part 23
Capital and margin requirements, Major swap participants, Swap
dealers, Swaps.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR part 23 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.
Section 23.160 also issued under 7 U.S.C. 2(i); Sec. 721(b), Pub. L.
111-203, 124 Stat. 1641 (2010).
0
2. In Sec. 23.151:
0
a. Revise the definition of ``Minimum transfer amount''; and
0
b. Add the definition for ``Separately managed account'' in
alphabetical order.
The revision and addition read as follows:
Sec. 23.151 Definitions applicable to margin requirements.
* * * * *
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. Where a counterparty to a
covered swap entity owns two or more separately managed accounts, a
minimum transfer amount of up to $50,000 may be applied for each
separately managed account.
* * * * *
Separately managed account means an account of a counterparty to a
covered swap entity that meets the following requirements:
(1) The account is managed by an asset manager and governed by an
investment management agreement, pursuant to which the counterparty
grants the asset manager authority with respect to a specified amount
of the counterparty's assets;
(2) Swaps are entered into between the counterparty and the covered
swap entity by the asset manager on behalf of the account pursuant to
authority granted by the counterparty through an investment management
agreement; and
(3) The swaps of such account are subject to a master netting
agreement that does not provide for the netting of initial or variation
margin obligations across all such accounts of the counterparty that
have swaps outstanding with the covered swap entity.
* * * * *
0
3. Amend Sec. 23.152 by revising paragraph (b)(3) to read as follows:
Sec. 23.152 Collection and posting of initial margin.
* * * * *
(b) * * *
(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 the minimum transfer
amount, as the term is defined in Sec. 23.151.
* * * * *
0
4. Amend Sec. 23.153 by revising paragraph (c) to read as follows:
Sec. 23.153 Collection and posting of variation margin.
* * * * *
(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 the minimum transfer
amount, as the term is defined in Sec. 23.151.
* * * * *
0
5. Amend Sec. 23.158 by revising paragraph (a) to read as follows:
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. 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. With
respect to the minimum transfer amount, if a covered swap entity and a
counterparty that is a swap entity or a financial end user agree to
have separate minimum transfer amounts for initial and variation
margin, the documentation shall specify the amounts to be allocated for
initial margin and variation margin. Such amounts, on a combined basis,
must not exceed the minimum transfer amount, as the term is defined in
Sec. 23.151.
* * * * *
Issued in Washington, DC, on August 14, 2020, by the Commission.
Robert Sidman,
Deputy 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 and
Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz,
Behnam, Stump, and Berkovitz voted in the affirmative. No
Commissioner voted in the negative.
Appendix 2--Supporting Statement of Commissioner Dawn D. Stump Overview
I am pleased to support the proposed rulemaking that the
Commission is issuing with respect to the ``minimum transfer
amount'' provisions of its margin requirements for uncleared swaps.
This proposed rulemaking addresses recommendations that the
Commission has received from its Global Markets Advisory Committee
(``GMAC''), which I am proud to sponsor, and is based on a
comprehensive report prepared by GMAC's Subcommittee on Margin
Requirements for Non-Cleared Swaps (``GMAC Margin
Subcommittee'').\1\ It demonstrates the value added to the
Commission's policymaking by its Advisory Committees, in which
market participants and other interested parties come together to
provide us with their perspectives and potential solutions to
practical problems.
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\1\ Recommendations to Improve Scoping and Implementation of
Initial Margin Requirements for Non-Cleared Swaps, Report to the
CFTC's Global Markets Advisory Committee by the Subcommittee on
Margin Requirements for Non-Cleared Swaps (April 2020), available at
https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download.
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The proposed rulemaking contains two proposals, which have much
to commend them. These proposals further objectives that I have
commented on before:
The need to tailor our rules to assure that they are
workable for those required to comply with them; and
the benefits of codifying relief that has been issued
by our Staff and re-visiting our rules, where appropriate.
