Margin and Capital Requirements for Covered Swap Entities

Federal RegisterSep 24, 2014

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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 45

[Docket No. OCC-2011-0008]

RIN 1557-AD43

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

12 CFR Part 237

[Docket No. R-1415]

RIN 7100-AD74

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 349

RIN 3064-AE21

FARM CREDIT ADMINISTRATION

12 CFR Part 624

RIN 3052-AC69

FEDERAL HOUSING FINANCE AGENCY

12 CFR Part 1221

RIN 2590-AA45

Margin and Capital Requirements for Covered Swap Entities

AGENCY:

Office of the Comptroller of the Currency, Treasury (“OCC”); Board of Governors of the Federal Reserve System (“Board”); Federal Deposit Insurance Corporation (“FDIC”); Farm Credit Administration (“FCA”); and the Federal Housing Finance Agency (“FHFA”).

ACTION:

Notice of proposed rulemaking and request for comment.

SUMMARY:

The OCC, Board, FDIC, FCA, and FHFA (each an “Agency” and, collectively, the “Agencies”) are seeking comment on a proposed joint rule to establish minimum margin and capital requirements for registered swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants for which one of the Agencies is the prudential regulator. This proposed rule implements sections 731 and 764 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which require the Agencies to adopt rules jointly to establish capital requirements and initial and variation margin requirements for such entities and their counterparties on all non-cleared swaps and non-cleared security-based swaps in order to offset the greater risk to such entities and the financial system arising from the use of swaps and security-based swaps that are not cleared.

DATES:

Comments should be received on or before November 24, 2014.

ADDRESSES:

Interested parties are encouraged to submit written comments jointly to all of the Agencies. Commenters are encouraged to use the title “Margin and Capital Requirements for Covered Swap Entities” to facilitate the organization and distribution of comments among the Agencies.

Office of the Comptroller of the Currency.

Because paper mail in the Washington, DC area and at the OCC is subject to delay, commenters are encouraged to submit comments by the Federal eRulemaking Portal or email, if possible. Please use the title “Margin and Capital Requirements for Covered Swap Entities” to facilitate the organization and distribution of the comments. You may submit comments by any of the following methods:

• Federal eRulemaking Portal—“regulations.gov”: Go to

http://www.regulations.gov.

Enter “Docket ID OCC-2011-0008” in the Search Box and click “Search”. Results can be filtered using the filtering tools on the left side of the screen. Click on “Comment Now” to submit public comments.

• Click on the “Help” tab on the Regulations.gov home page to get information on using Regulations.gov, including instructions for submitting public comments.

• Email:

regs.comments@occ.treas.gov.

• Mail: Legislative and Regulatory Activities Division, Office of the Comptroller of the Currency, 400 7th Street SW., Suite 3E-218, Mail Stop 9W-11, Washington, DC 20219.

• Hand Delivery/Courier: 400 7th Street SW., Suite 3E-218, Mail Stop 9W-11, Washington, DC 20219.

• Fax: (571) 465-4326.

Instructions:

You must include “OCC” as the agency name and “Docket ID OCC-2011-0008” in your comment. In general, OCC will enter all comments received into the docket and publish them on the Regulations.gov Web site without change, including any business or personal information that you provide such as name and address information, email addresses, or phone numbers. Comments received, including attachments and other supporting materials, are part of the public record and subject to public disclosure. Do not enclose any information in your comment or supporting materials that you consider confidential or inappropriate for public disclosure.

You may review comments and other related materials that pertain to this rulemaking action by any of the following methods:

• Viewing Comments Electronically: Go to

http://www.regulations.gov.

Enter “Docket ID OCC-2011-0008” in the Search box and click “Search”. Comments can be filtered by Agency using the filtering tools on the left side of the screen.

• Click on the “Help” tab on the Regulations.gov home page to get information on using Regulations.gov, including instructions for viewing public comments, viewing other supporting and related materials, and viewing the docket after the close of the comment period.

• Viewing Comments Personally: You may personally inspect and photocopy comments at the OCC, 400 7th Street SW., Washington, DC. For security reasons, the OCC requires that visitors make an appointment to inspect comments. You may do so by calling (202) 649-6700. Upon arrival, visitors will be required to present valid government-issued photo identification and to submit to a security screening in order to inspect and photocopy comments.

• Docket: You may also view or request available background documents and project summaries using the methods described above.

Board of Governors of the Federal Reserve System:

You may submit comments, identified by Docket No. R-1415 and RIN 7100 AD74, by any of the following methods:

• Agency Web site:

http://www.federalreserve.gov.

Follow the instructions for submitting comments at

http://www.federalreserve.gov/apps/foia/proposedregs.aspx.

• Federal eRulemaking Portal:

http://www.regulations.gov.

Follow the instructions for submitting comments.

• Email:

regs.comments@federalreserve.gov.

Include the docket number in the subject line of the message.

• Fax: (202) 452-3819 or (202) 452-3102.

• Mail: Address to Robert deV. Frierson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue NW., Washington, DC 20551.

All public comments will be made available on the Board's Web site at

http://www.federalreserve.gov/apps/foia/proposedregs.aspx

as submitted, unless modified for technical reasons. Accordingly, comments will not be edited to remove any identifying or contact information. Public comments may also be viewed electronically or in

paper in Room MP-500 of the Board's Martin Building (20th and C Streets NW.) between 9:00 a.m. and 5:00 p.m. on weekdays.

Federal Deposit Insurance Corporation:

You may submit comments, identified by RIN 3064-AE21, by any of the following methods:

• Agency Web site:

http://www.fdic.gov/regulations/laws/federal/propose.html.

Follow instructions for submitting comments on the Agency Web site.

• Email:

Comments@FDIC.gov.

Include RIN 3064-AE21 on the subject line of the message.

• Mail: Robert E. Feldman, Executive Secretary, Attention: Comments, Federal Deposit Insurance Corporation, 550 17th Street NW., Washington, DC 20429.

• Hand Delivery: Comments may be hand delivered to the guard station at the rear of the 550 17th Street Building (located on F Street) on business days between 7:00 a.m. and 5:00 p.m.

Instructions:

All comments received must include the agency name and RIN for this rulemaking and will be posted without change to

https://www.fdic.gov/regulations/laws/federal/index.html,

including any personal information provided.

Federal Housing Finance Agency:

You may submit your written comments on the proposed rulemaking, identified by regulatory information number: RIN 2590-AA45, by any of the following methods:

• Agency Web site:

www.fhfa.gov/open-for-comment-or-input.

• Federal eRulemaking Portal:

http://www.regulations.gov.

Follow the instructions for submitting comments. If you submit your comment to the Federal eRulemaking Portal, please also send it by email to FHFA at

RegComments@fhfa.gov

to ensure timely receipt by the Agency. Please include “RIN 2590-AA45” in the subject line of the message.

• Hand Delivery/Courier: The hand delivery address is: Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590-AA45, Federal Housing Finance Agency, Constitution Center (OGC Eighth Floor), 400 7th St. SW., Washington, DC 20024. Deliver the package to the Seventh Street entrance Guard Desk, First Floor, on business days between 9:00 a.m. and 5:00 p.m.

• U.S. Mail, United Parcel Service, Federal Express, or Other Mail Service: The mailing address for comments is: Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590-AA45, Federal Housing Finance Agency, Constitution Center (OGC Eighth Floor), 400 7th St. SW., Washington, DC 20024.

All comments received by the deadline will be posted for public inspection without change, including any personal information you provide, such as your name, address, email address and telephone number on the FHFA Web site at

http://www.fhfa.gov.

