Overview

I am pleased to support the two proposed rulemakings that the Commission is issuing with respect to margin requirements for uncleared swaps.

These proposed rulemakings address several recommendations that the Commission has received from its Global Markets Advisory Committee (GMAC), which I am proud to sponsor, and are based on a comprehensive report prepared by GMAC’s Subcommittee on Margin Requirements for Non-Cleared Swaps (GMAC Margin Subcommittee).[1]  They demonstrate 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.

These two proposed rulemakings contain four proposals, which have much to commend them.  Each of the proposals furthers 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;
• the benefits of codifying relief that has been issued by our Staff and re-visiting our rules, where appropriate; and
• the imperative of harmonizing our margin requirements with those of our international colleagues around the world in order to facilitate compliance and coordinated regulatory oversight.

I am very appreciative of the many people whose efforts have contributed to bringing these proposed rulemakings to fruition.  First, the members of the GMAC, and especially the GMAC Margin Subcommittee, who devoted a tremendous amount of time to 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 these proposed rulemakings 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 and are in line with international standards, 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.

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]

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]

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]

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.

Two other proposals that we are issuing today similarly would codify existing DSIO no-action relief in recognition of market realities.

Separate MTAs for IM and VM:  Our second proposal regarding the MTA, consistent with DSIO’s Letter No. 19-25,[8] 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.

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.

Reliance on Counterparty’s Model Calculation of IM:  A third proposal we are issuing today would codify a DSIO no-action position taken in Letter No. 19-29,[10] providing that a swap dealer may use the risk-based model calculation of IM of a counterparty that is a CFTC-registered swap dealer as the amount of IM that the former must collect from the latter.  The proposing release states the Commission’s expectation that the proposal generally would be used by swap dealers with a discrete and limited swap business consisting primarily of entering into uncleared swaps with end-user counterparties and then hedging the risk of those swaps with uncleared swaps entered into with a few swap dealers.

This proposal is subject to conditions that:  1) the applicable risk-based model be approved by either the Commission, the National Futures Association, or a prudential regulator; and 2) the uncleared swaps for which a swap dealer uses the risk-based model calculation of IM of its swap dealer counterparty are entered into for the purpose of hedging the former’s own risk from entering into swaps with non-swap dealer counterparties.

Simply put, not all swap dealers are created equal.  It is therefore appropriate to tailor our uncleared margin regime accordingly.  Letter No. 19-29 recognized this reality and smoothed the rough edges of our otherwise one-size-fits-all uncleared margin rules, and I support the proposal to codify that result.

International Harmonization to Enhance Compliance and Coordinated Regulation

The Commission’s fourth proposal would revise the calculation method for determining whether financial end-users come within the scope of the IM requirements, and the timing for compliance with the IM requirements after the end of the phased compliance schedule.  These changes would align certain timing and calculation issues under the Commission’s margin rules with both the BCBS/IOSCO Framework and the manner in which these issues are handled by our regulatory colleagues in all other major market jurisdictions.

Swap dealers must exchange IM with respect to uncleared swaps that they enter into with a financial end-user counterparty that has “material swap exposure” (MSE).  The Commission’s margin rules provide that after the last phase of compliance, MSE is to be determined on January 1, and that an entity has MSE if it has more than $8 billion in average aggregate notional amount (AANA) during June, July, and August of the prior year.  By contrast, under the BCBS/IOSCO Framework and in virtually every other country in the world, an entity is determined to come into scope of the IM requirement on September 1, and an entity has MSE if it has the equivalent of $8 billion in AANA[11] during March, April, and May of that year.

The reason the United States is out-of-step with the rest of the world on these timing and calculation issues is not because of any considered policy determination.  Rather, it is simply the result of a quirk that the margin rules were adopted based on the BCBS/IOSCO Framework that was in effect at the time–but the BCBS/IOSCO Framework was revised two years later.

In a further disconnect, the Commission’s margin rules look to the daily average AANA during the three-month calculation period for determining MSE, whereas the BCBS/IOSCO Framework and other major market jurisdictions base the AANA calculation on an average of month-end dates during that period.  Yet, the proposing release notes that the Commission’s Office of the Chief Economist has estimated that calculations based on end-of-month AANA generally would yield similar results as calculations based on the Commission’s current daily AANA approach.

The Commission is proposing to amend these timing and calculation provisions of its uncleared margin rules to harmonize them with the BCBS/IOSCO Framework and the approach followed by our international colleagues around the world.  Given the global nature of the derivatives markets, we should always seek international harmonization of our regulations unless a compelling reason exists not to do so–which is not the case here.

Indeed, in the Dodd-Frank Act, Congress specifically directed the Commission, “[i]n order to promote effective and consistent global regulation of swaps,” to “consult and coordinate with foreign regulatory authorities on the establishment of consistent international standards with respect to the regulation . . . of swaps [and] swap entities . . .”[12]  And when the G-20 leaders met in Pittsburgh in the midst of the financial crisis in 2009, they, too, recognized that a workable solution for global derivatives markets demands coordinated policies and cooperation.[13]

The MSE proposal being issued today is true to the direction of Congress in the Dodd-Frank Act, and honors the commitment of the G-20 leaders at the Pittsburgh summit.  Differences between countries in the detailed timing and calculation requirements with respect to uncleared margin compel participants in these global markets to run multiple compliance calculations–for no particular regulatory reason.  This not only forces market participants to bear unnecessary costs, but actually hinders compliance with margin requirements because of the entirely foreseeable prospect of calculation errors in applying the different rules.

As noted above, now is the time to address this disjunction in MSE timing and calculation requirements because the financial end-users to which the MSE definition applies are coming into scope of the margin rules.  Both Congress and the G-20 leaders recognized that because modern swap markets are not bound by jurisdictional borders, they cannot function absent consistent international standards.  Harmonization fosters both improved compliance and effectively regulated markets through coordinated oversight–which must always be our goals.

During the unfortunate events of the financial crisis, we learned that coordination among global regulators, working towards a common objective, is essential.  That lesson remains true today, and we are reminded that disregarding this reality has the potential to weaken, rather than strengthen, the effectiveness of our oversight and the resilience of global derivatives markets.

There Remains Unfinished Business

The report of the GMAC Margin Subcommittee recommended several actions beyond those that we are considering today 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 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 today, I hope that we can continue to work together to address the other recommendations contained 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 align them with the rest of the international regulatory community, and 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.

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.

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.

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.

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.   

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.