I am very appreciative of the many people whose efforts have
contributed to bringing this proposed rulemaking to fruition. First,
the members of the GMAC, and especially the GMAC Margin
Subcommittee, who devoted a tremendous amount of time to
[[Page 59479]]
quickly provide us with a high-quality report on complex margin
issues at the same time they were performing their ``day jobs''
during a global pandemic. Second, Chairman Tarbert, for his
willingness to include this proposed rulemaking on the busy agenda
that he has laid out for the Commission for the rest of this year.
Third, my fellow Commissioners, for working with me on these
important issues. And finally, the Staff of the Division of Swap
Dealer and Intermediary Oversight (``DSIO''), whose tireless efforts
have enabled us to advance these initiatives to assure that our
uncleared margin rules are workable for all, thereby enhancing
compliance consistent with our responsibilities under the Commodity
Exchange Act (``CEA'').
A Different Universe is coming into Scope of the Uncleared Margin Rules
The Commission's uncleared margin rules for swap dealers, like
the Framework of the Basel Committee on Banking Supervision and the
Board of the International Organization of Securities Commissions
(``BCBS/IOSCO'') \2\ on which they are based, were designed
primarily to ensure the exchange of margin between the largest
financial institutions for their uncleared swap transactions with
one another. These institutions and transactions are already subject
to uncleared margin requirements.
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\2\ See generally BCBS/IOSCO, Margin requirements for non-
centrally cleared derivatives (July 2019), available at https://www.bis.org/bcbs/publ/d475.pdf.
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Pursuant to the phased implementation schedule of the
Commission's rules and the BCBS/IOSCO Framework, though, a different
universe of market participants--presenting unique considerations--
is coming into scope of the margin rules. It is only now, as we
enter into the final phases of the implementation schedule, that the
Commission's uncleared margin rules will apply to a significant
number of financial end-users, and we have a responsibility to make
sure they are fit for that purpose.
Accordingly, now is the time we must explore whether the
regulatory parameters that we have applied to the largest financial
institutions in the earlier phases of margin implementation need to
be tailored to account for the practical operational challenges
posed by the exchange of margin when one of the counterparties is a
pension plan, endowment, insurance provider, mortgage service
provider, or other financial end-user.
The proposed rulemaking regarding the ``minimum transfer
amount'' does exactly that. The Commission's uncleared margin rules
provide that a swap dealer is not required to collect or post
initial margin (``IM'') or variation margin (``VM'') with a
counterparty until the combined amount of such IM and VM exceeds the
minimum transfer amount (``MTA'') of $500,000. Yet, the application
of the MTA presents a significant operational challenge for
institutional investors that typically hire asset managers to
exercise investment discretion over portions of their assets in
separately managed accounts (``SMAs'') for purposes of
diversification. As a practical matter, neither the owner of the
SMA, the manager of the assets in the SMA, nor the swap dealer that
is a counterparty to the SMA is in a position to readily determine
when the MTA has been exceeded on an aggregate basis (or to assure
that it is not).
To address this challenge, the Commission is proposing to amend
the definition of MTA in its margin rules to allow a swap dealer to
apply an MTA of up to $50,000 to each SMA owned by a counterparty
with which the swap dealer enters into uncleared swaps. As noted in
the proposing release, any potential increase in uncollateralized
credit risk as a result would be mitigated both by the conditions
set out in the proposed rules, as well as existing safeguards in the
CEA and the Commission's regulations.\3\
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\3\ Specifically, CEA Section 4s(j)(2), 7 U.S.C. 6s(j)(2),
requires swap dealers to adopt a robust risk management system
adequate for the management of their swap activities, and CFTC Rule
23.600, 17 CFR 23.600, requires swap dealers to establish a risk
management program to monitor and manage risks associated with their
swap activities.
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I believe that this is a sensible approach and an appropriate
refinement to make the Commission's uncleared margin rules workable
for SMAs given the realities of the modern investment management
environment. As I have stated before, no matter how well-intentioned
a rule may be, if it is not workable, it cannot deliver on its
intended purpose.\4\
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\4\ Statement of Commissioner Dawn D. Stump Regarding Final
Rule: Cross-Border Application of the Registration Thresholds and
Certain Requirements Applicable to Swap Dealers and Major Swap
Participants (July 23, 2020), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement072320.