Copies of all comments timely received will be available for public inspection and copying at the address above on government-business days between the hours of 10 a.m. and 3 p.m. To make an appointment to inspect comments please call the Office of General Counsel at (202) 649-3804.

Farm Credit Administration:

We offer a variety of methods for you to submit your comments. For accuracy and efficiency reasons, commenters are encouraged to submit comments by email or through the FCA's Web site. As facsimiles (fax) are difficult for us to process and achieve compliance with section 508 of the Rehabilitation Act, we are no longer accepting comments submitted by fax. Regardless of the method you use, please do not submit your comments multiple times via different methods. You may submit comments by any of the following methods:

• Email: Send us an email at

reg-comm@fca.gov.

• FCA Web site:

http://www.fca.gov.

Select “Law & Regulation,” then “FCA Regulations,” then “Public Comments,” then follow the directions for “Submitting a Comment.”

• Federal eRulemaking Portal:

http://www.regulations.gov.

Follow the instructions for submitting comments.

• Mail: Barry F. Mardock, Deputy Director, Office of Regulatory Policy, Farm Credit Administration, 1501 Farm Credit Drive, McLean, VA 22102-5090.

You may review copies of all comments we receive at our office in McLean, Virginia or on our Web site at

http://www.fca.gov.

Once you are in the Web site, select “Law & Regulation,” then “FCA Regulations,” then “Public Comments,” and follow the directions for “Reading Submitted Public Comments.” We will show your comments as submitted, including any supporting data provided, but for technical reasons we may omit items such as logos and special characters. Identifying information that you provide, such as phone numbers and addresses, will be publicly available. However, we will attempt to remove email addresses to help reduce Internet spam.

FOR FURTHER INFORMATION CONTACT:

OCC:

Kurt Wilhelm, Director, Financial Markets Group, (202) 649-6437, Carl Kaminski, Counsel, Legislative and Regulatory Activities Division, (202) 649-5490, or Laura Gardy, Counsel, Securities and Corporate Practices, (202) 649-5510, for persons who are deaf or hard of hearing, TTY (202) 649-5597, Office of the Comptroller of the Currency, 400 7th Street SW., Washington, DC 20219.

Board:

Sean D. Campbell, Deputy Associate Director, Division of Research and Statistics, (202) 452-3760, Victoria M. Szybillo, Counsel, (202) 475-6325, or Anna M. Harrington, Senior Attorney, Legal Division, (202) 452-6406, Elizabeth MacDonald, Senior Supervisory Financial Analyst, Banking Supervision and Regulation, (202) 475-6316, Board of Governors of the Federal Reserve System, 20th and C Streets NW., Washington, DC 20551.

FDIC:

Bobby R. Bean, Associate Director, Capital Markets Branch,

bbean@fdic.gov,

John Feid, Senior Policy Analyst,

jfeid@fdic.gov,

Ryan Clougherty, Capital Markets Policy Analyst,

rclougherty@fdic.gov,

Jacob Doyle, Capital Markets Policy Analyst,

jdoyle@fdic.gov,

Division of Risk Management Supervision, (202) 898-6888; Thomas F. Hearn, Counsel,

thohearn@fdic.gov,

or Catherine Topping, Counsel,

ctopping@fdic.gov,

Legal Division, Federal Deposit Insurance Corporation, 550 17th Street NW., Washington, DC 20429.

FHFA:

Robert Collender, Principal Policy Analyst, Office of Policy Analysis and Research, (202) 649-3196,

Robert.Collender@fhfa.gov,

or Peggy K. Balsawer, Associate General Counsel, Office of General Counsel, (202) 649-3060,

Peggy.Balsawer@fhfa.gov,

Federal Housing Finance Agency, Constitution Center, 400 7th St. SW., Washington, DC 20024. The telephone number for the Telecommunications Device for the Hearing Impaired is (800) 877-8339.

FCA:

Timothy T. Nerdahl, Senior Financial Analyst, Jeremy R. Edelstein, Financial Analyst, Office of Regulatory Policy, (703) 883-4414, TTY (703) 883-4056, or Richard A. Katz, Senior Counsel, Office of General Counsel, (703) 883-4020, TTY (703) 883-4056, Farm Credit Administration, 1501 Farm Credit Drive, McLean, VA 22102-5090.

SUPPLEMENTARY INFORMATION:

I. Background

A. The Dodd-Frank Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act” or “Dodd-Frank Act”) was enacted on July 21, 2010.

Title VII of the Dodd-

Frank Act established a comprehensive new regulatory framework for derivatives, which the Act generally characterizes as “swaps” (which are defined in section 721 of the Dodd-Frank Act to include interest rate swaps, commodity-based swaps, and broad-based credit swaps) and “security-based swaps” (which are defined in section 761 of the Dodd-Frank Act to include single-name and narrow-based credit swaps and equity-based swaps).

For the remainder of this preamble, the term “swaps” refers to swaps and security-based swaps unless the context requires otherwise.

Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010).

See

7 U.S.C. 1a(47); 15 U.S.C. 78c(a)(68).

As part of this new regulatory framework, sections 731 and 764 of the Dodd-Frank Act add a new section, section 4s, to the Commodity Exchange Act of 1936, as amended (“Commodity Exchange Act”) and a new section, section 15F, to the Securities Exchange Act of 1934, as amended (“Exchange Act”), respectively, which require the registration by the Commodity Futures Trading Commission (the “CFTC”) and the Securities and Exchange Commission (the “SEC”) of swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants (each a “swap entity” and, collectively, “swap entities”).

For swap entities that are prudentially regulated by one of the Agencies,

sections 731 and 764 of the Dodd-Frank Act require the Agencies to adopt rules jointly for swap entities under their respective jurisdictions imposing (i) capital requirements and (ii) initial and variation margin requirements on all swaps not cleared by a central counterparty (“CCP”).

Swap entities that are prudentially regulated by one of the Agencies and therefore subject to the proposed rule are referred to herein as “covered swap entities.”

See

7 U.S.C. 6s; 15 U.S.C. 78o-10. Section 731 of the Dodd-Frank Act requires swap dealers and major swap participants to register with the CFTC, which is vested with primary responsibility for the oversight of the swaps market under Title VII of the Dodd-Frank Act. Section 764 of the Dodd-Frank Act requires security-based swap dealers and major security-based swap participants to register with the SEC, which is vested with primary responsibility for the oversight of the security-based swaps market under Title VII of the Dodd-Frank Act. Section 712(d)(1) of the Dodd-Frank Act requires the CFTC and SEC to issue joint rules further defining the terms swap, security-based swap, swap dealer, major swap participant, security-based swap dealer, and major security-based swap participant. The CFTC and SEC issued final joint rulemakings with respect to these definitions in May 2012 and August 2012, respectively.

See

77 FR 30596 (May 23, 2012); 77 FR 39626 (July 5, 2012) (correction of footnote in the

SUPPLEMENTARY INFORMATION

accompanying the rule); and 77 FR 48207 (August 13, 2012). 17 CFR part 1; 17 CFR parts 230, 240 and 241.

Section 1a(39) of the Commodity Exchange Act defines the term “prudential regulator” for purposes of the capital and margin requirements applicable to swap dealers, major swap participants, security-based swap dealers and major security-based swap participants. The Board is the prudential regulator for any swap entity that is (i) a State-chartered bank that is a member of the Federal Reserve System, (ii) a State-chartered branch or agency of a foreign bank, (iii) a foreign bank which does not operate an insured branch, (iv) an organization operating under section 25A of the Federal Reserve Act (an Edge corporation) or having an agreement with the Board under section 25 of the Federal Reserve Act (an Agreement corporation), and (v) a bank holding company, a foreign bank that is treated as a bank holding company under section 8(a) of the International Banking Act of 1978, as amended, or a savings and loan holding company (on or after the transfer date established under section 311 of the Dodd-Frank Act), or a subsidiary of such a company or foreign bank (other than a subsidiary for which the OCC or FDIC is the prudential regulator or that is required to be registered with the CFTC or SEC as a swap dealer or major swap participant or a security-based swap dealer or major security-based swap participant, respectively). The OCC is the prudential regulator for any swap entity that is (i) a national bank, (ii) a federally chartered branch or agency of a foreign bank, or (iii) a Federal savings association. The FDIC is the prudential regulator for any swap entity that is (i) a State-chartered bank that is not a member of the Federal Reserve System or (ii) a State savings association. The FCA is the prudential regulator for any swap entity that is an institution chartered under the Farm Credit Act of 1971, as amended (the “Farm Credit Act”). FHFA is the prudential regulator for any swap entity that is a “regulated entity” under the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, as amended (the “Federal Housing Enterprises Financial Safety and Soundness Act”) (

i.e.,

the Federal National Mortgage Association (“Fannie Mae”) and its affiliates, the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and its affiliates, and the Federal Home Loan Banks).

See

7 U.S.C. 1a(39). In addition, OCC regulations provide that an operating subsidiary may engage only in activities that are permissible for its parent to conduct directly and require operating subsidiaries to conduct activities subject to the same authorization, terms, and conditions as apply to the conduct of those activities by the parent bank. FDIC regulations for subsidiaries of state-chartered banks incorporate similar limits to those imposed by the OCC for operating subsidiaries. Thus, if operating subsidiaries of a national bank or subsidiaries of a state-chartered bank engage in swap dealing below the aggregate

de minimis

dealer registration exemption thresholds established by the CFTC and SEC for registration as a swap dealer or security-based swap dealer, those subsidiaries must comply with the banking agencies' swap counterparty credit risk exposure safety and soundness requirements, regardless of whether the parent bank is registered as a swap dealer. If those subsidiaries engage in dealing activities above the CFTC and SEC registration thresholds, the subsidiaries must also comply with the margin requirements of this rule.

See

7 U.S.C. 6s(e)(2)(A); 15 U.S.C. 78o-10(e)(2)(A). Section 6s(e)(1)(A) of the Commodity Exchange Act directs registered swap dealers and major swap participants for which there is a prudential regulator to comply with margin and capital rules issued by the prudential regulators, while section 6s(e)(1)(B) directs registered swap dealers and major swap participants for which there is not a prudential regulator to comply with margin and capital rules issued by the CFTC and SEC. Section 78o-10(e)(1) generally parallels section 6s(e)(1), except that section 78o-10(e)(1)(A) refers to registered security-based swap dealers and major security-based swap participants for which “there is not a prudential regulator.” The Agencies construe the “not” in section 78o-10(e)(1)(A) to have been included by mistake, in conflict with section 78o-10(e)(2)(A), and of no substantive meaning. Otherwise, registered security-based swap dealers and major security-based swap participants for which there is not a prudential regulator could be subject to multiple capital and margin rules, and institutions regulated by the prudential regulators and registered as security-based swap dealers and major security-based swap participants might not be subject to any capital and margin requirements under section 78o-10(e).

Sections 731 and 764 of the Dodd-Frank Act also require the CFTC and SEC separately to adopt rules imposing capital and margin requirements for swap entities for which there is no prudential regulator.

The Dodd-Frank Act requires the CFTC, SEC, and the Agencies to establish and maintain, to the maximum extent practicable, capital and margin requirements that are comparable, and to consult with each other periodically (but no less than annually) regarding these requirements.

See

7 U.S.C. 6s(e)(2)(B); 15 U.S.C. 78o-10(e)(2)(B).

See

7 U.S.C. 6s(e)(2)(A); 6s(e)(3)(D); 15 U.S.C. 78o-10(e)(2)(A), 78o-10(e)(3)(D). Staff of the Agencies have consulted with staff of the CFTC and SEC in developing the proposed rule.

The capital and margin standards for swap entities imposed under sections 731 and 764 of the Dodd-Frank Act are intended to offset the greater risk to the swap entity and the financial system arising from non-cleared swaps.

Sections 731 and 764 of the Dodd-Frank Act require that the capital and margin requirements imposed on swap entities must, to offset such risk, (i) help ensure the safety and soundness of the swap entity and (ii) be appropriate for the greater risk associated with non-cleared swaps.

In addition, sections 731 and 764 of the Dodd-Frank Act require the Agencies, in establishing capital requirements for entities designated as covered swap entities for a single type or single class or category of swap or

activities, to take into account the risks associated with other types, classes, or categories of swaps engaged in, and the other activities conducted by swap entities that are not otherwise subject to regulation.

Sections 731 and 764 become effective not less than 60 days after publication of the final rule or regulation implementing these sections.

See

7 U.S.C. 6s(e)(3)(A); 15 U.S.C. 78o-10(e)(3)(A).

See

7 U.S.C. 6s(e)(3)(A); 15 U.S.C. 78o-10(e)(3)(A). In addition, section 1313 of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 requires the Director of FHFA, when promulgating regulations relating to the Federal Home Loan Banks, to consider the following differences between the Federal Home Loan Banks and Fannie Mae and Freddie Mac: Cooperative ownership structure; mission of providing liquidity to members; affordable housing and community development mission; capital structure; and joint and several liability.

See

12 U.S.C. 4513. The Director of FHFA also may consider any other differences that are deemed appropriate. For purposes of this proposed rule, FHFA considered the differences as they relate to the above factors. FHFA requests comments from the public about whether differences related to these factors should result in any revisions to the proposal.

See

7 U.S.C. 6s(e)(2)(C); 15 U.S.C. 78o-10(e)(2)(C). In addition, the margin requirements imposed by the Agencies must permit the use of noncash collateral, as the Agencies determine to be consistent with (i) preserving the financial integrity of the markets trading swaps and (ii) preserving the stability of the U.S. financial system.

See

7 U.S.C. 6s(e)(3)(C); 15 U.S.C. 78o-10(e)(3)(C).

In addition to the Dodd-Frank Act authorities mentioned above, the Agencies also have safety and soundness authority over the entities they supervise.

The Dodd-Frank Act specified that the provisions of its Title VII shall not be construed as divesting any Agency of its authority to establish or enforce prudential or other standards under other law.

12 U.S.C. 221

et seq.,

12 U.S.C. 1818, 12 U.S.C. 1841

et seq.,

12 U.S.C. 3101

et seq.

and 12 U.S.C. 1461

et seq.

(Board); 12 U.S.C. 2001

et seq.;

12 U.S.C. 2241 through 2274; 12 U.S.C. 2279aa-11; 12 U.S.C. 2279bb through bb-7 (FCA); 12 U.S.C. 4513 (FHFA).

See

Dodd-Frank Act sections 741(c) and 764(b).

The capital and margin requirements for non-cleared swaps under sections 731 and 764 of the Dodd-Frank Act complement other Dodd-Frank Act provisions that require all sufficiently standardized swaps to be cleared through a derivatives clearing organization or clearing agency.

This requirement is consistent with the consensus of the G-20 leaders to clear derivatives through central counterparties where appropriate.