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The Benefits of Codifying Staff Relief and Re-Visiting our Rules
Application of MTA to SMAs: The proposal that I have discussed
above to amend the application of the MTA to SMAs would codify no-
action relief in Letter No. 17-12 that DSIO issued in 2017.\5\ Our
Staff often has occasion to issue relief or take other action in the
form of no-action letters, interpretative letters, or advisories on
various issues and in various circumstances. This affords the
Commission a chance to observe how the Staff action operates in
real-time, and to evaluate lessons learned. With the benefit of this
time and experience, the Commission should then consider whether
codifying such staff action into rules is appropriate.\6\
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\5\ CFTC Letter No. 17-12, Commission Regulations 23.152(b)(3)
and 23.153(c): No-Action Position for Minimum Transfer Amount with
respect to Separately Managed Accounts (February 13, 2017),
available at https://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/17-12.pdf.
\6\ See comments of Commissioner Dawn D. Stump during Open
Commission Meeting on January 30, 2020, at 183 (noting that after
several years of no-action relief regarding trading on swap
execution facilities (``SEFs''), ``we have the benefit of time and
experience and it is time to think about codifying some of that
relief. . . . [T]he SEFs, the market participants, and the
Commission have benefited from this time and we have an obligation
to provide more legal certainty through codifying these provisions
into rules.''), available at https://www.cftc.gov/sites/default/files/2020/08/1597339661/openmeeting_013020_Transcript.pdf.
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As I have said before, ``[i]t is simply good government to re-
visit our rules and assess whether certain rules need to be updated,
evaluate whether rules are achieving their objectives, and identify
rules that are falling short and should be withdrawn or improved.''
\7\ Experience with DSIO's no-action relief in Letter No. 17-12
supports today's proposal to tailor the application of the MTA under
the Commission's uncleared margin rules in the SMA context.
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\7\ Statement of Commissioner Dawn D. Stump for CFTC Open
Meeting on: (1) Final Rule on Position Limits and Position
Accountability for Security Futures Products; and (2) Proposed Rule
on Public Rulemaking Procedures (Part 13 Amendments) (September 16,
2019), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement091619.
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Separate MTAs for IM and VM: The second proposal regarding the
MTA in this proposed rulemaking similarly would codify existing DSIO
no-action relief in recognition of market realities. Consistent with
DSIO's Letter No. 19-25,\8\ it would recognize that a swap dealer
may apply separate MTAs for IM and VM with each counterparty,
provided that the MTAs corresponding to IM and VM are specified in
the margin documentation required under the Commission's
regulations, and that the MTAs, on a combined basis, do not exceed
the prescribed MTA.
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\8\ CFTC Letter No. 19-25, Commission Regulations 23.151,
23.152, and 23.153--Staff Time-Limited No-Action Position Regarding
Application of Minimum Transfer Amount under the Uncleared Margin
Rules (December 6, 2019), available at https://www.cftc.gov/csl/19-25/download.
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DSIO's no-action relief, and the Commission's proposed
codification, take into account the separate settlement workflows
that swap counterparties maintain to reflect, from an operational
perspective, the different regulatory treatment of IM and VM.\9\ At
the same time, given that the total amount of combined IM and VM
exchanged would not exceed the prescribed MTA, separate MTAs for IM
and VM would not materially increase the amount of credit risk at a
given time. Under Letter No. 19-25 and this proposal, swap dealers
and their counterparties can manage MTA in an operationally
practicable way that aligns with the market standard.
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\9\ Under the Commission's uncleared margin rules, IM posted or
collected by a swap dealer must be held by one or more custodians
that are not affiliated with the swap dealer or the counterparty,
whereas VM posted or collected by a swap dealer is not required to
be segregated with an independent custodian. See 17 CFR 23.157.