See

7 U.S.C. 2(h); 15 U.S.C. 78c-3. Certain types of counterparties (

e.g.,

counterparties that are not financial entities and are using swaps to hedge or mitigate commercial risks) are exempt from this mandatory clearing requirement and may elect not to clear a swap that would otherwise be subject to the clearing requirement.

G-20 Leaders, June 2010 Toronto Summit Declaration, Annex II, ¶ 25. The dealer community has also recognized the importance of clearing—beginning in 2009, in an effort led by the Federal Reserve Bank of New York, the dealer community agreed to increase central clearing for certain credit derivatives and interest rate derivatives.

See

Press Release, Federal Reserve Bank of New York, New York Fed Welcomes Further Industry Commitments on Over-the-Counter Derivatives (June 2, 2009),

available at www.newyorkfed.org/newsevents/news/markets/2009/ma090602.html.

In the derivatives clearing process, CCPs manage credit risk through a range of controls and methods, including a margining regime that imposes both initial margin and variation margin requirements on parties to cleared transactions.

Thus, the mandatory clearing requirement established by the Dodd-Frank Act for swaps effectively will require any party to any transaction subject to the clearing mandate to post initial and variation margin in connection with that transaction.

CCPs interpose themselves between counterparties to a swap transaction, becoming the buyer to the seller and the seller to the buyer and, in the process, taking on the credit risk that each party poses to the other. For example, when a swaps contract between two parties that are members of a CCP is executed and submitted for clearing, it is typically replaced by two new contracts—separate contracts between the CCP and each of the two original counterparties. At that point, the original counterparties are no longer counterparties to each other; instead, each faces the CCP as its counterparty, and the CCP assumes the counterparty credit risk of each of the original counterparties.

However, if a particular swap is not cleared because it is not subject to the mandatory clearing requirement (or because one of the parties to a particular swap is eligible for, and uses, an exemption from the mandatory clearing requirement), that swap will be a “non-cleared” swap and may be subject to the capital and margin requirements for such transactions established under sections 731 and 764 of the Dodd-Frank Act.

The swaps-related provisions of Title VII of the Dodd-Frank Act, including sections 731 and 764, are intended in general to reduce risk, increase transparency, promote market integrity within the financial system, and, in particular, address a number of weaknesses in the regulation and structure of the swaps markets that were revealed during the financial crisis of 2008 and 2009. During the financial crisis, the opacity of swap transactions among dealers and between dealers and their counterparties created uncertainty about whether market participants were significantly exposed to the risk of a default by a swap counterparty. By imposing a regulatory margin requirement on non-cleared swaps, the Dodd-Frank Act reduces the uncertainty around the possible exposures arising from non-cleared swaps.

Further, the most recent financial crisis revealed that a number of significant participants in the swaps markets had taken on excessive risk through the use of swaps without sufficient financial resources to make good on their contracts. By imposing an initial and variation margin requirement on non-cleared swaps, sections 731 and 764 of the Dodd-Frank Act will reduce the ability of firms to take on excessive risks through swaps without sufficient financial resources. Additionally, the minimum margin requirement will reduce the amount by which firms can leverage the underlying risk associated with the swap contract.

The Agencies originally published proposed rules to implement sections 731 and 764 of the Act in May 2011 (the “2011 proposal”).

Over 100 comments were received in response to the 2011 proposal from a variety of commenters, including banks, asset managers, commercial end users, and various trade associations. Like the current proposal, the 2011 proposal was issued pursuant to the Dodd-Frank Act and each Agency's safety and soundness authority.

76 FR 27564 (May 11, 2011).

B. Other Dodd-Frank Act Provisions Affecting the Margin and Capital Rule

The applicability of the prudential regulators' margin requirements rely in part on regulatory action taken by the CFTC, the SEC, and the Secretary of the Treasury. The margin requirements will apply to an entity listed as prudentially regulated by the Agencies under the definition of “prudential regulator” in the Commodity Exchange Act

if that entity: (1) Is a swap dealer, major swap participant, security-based swap dealer, major security-based swap participant and (2) enters into a non-cleared swap. In addition, as a means of ensuring the safety and soundness of the covered swap entity's non-cleared swap activities under the proposed rule, the requirements would apply to all of a covered swap entity's swap and security-based swap activities without regard to whether the entity has registered as both a swaps entity and a security-based swaps entity. Thus, for example, for an entity that is a swap dealer but not a security-based swap dealer or major security-based swap participant, the proposed rule's requirements would apply to all of that swap dealer's non-cleared swaps and security-based swaps.

See

Dodd-Frank Act section 721; 7 U.S.C. 1(a)(39).

On May 23, 2012, the CFTC and SEC adopted a final joint rule defining “swap dealer,” “major swap participant,” “security-based swap dealer,” and “major security-based swap dealer.” These definitions include quantitative thresholds in the relevant activity that affect whether an entity subject to the “prudential regulator” definition also will be subject to the margin regulations being proposed.

See

77 FR 30596 (May 23, 2012), 77 FR 39626 (July 5, 2012) (correction of footnote in

SUPPLEMENTARY INFORMATION

accompanying the rule) and 77 FR 48207 (August 13, 2012); 17 CFR part 1; 17 CFR parts 230, 240, and 241.

On August 13, 2012, the CFTC and SEC adopted a final joint rule defining “swap,” “security-based swap,” “foreign exchange swap,” and “foreign

exchange forward.”

On November 16, 2012, the Secretary of the Treasury made a determination pursuant to sections 1a(47)(E) and 1(b) of the Commodity Exchange Act to exempt foreign exchange swaps and foreign exchange forwards from certain swap requirements, including margin requirements, that Title VII of the Dodd-Frank Act added to the Commodity Exchange Act.

See

77 FR 48207 (August 13, 2012); 17 CFR part 1; 17 CFR parts 230, 240, and 241.

77 FR 69694 (November 20, 2013).

The CFTC has adopted a final rule requiring registration by entities meeting the substantive definition of swap dealer or major swap participant and engaging in relevant activities above the applicable quantitative thresholds.

As of June 29, 2014, 102 entities have registered as swap dealers, and 2 entities have registered as major swap participants, neither of which are insured depository institutions or otherwise among the entities listed in the prudential regulator definition. The SEC has not yet imposed a registration requirement on entities that meet the definition of “security-based swap dealer,” or “major security-based swap participant.”

77 FR 2613 (January 1, 2012); 17 CFR 23.21.

The CFTC and SEC have also adopted policies addressing how the Commodity Exchange Act's and Exchange Act's swap requirements will apply to “cross-border swaps.”

78 FR 45292 (July 26, 2013); 17 CFR part 1; 79 FR 39067 (July 9, 2014); 17 CFR parts 240, 241, and 250.

C. The 2013 International Framework

Following the release of the Agencies' 2011 proposal, the Basel Committee on Banking Supervision (“BCBS”) and the Board of the International Organization of Securities Commissions (“IOSCO”) proposed an international framework for margin requirements on non-cleared swaps with the goal of creating an international standard for non-cleared swaps (the “2012 international framework”).

Following the issuance of the 2012 international framework, the Agencies re-opened the comment period on the Agencies' 2011 proposal to allow for additional comment in relation to the 2012 international framework.

The 2012 international framework was also subject to extensive public comment before being finalized in September 2013 (the “2013 international framework”).

See BCBS and IOSCO “Consultative Document—Margin requirements for non-centrally cleared derivatives” (July 2012),

available at http://www.bis.org/publ/bcbs226.pdf

and “Second consultative document—Margin requirements for non-centrally cleared derivatives” (February 2013),

available at http://www.bis.org/publ/bcbs242.pdf.

77 FR 60057 (October 2, 2012).

See

BCBS and IOSCO “Margin requirements for non-centrally cleared derivatives,” (September 2013),

available at https://www.bis.org/publ/bcbs261.pdf.

The 2013 international framework articulates eight key principles for non-cleared derivatives margin rules, which are described in further detail below. These principles represent the minimum standards approved by BCBS and IOSCO and recommended to the regulatory authorities in member jurisdictions of these organizations. Key principles 1 through 8 are described below.

The 2013 international framework refers to swaps as “derivatives.” For purposes of the discussion in this section, the terms “swaps” and “derivatives” can be used interchangeably.

1. Appropriate Margining Practices Should Be in Place With Respect to All Non-Cleared Derivative Transactions

The 2013 international framework recommends that appropriate margining practices be in place with respect to all derivative transactions that are not cleared by CCPs. The 2013 international framework does not include a margin requirement for physically settled foreign exchange (FX) forwards and swaps.

The framework would also not apply initial margin requirements to the fixed physically settled FX component of cross-currency swaps.

The 2013 international framework states that variation margin standards for physically settled FX forwards and swaps should be addressed by national supervisors in a manner consistent with the BCBS supervisory guidance recommendations for these products.

See

BCBS “Supervisory guidance for managing risks associated with the settlement of foreign exchange transactions,” (February 2013),

available at: https://www.bis.org/publ/bcbs241.pdf

(BCBS FX supervisory guidance). The Board implemented the BCBS FX supervisory guidance in SR letter 13-24 “Managing Foreign Exchange Settlement Risks for Physically Settled Transactions” (December 23, 2013) available at

http://www.federalreserve.gov/bankinforeg/srletters/sr1324.htm.

As discussed elsewhere in this preamble, in 2012, the Secretary of the Treasury made a determination that physically-settled foreign exchange forwards and swaps are not to be considered swaps under the Dodd-Frank Act. 77 FR 69694 (November 20, 2012).

2. Financial Firms and Systemically Important Nonfinancial Entities (Covered Entities) Must Exchange Initial and Variation Margin

The 2013 international framework recommends bilateral exchange of initial and variation margin for non-cleared derivatives between covered entities. The precise definition of “covered entities” is to be determined by each national regulator, but in general should include financial firms and systemically important nonfinancial entities. Sovereigns, central banks, certain multilateral development banks, the Bank for International Settlements (BIS), and non-systemic, nonfinancial firms are not included as covered entities.

Under the 2013 international framework, all covered entities that engage in non-cleared derivatives should exchange, on a bilateral basis, the full amount of variation margin with a zero threshold on a regular basis (

e.g.,

daily). All covered entities are also expected to exchange, on a bilateral basis, initial margin with a threshold not to exceed €50 million. The threshold applies on a consolidated group, rather than legal entity, basis. In addition, and in light of the permitted initial margin threshold, the 2013 international framework recommends that entities with non-cleared derivative activity of €8 billion notional or more would be subject to initial margin requirements.

3. The Methodologies for Calculating Initial and Variation Margin Should (i) Be Consistent Across Covered Entities, and (ii) Ensure That All Counterparty Risk Exposures Are Covered With a High Degree of Confidence

The 2013 international framework states that the potential future exposure of a non-cleared derivative should reflect an estimate of an increase in the value of the instrument that is consistent with a one-tailed 99% confidence level over a 10-day horizon (or longer, if variation margin is not collected on a daily basis), based on historical data that incorporates a period of significant financial stress.

The 2013 international framework permits the amount of initial margin to be calculated by reference to internal models approved by the relevant national regulator or a standardized margin schedule, but covered entities should not “cherry pick” between the two calculation methods. Models may allow for conceptually sound and empirically demonstrable portfolio risk offsets where there is an enforceable netting agreement in effect. However, portfolio risk offsets may only be recognized within, and not across, certain well-defined asset classes: Credit, equity, interest rates and foreign exchange, and commodities. A covered entity using the standardized margin schedule may adjust the gross initial margin amount (notional exposure multiplied by the relevant percentage in the table) by a “net-to-gross ratio,” which is also used in the bank counterparty credit risk capital rules to reflect a degree of netting of derivative

positions that are subject to an enforceable netting agreement.

4. To Ensure That Assets Collected as Collateral Can Be Liquidated in a Reasonable Amount of Time To Generate Proceeds That Could Sufficiently Protect Covered Entities From Losses in the Event of a Counterparty Default, These Assets Should Be Highly Liquid and Should, After Accounting for an Appropriate Haircut, Be Able To Hold Their Value in a Time of Financial Stress

The 2013 international framework recommends that national supervisors develop a definitive list of eligible collateral assets. The 2013 international framework includes examples of permissible collateral types, provides a schedule of standardized haircuts, and indicates that model-based haircuts may be appropriate. In the event that a dispute arises over the value of eligible collateral, the 2013 international framework provides that both parties should make all necessary and appropriate efforts, including timely initiation of dispute resolution protocols, to resolve the dispute and exchange any required margin in a timely fashion.

5. Initial Margin Should Be Exchanged on a Gross Basis and Held in Such a Way as To Ensure That (i) the Margin Collected Is Immediately Available to the Collecting Party in the Event of the Counterparty's Default, and (ii) the Collected Margin Is Subject to Arrangements That Fully Protect the Posting Party

The 2013 international framework provides that collateral collected as initial margin from a “customer” (defined as a “buy-side financial firm”) should be segregated from the initial margin collector's proprietary assets. The initial margin collector also should give the customer the option to individually segregate its initial margin from other customers' margin. In very specific circumstances, the initial margin collector may use margin provided by the customer to hedge the risks associated with the customer's positions with a third party. To the extent that the customer consents to rehypothecation, it should be permitted only where applicable insolvency law gives the customer protection from risk of loss of initial margin in instances where either the initial margin collector or the third party become insolvent, or they both do. Where a customer has consented to rehypothecation and adequate legal safeguards are in place, the margin collector and the third party to whom customer collateral is rehypothecated should comply with additional restrictions detailed in the 2013 international framework, including a prohibition on any further rehypothecation of the customer's collateral by the third party.

6. Requirements for Transactions Between Affiliates Are Left to the National Supervisors

The 2013 international framework recommends that national supervisors establish margin requirements for transactions between affiliates as appropriate in a manner consistent with each jurisdiction's legal and regulatory framework.

7. Requirements for Margining Non-Cleared Derivatives Should Be Consistent and Non-Duplicative Across Jurisdictions

Under the 2013 international framework, home-country supervisors may allow a covered entity to comply with a host-country's margin regime if the host-country margin regime is consistent with the 2013 international framework. A branch may be subject to the margin requirements of either the headquarters' jurisdiction or the host country.

8. Margin Requirements Should Be Phased in Over an Appropriate Period of Time

The 2013 international framework phases in margin requirements between December 2015 and December 2019. Covered entities should begin exchanging variation margin by December 1, 2015. The date on which a covered entity should begin to exchange initial margin with a counterparty depends on the notional amount of non-cleared derivatives (including physically settled FX forwards and swaps) entered into both by its consolidated corporate group and by the counterparty's consolidated corporate group.

Currency denomination.