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There Remains Unfinished Business
The report of the GMAC Margin Subcommittee recommended several
actions beyond those contained in this proposed rulemaking in order
to address the unique challenges associated with the application of
uncleared margin requirements to end-users. Having been present for
the development of the Dodd-Frank Act, I recall the concerns
expressed by many lawmakers about applying the new requirements to
end-users. The practical challenges with respect to
[[Page 59480]]
uncleared margin that caused uneasiness back in 2009-2010 are now
much more immediate as the margin requirements are being phased in
to apply to these end-users.
So, while I am pleased at the steps the Commission is taking in
this proposed rulemaking, I hope that we can continue to work
together to address the other recommendations included in the GMAC
Margin Subcommittee's report. The need to do so will only become
more urgent as time marches on.
Conclusion
To be clear, these proposals to amend the Commission's uncleared
margin rules are not a ``roll-back'' of the margin requirements that
apply today to the largest financial institutions in their swap
transactions with one another. Rather, the proposals reflect a
thoughtful refinement of our rules to take account of specific
circumstances in which they impose substantial operational
challenges (i.e., they are not workable) when applied to other
market participants that are coming within the scope of their
mandates. I look forward to receiving public input on any
improvements that can be made to the proposals to further enhance
compliance with the Commission's uncleared margin requirements.
Appendix 3--Statement of Commissioner Dan M. Berkovitz
I support issuing for public comments two notices of proposed
rulemaking to improve the operation of the CFTC's Margin Rule.\1\
The Margin Rule requires certain swap dealers (``SDs'') and major
swap participants (``MSPs'') to post and collect initial and
variation margin for uncleared swaps.\2\ The Margin Rule is critical
to mitigating risks in the financial system that might otherwise
arise from uncleared swaps. I support a strong Margin Rule, and I
look forward to public comments on the proposals, including whether
certain elements of the proposals could increase risk to the
financial system and how the final rule should address such risks.
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\1\ Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants, 81 FR 636 (Jan. 6, 2016) (``Margin Rule'').
\2\ See also Commodity Exchange Act (``CEA'') section 4s(e). The
CEA, as amended by the Dodd-Frank Act, requires the Commission to
adopt rules for minimum initial and variation margin for uncleared
swaps entered into by SDs and MSPs for which there is no prudential
regulator. Although addressed in the rules, there are currently no
registered MSPs.
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The proposals address: (1) The definition of material swap
exposure (``MSE'') and an alternative method for calculating initial
margin (``the MSE and Initial Margin Proposal''); and (2) the
application of the minimum transfer amount (``MTA'') for initial and
variation margin (``the MTA Proposal''). They build on frameworks
developed by the Basel Committee on Banking Supervision and
International Organization of Securities Commissions (``BCBS/
IOSCO''),\3\ existing CFTC staff no-action letters, and
recommendations made to the CFTC's Global Markets Advisory Committee
(``GMAC'').\4\ I thank Commissioner Stump for her leadership of the
GMAC and her work to bring these issues forward for the Commission's
consideration.
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\3\ BCBS/IOSCO, Margin requirements for non-centrally cleared
derivatives (July 2019), https://www.bis.org/bcbs/publ/d475.pdf. The
BCBS/IOSCO framework was originally promulgated in 2013 and later
revised in 2015.
\4\ Recommendations to Improve Scoping and Implementation of
Initial Margin Requirements for Non-Cleared Swaps, Report to the
CFTC's Global Markets Advisory Committee by the Subcommittee on
Margin Requirements for Non-Cleared Swaps, April 2020, https://www.cftc.gov/media/3886/GMAC_051920MarginSubcommitteeReport/download.
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Today's proposed amendments to the Margin Rule could help
promote liquidity and competition in swaps markets by allowing the
counterparties of certain end-users to rely on the initial margin
calculations of the more sophisticated SDs with whom they enter into
transactions designed to manage their risks, subject to safeguards.
They would also address practical challenges in the Commission's MTA
rules that arise when an entity such as a pension plan or endowment
retains asset managers to invest multiple separately managed
accounts (``SMAs''). Similar operational issues are addressed with
respect to initial and variation margin MTA calculations.