The 2013 international framework generally lays out a broad conceptual framework for margining requirements on non-cleared derivatives. It also recommends specific quantitative levels for several parameters such as the level of notional derivative exposure that results in an entity being subject to the margin requirements (€8 billion), permitted initial margin thresholds (€50 million), and minimum transfer amounts (€500,000). In the 2013 international framework, all such amounts are denominated in Euros. In this proposal all such amounts are denominated in U.S. dollars. The Agencies are aware that, over time, amounts that are denominated in different currencies in different jurisdictions may fluctuate relative to one another due to changes in exchange rates. The Agencies seek comment on whether and how fluctuations resulting from exchange rate movements should be addressed. In particular, should these amounts be expressed in terms of a single currency in all jurisdictions to prevent such fluctuations? Should the amounts be adjusted over time if and when exchange rate movements necessitate realignment? Are there other approaches to deal with fluctuations resulting from significant exchange rate movements? Are there other issues that should be considered in connection to the effects of fluctuating exchange rates?

II. Overview of Proposed Rule

A. Margin Requirements

The Agencies have reviewed the comments received on the 2011 proposal and the 2013 international framework. The Agencies believe that a number of changes to the 2011 proposal are warranted in order to reflect certain comments received, as well as to achieve the 2013 international framework's goal of promoting global consistency and reducing regulatory arbitrage opportunities. In light of the significant differences from the 2011 proposal, the Agencies are seeking comment on a revised proposed rule to implement section 4s of the Commodity Exchange Act and section 15F of the Exchange Act (the “proposal” or the “proposed rule”).

The Agencies are proposing to adopt a risk-based approach that would establish initial and variation margin requirements for covered swap entities. Consistent with the statutory requirement, the proposed rule would help ensure the safety and soundness of the covered swap entity and would be appropriate for the risk to the financial system associated with non-cleared swaps held by covered swap entities. The proposed rule takes into account the risk posed by a covered swap entity's counterparties in establishing the minimum amount of initial and variation margin that the covered swap entity must exchange with its counterparties.

In implementing this risk-based approach, the proposed rule distinguishes among four separate types of swap counterparties: (i) Counterparties that are themselves swap entities; (ii) counterparties that are financial end users with a material swaps exposure; (iii) counterparties that are financial end users without a material swaps exposure, and (iv) other

counterparties, including nonfinancial end users, sovereigns, and multilateral development banks.

These categories reflect the Agencies' current belief that risk-based distinctions can be made between these types of swap counterparties.

See

§ __.2 of the proposed rule for the various constituent definitions that identify these four types of swap counterparties.

The proposed rule's initial and variation margin requirements generally apply to the posting, as well as the collection, of minimum initial and variation margin amounts by a covered swap entity from and to its counterparties. This proposal represents a refinement to the Agencies' original collection-only approach to margin requirements based on consideration of comments made on the 2011 proposal and the 2013 international framework. While the Agencies believe that imposing requirements with respect to the minimum amount of initial and variation margin to be collected is a critical aspect of offsetting the greater risk to the covered swap entity and the financial system arising from the covered swap entity's non-cleared swap exposure, the Agencies also believe that requiring a covered swap entity to post margin to other financial entities could forestall a build-up of potentially destabilizing exposures in the financial system. The proposed rule's approach therefore is designed to ensure that covered swap entities transacting with other swap entities and with financial end users in non-cleared swaps will be collecting and posting appropriate minimum margin amounts with respect to those transactions.

For initial margin, the proposed rule would require a covered swap entity to calculate its minimum initial margin requirement in one of two ways. The covered swap entity may use a standardized margin schedule, which is set out in Appendix A of the proposed rule. The standardized margin schedule allows for certain types of netting and offsetting of exposures. In the alternative, a covered swap entity may use an internal margin model that satisfies certain criteria outlined within § __.8 of the proposed rule and that has been approved by the relevant prudential regulator.

See

§ __.8 and Appendix A of the proposed rule for a complete description of the requirements for initial margin models and standardized minimum initial margin requirements.

Where a covered swap entity transacts with another swap entity (regardless of whether the other swap entity meets the definition of a “covered swap entity” under the proposed rule), the covered swap entity must collect at least the amount of initial margin required under the proposed rule. Likewise, the swap entity counterparty also will be required, under margin rules that are applicable to that swap entity,

to collect a minimum amount of initial margin from the covered swap entity.

Accordingly, covered swap entities will both collect and post a minimum amount of initial margin when transacting with another swap entity. A covered swap entity transacting with a financial end user with a material swaps exposure as specified by this proposed rule must collect at least the amount of initial margin required by the proposed rule and must post at least the amount of initial margin that the covered swap entity would be required by the proposal to collect if the covered swap entity were in the place of the counterparty. In addition, a covered swap entity must post or collect initial margin on at least a daily basis as required under the proposed rule in response to changes in the required initial margin amounts stemming from changes in portfolio composition or any other factors that result in a change in the required initial margin amounts.

All swap entities will be subject to a rule on minimum margin for non-cleared swaps promulgated by one of the Agencies, the SEC or the CFTC.

The counterparty may be a covered swap entity subject to this proposed rule or a swap entity that is subject to the margin rules of the CFTC or SEC. If the counterparty is a covered swap entity, it must collect at least the amount of margin required under this proposal. If the counterparty is a swap entity subject to the margin rules of the CFTC or SEC, it must collect the amount of margin required under the CFTC or SEC margin rules.

Under the proposed rule, when entering into a swap transaction, the first collection and posting of initial margin may be delayed for one day following the day the swap transaction is executed. Thereafter, posting and collecting initial margin must be made on at least a daily basis in response to changes in portfolio composition or any other factors that would change the required initial margin amounts.

The proposed rule permits a covered swap entity to adopt a maximum initial margin threshold amount of $65 million, below which it need not collect or post initial margin from or to swap entities and financial end users with material swaps exposures. The threshold would be applied on a consolidated basis, and would apply both to the consolidated covered swap entity as well as to the consolidated counterparty.

See

§§ __.3 and ___.8 of the proposed rule for a complete description of the initial margin requirements.

With respect to variation margin, the proposed rule generally requires a covered swap entity to collect or post variation margin on swaps with a swap entity or a financial end user (regardless of whether the financial end user has a material swaps exposure) in an amount that is at least equal to the increase or decrease in the value of the swap since the counterparties' previous exchange of variation margin. The proposed rule would not permit a covered swap entity to adopt a threshold amount below which it need not collect or post variation margin on swaps with swap entity and financial end user counterparties. In addition, a covered swap entity must collect or post variation margin with swap entities and financial end user counterparties under the proposed rule on at least a daily basis.

See

§ __.4 of the proposed rule for a complete description of the variation margin requirements.

The proposed rule's margin provisions establish only

minimum

requirements with respect to initial and variation margin. Nothing in the proposed rule is intended to prevent or discourage a covered swap entity from collecting or posting margin in amounts greater than is required under the proposed rule.

Under the proposal, a covered swap entity's collection of margin from “other counterparties” that are not swap entities or financial end users (e.g., nonfinancial or “commercial” end users that generally engage in swaps to hedge commercial risk, sovereigns, and multilateral developments banks), is subject to the judgment of the covered swap entity. That is, under the proposed rule, a covered swap entity is not required to collect initial and variation margin from these “other counterparties” as a matter of course. However, a covered swap entity should continue with the current practice of collecting initial or variation margin at such times and in such forms and amounts (if any) as the covered swap entity determines in its overall credit risk management of the swap entity's exposure to the customer.

Although covered swap entities would be required to collect variation margin from all financial end user counterparties under the proposed rule, no minimum initial margin requirement would apply to transactions with those financial end users that are not swap entities and that do not have a material swaps exposure. Thus, for the purpose of the initial margin requirements, financial end users that are not swap entities and that do not have a material swaps exposure would be treated in the same manner as entities characterized as “other counterparties.”

The Agencies believe that differential treatment of “other counterparties” is consistent with the Dodd-Frank Act's

risk-based approach to establishing margin requirements. However, the Agencies recognize that a covered swap entity may find it prudent from a risk management perspective to collect margin from one or more of these “other counterparties.”

See

§ __.3 and § __.4 of the proposed rule for a complete description of the initial and variation margin requirements that apply to “other counterparties.”

The proposed rule limits the types of collateral that are eligible to be used to satisfy both the initial and variation margin requirements. Eligible collateral is generally limited to high-quality, liquid assets that are expected to remain liquid and retain their value, after accounting for an appropriate risk-based “haircut,” during a severe economic downturn. Eligible collateral for variation margin is limited to cash only. Eligible collateral for initial margin includes cash, debt securities that are issued or guaranteed by the U.S. Department of Treasury or by another U.S. government agency, the Bank for International Settlements, the International Monetary Fund, the European Central Bank, multilateral development banks, certain U.S. Government-sponsored enterprises' (“GSEs”) debt securities, certain foreign government debt securities, certain corporate debt securities, certain listed equities, and gold.

When determining the collateral's value for purposes of satisfying the proposed rule's margin requirements, non-cash collateral and cash collateral that is not denominated in U.S. dollars or the currency in which payment obligations under the swap are required to be settled would be subject to an additional “haircut” as determined using Appendix B of the proposed rule.

The limits on eligible collateral and application of a haircut would not apply to margin collected in excess of what is required by the rule.

An asset-backed security guaranteed by a U.S. Government-sponsored enterprise is eligible collateral for purposes of initial margin if the GSE is operating with capital support or another form of direct financial assistance from the U.S. government (§ __.6(a)(2)(iii)).

See

§ __.6 and Appendix B of the proposed rule for a complete description of the eligible collateral requirements.

Separate from the proposed rule's requirements with respect to the collection and posting of initial and variation margin, the proposed rule also would require a covered swap entity to require that any collateral other than variation margin that it posts to its counterparty (even collateral in excess of any required by the proposed rule) be segregated at one or more custodians that are not affiliates of the covered swap entity or the counterparty (“third-party custodian”). The proposed rule would also require a covered swap entity to place the initial margin it collects (in accordance with the proposed rule) from a swap entity or a financial end user with material swaps exposure at a third-party custodian.

In both of the foregoing cases, the proposed rule would require that the third-party custodian be prohibited by agreement from certain actions with respect to any of the funds or other property it holds as initial margin. First, the custodial agreement must prohibit rehypothecating, repledging, reusing or otherwise transferring, any of the funds or other property the third-party custodian holds. Second, with respect to initial margin required to be posted or collected, the custodial agreement must prohibit substituting or reinvesting any funds or other property in any asset that would not qualify as eligible collateral under the proposed rule. Third, the custodial agreement must require that after such substitution or reinvestment, the amount net of applicable discounts described in Appendix B continue to be sufficient to meet the requirements for initial margin under the proposal.

Funds or other property held by a third-party custodian but not required to be posted or collected under the rule are not subject to any of these restrictions on collateral substitution or reinvestment.

The segregation requirement therefore applies only to the minimum amount of initial margin that a covered swap entity is required to collect by the rule from a swap entity or financial end user with a material swaps exposure, but applies to all collateral (other than variation margin) that the covered swap entity posts to any counterparty.

See

§ __.7 of the proposed rule for a complete description of the segregation requirements.

Given the global nature of swaps markets and swap transactions, margin requirements will be applied to transactions across different jurisdictions. As required by the Dodd-Frank Act, the Agencies are proposing a specific approach to address cross-border non-cleared swap transactions. Under the proposal, foreign swaps of foreign covered swap entities would not be subject to the margin requirements of the proposed rule.

In addition, certain covered swap entities that are operating in a foreign jurisdiction and covered swap entities that are organized as U.S. branches of foreign banks may choose to abide by the swap margin requirements of the foreign jurisdiction if the Agencies determine that the foreign regulator's swap margin requirements are comparable to those of the proposed rule.

See

§ __.9 of the proposed rule.

See

§ __.9 of the proposed rule for a complete description of the treatment of cross-border swap transactions.

B. Capital Requirements

Sections 731 and 764 of the Dodd-Frank Act also require each Agency to issue, in addition to margin rules, joint rules on capital for covered swap entities for which it is the prudential regulator.

The Board, FDIC, and OCC (each a “banking agency” and, collectively, the “banking agencies”) have had risk-based capital rules in place for banks to address over-the-counter (“OTC”) swaps since 1989 when the banking agencies implemented their risk-based capital adequacy standards (general banking risk-based capital rules)

based on the first Basel Accord.

The general banking risk-based capital rules have been amended and supplemented over time to take into account developments in the swaps market. These supplements include the addition of the market risk rule which requires banks and bank holding companies meeting certain thresholds to calculate their capital requirements for trading positions through models approved by their primary Federal supervisor.

In addition, certain large, complex banks and bank holding companies are subject to the banking agencies' advanced approaches risk-based capital rule (advanced approaches rules), based on the advanced approaches of the Basel II Accord.

7 U.S.C. 6s(e)(2); 15 U.S.C. 78o-10(e)(2).

See

54 FR 4186 (January 27, 1989). The general banking risk-based capital rules are at 12 CFR part 3, Appendices A, B, and C (national banks); 12 CFR part 167 (federal savings banks); 12 CFR part 208, Appendices A, B, and E (state member banks); 12 CFR part 225, Appendices A, D, and E (bank holding companies); 12 CFR part 325, Appendices A, B, C, and D (state nonmember banks); 12 CFR part 390, subpart Z (state savings associations). The general risk-based capital rules are supplemented by the market risk capital rules.

The Basel Committee on Banking Supervision developed the first international banking capital framework in 1988, entitled,

International Convergence of Capital Measurement and Capital Standards.

The banking agencies' market risk capital rules are currently at 12 CFR part 3, Appendix B (OCC); 12 CFR parts 208 and 225, Appendix E (Board); and 12 CFR part 325, Appendix C (FDIC). The rules apply to banks and bank holding companies with trading activity (on a worldwide consolidated basis) that equals 10 percent or more of the institution's total assets, or $1 billion or more.

See

BCBS,

International Convergence of Capital Measurement and Capital Standards: A Revised Framework

(2006). The banking agencies implemented the advanced approaches of the Basel II Accord in 2007.

See

72 FR 69288 (December 7, 2010). The advanced approaches rules are codified at 12 CFR part 3, Appendix C (OCC); 12 CFR part

208, Appendix F and 12 CFR part 225, Appendix G (Board); and 12 CFR part 325, Appendix D (FDIC).

In July 2013 the Board and the OCC issued a final rule (revised capital framework) implementing regulatory capital reforms reflecting agreements reached by the BCBS in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems.”

The revised capital framework includes the capital requirements for OTC swaps described above. The FDIC adopted an interim final rule that was substantively identical to the revised capital framework in July 2013 and later issued a final rule in April 2014 identical to the Board's and the OCC's final rule.

See

BCBS,

Basel III: A Global Regulatory Framework For More Resilient Banks and Banking Systems

(2010),

available at www.bis.org/publ.bcbs189.htm.