These operational and other benefits justify publishing the MSE
and Initial Margin Proposal and the MTA Proposal in the Federal
Register for public comment. However, I am concerned that specific
aspects of each of these proposed rules could weaken the Margin Rule
and increase risk by creating a potentially larger pool of
uncollateralized, uncleared swaps exposure. My support for
finalizing these proposals will depend on how the potential
increased risks are addressed.
One potential risk in the MSE and Initial Margin Proposal arises
from amending the definition of MSE to align it with the BCBS/IOSCO
framework.\5\ One element of the proposal would amend the
calculation of the average daily aggregate notional amount
(``AANA'') of swaps. The proposed rule would greatly reduce the
number of days used in the calculation, reducing it from an average
of all business days in a three month period to the average of the
last business day in each month of a three month period.\6\ The
result would be that a value now calculated across approximately 60+
data points (i.e., business days) would be confined to only three
data points, and could potentially become less representative of an
entity's true AANA and swaps exposure. Month-end trading adjustments
could greatly skew the AANA average for an entity.
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\5\ 17 CFR 23.151.
\6\ Existing Commission regulation 23.151 specifies June, July,
and August of the prior year as the relevant calculation months. The
proposed rule would amend this to March, April, and May of the
current year. The proposed rule would also amend the calculation
date from January 1 to September 1. These amendments would be
consistent with the BCBS/IOSCO framework.
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When the Commission adopted the Margin Rule in 2016, it rejected
the MSE calculation approach now under renewed consideration. U.S.
prudential regulators also declined to follow the BCBS/IOSCO
framework in this regard. The Commission noted in 2016 that an
entity could ``window dress'' its exposure and artificially reduce
its AANA during the measurement period.\7\ Even in the absence of
window dressing, there are also concerns that short-dated swaps,
including intra-month natural gas and electricity swaps, may not be
captured in a month-end calculation window. While the MSE and
Initial Margin Proposal offers some analysis addressing these
issues, it may be difficult to extrapolate market participants'
future behavior based on current regulatory frameworks. I look
forward to public comment on these issues.
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\7\ See CFTC Margin Rule, 81 FR at 645.
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The MSE and Initial Margin Proposal and the MTA Proposal each
raise additional concerns that merit public scrutiny and comment.
The MTA Proposal, for example, would permit a minimum transfer
amount of $50,000 for each SMA of a counterparty. In the event of
more than 10 SMAs with a single counterparty (each with an MTA of
$50,000), the proposal would functionally displace the existing
aggregate limit of $500,000 on a particular counterparty's
uncollateralized risk for uncleared swaps. The proposal would also
state that if certain entities agree to have separate MTAs for
initial and variation margin, the respective amounts of MTA must be
reflected in their required margin documentation. Under certain
scenarios, these separate MTAs could result in the exchange of less
total margin than if initial and variation margin were aggregated.
The MSE and Initial Margin Proposal and the MTA Proposal both
articulate rationales why the Commission preliminarily believes that
the risks summarized above, and others noted in the proposals, may
not materialize. The Commission's experience with relevant staff no-
action letters may also appear to lessen concerns around the
proposals. While each item standing on its own may not be a
significant concern, the collective impact of the proposed rules may
be a reduction in the strong protections afforded by the 2016 Margin
Rule--and an increase in risk to the U.S. financial system. The
Commission must resist the allure of apparently small, apparently
incremental, changes that, taken together, dilute the comprehensive
risk framework for uncleared swaps.
I look forward to public comments and to continued deliberation
on what changes to the MSE and Initial Margin Proposal and the MTA
Proposal are appropriate. I thank Commissioner Stump, our fellow
Commissioners, and staff of the Division of Swap Dealer and
Intermediary Oversight for their extensive engagement with my office
on these proposals.
[FR Doc. 2020-18222 Filed 9-21-20; 8:45 am]
BILLING CODE 6351-01-P