78 FR 62018 (October 11, 2013) (Board and OCC); 78 FR 20754 (April 14, 2014) (FDIC). These rules are codified at 12 CFR part 3 (national banks and federal savings associations), 12 CFR part 217 (state member banks, bank holding companies, and savings and loan holding companies), and 12 CFR part 324 (state nonmember banks and state savings associations).

FHFA's predecessor agencies used a methodology similar to that endorsed by the BCBS prior to the development of its recent revised and enhanced framework to develop the risk-based capital rules applicable to those entities now regulated by FHFA. Those rules still apply to all FHFA-regulated entities.

FHFA is in the process of revising and updating these regulations for the Federal Home Loan Banks. The FCA's risk-based capital regulations for Farm Credit System (“FCS”) institutions, except for the Federal Agricultural Mortgage Corporation (“Farmer Mac”), have been in place since 1988 and were last updated in 2005.

The FCA's risk-based capital regulations for Farmer Mac have been in place since 2001 and were updated in 2011.

On May 8, 2014, the FCA proposed revisions to its capital rules for all FCS institutions, except Farmer Mac, that are comparable to the Basel III framework.

For the duration of the conservatorships of Fannie Mae and Freddie Mac (together, the “Enterprises”), FHFA has directed that its existing regulatory capital requirements would not be binding. However, FHFA continues to closely monitor the Enterprises' activities. Such monitoring, coupled with the unique financial support available to the Enterprises from the U.S. Department of the Treasury and the likelihood that FHFA will promulgate new risk-based capital rules in due course to apply to the Enterprises (or their successors) once the conservatorships have ended, lead to FHFA's preliminary view that the reference to existing capital rules is sufficient to address the risks discussed in the text above as to the Enterprises.

See

53 FR 40033 (October 13, 1988); 70 FR 35336 (June 17, 2005); 12 CFR part 615, subpart H.

See

66 FR 19048 (April 12, 2001); 76 FR 23459 (April 27, 2011); 12 CFR part 652.

The FCA recently proposed revisions to its capital rules for all FCS institutions, except Farmer Mac, that are comparable to the Basel III Framework.

As described below, the proposed rule requires a covered swap entity to comply with regulatory capital rules already made applicable to that covered swap entity as part of its prudential regulatory regime. Given that these existing regulatory capital rules specifically take into account and address the unique risks arising from swap transactions and activities, the Agencies are proposing to rely on these existing rules as appropriate and sufficient to offset the greater risk to the covered swap entity and the financial system arising from the use of swaps that are not cleared and to protect the safety and soundness of the covered swap entity.

C. 2011 FCA and FHFA Special Section

In the 2011 proposal, FHFA and FCA (but not the other Agencies) had proposed an additional provision, § __.11 of FHFA's and FCA's proposed rules. Proposed § __.11 would have required any entity that was regulated by FHFA or FCA, but was not itself a covered swap entity, to collect initial margin and variation margin from its swap entity counterparty when entering into a non-cleared swap.

Federal Home Loan Banks, Fannie Mae and its affiliates, Freddie Mac and its affiliates, and all Farm Credit System institutions including Farmer Mac (each a “regulated entity” and, collectively, “regulated entities”) would have been subject to this provision. Regulated entities that were covered swap entities would have been subject to §§ 1 through 9 of the 2011 proposal with respect to margin.

See

76 FR 27564, 27582-83 (May 11, 2011). Section __.11 of the 2011 proposal would have required regulated entities to collect initial and variation margin from their swap entity counterparties on parallel terms to the requirements governing collection by covered swap entities under other sections of the 2011 proposal, including with respect to initial margin calculation methods (via the use of a model or a standardized “lookup” table), documentation standards and segregation requirements. Section __.11 of the 2011 proposal would not have applied to swaps entered into between regulated entities and end users.

FHFA and FCA proposed § __.11 to account for the fact that the 2011 proposal only required covered swap entities to collect initial and variation margin from, but did not require them to post initial and variation margin to, their counterparties.

The approach that FHFA and FCA proposed in § __.11 recognized that a default by a swap counterparty to a regulated entity could adversely affect the safe and sound operations of the regulated entity. FHFA and FCA proposed § __.11 pursuant to each Agency's role as safety and soundness regulator for its respective regulated entities.

Where a covered swap entity's counterparty was another covered swap entity, the collection requirement would have applied in both directions to make the requirement effectively bilateral.

FHFA and FCA are not re-proposing as part of this proposal a provision similar to that found in § __.11 of the 2011 proposal. Unlike the 2011 proposal, this proposal generally would require two-way margining in swap transactions between covered swap entities and FHFA- and FCA-regulated entities.

This two-way margining regime effectively reduces systemic risk by protecting both the regulated entity and its covered swap entity counterparty from the effects of a counterparty default, thereby eliminating the need for FHFA and FCA to propose a separate provision similar to the earlier proposed § __.11. However, should any changes adopted as part of the final joint rule alter the current proposed two-way margining regime in ways that raise safety and soundness concerns for FHFA or FCA with regard to their respective regulated entities, FHFA or FCA may decide to exercise its authority to adopt a provision similar to § __.11 of the 2011 proposal to address these concerns.

Furthermore, FHFA and FCA each reserves the right and authority to address its safety and soundness concerns through the Agencies' final joint rulemaking or through a separate rulemaking or guidance applicable only to its respective regulated entities.

Two-way margining would not necessarily apply in all circumstances. A regulated entity that is not itself a swap entity would meet the proposed definition of financial end user. As a result, if it engaged in swap activity above the threshold set in the definition of material swaps exposure, then the rule would require two-way margining as to both initial and variation margin, with respect to its transactions with covered swap entities. If a regulated entity does not have material swaps exposure, then a covered swap entity and the regulated entity would be required to exchange variation margin with each other but would only be required to collect or post initial margin in such amounts as the parties determine to be appropriate. In such circumstances, no specific amount of initial margin would be required to be collected or posted pursuant to this proposal.

Any final joint rule issued by the Agencies, once effective, would address these safety and soundness concerns only in circumstances where a regulated entity is transacting with a covered swap entity regulated by a prudential regulator. Where a regulated entity is instead engaged in a non-cleared swap with a swap entity that is not subject to the oversight of one of the prudential regulators, the applicable margin requirements would be those issued by the regulator having jurisdiction over the swap entity, namely the CFTC or the SEC. If one of those agencies were to diverge from the two-way margining regime proposed here (and recommended by the 2013 international framework) in a manner that raises safety and soundness concerns for FHFA or FCA with regard to their respective regulated entities, FHFA or FCA also may exercise its authority to adopt a special section to account for those situations as well, either in the final joint rulemaking, or in a separate rulemaking or guidance at a later date.

D. The Proposed Rule and Community Banks

The Agencies expect that the proposed rule likely will have minimal impact on community banks. The Agencies anticipate that community banks will not engage in swap activity to the level necessary to meet the definition of a swap dealer, major swap participant, security-based swap dealer, or major security-based swap participant; and therefore, are unlikely to fall within the proposed definition of a covered swap entity. Because the proposed rule imposes requirements on covered swap entities, no community bank will likely be directly subject to the rule. Thus, a community bank that enters into non-cleared interest rate swaps with its commercial customers would not be required to apply to those swaps the proposed rule's requirements for initial margin or variation margin.

When a community bank enters into a swap with a covered swap entity, the covered swap entity would be required to post and collect initial margin pursuant to the rule only if the community bank had a material swaps exposure.

The Agencies believe that the vast majority of community banks do not engage in swaps at or near that level of activity. Thus, for most, if not all community banks, the proposed rule would only require a covered swap entity to collect initial margin that it determines is appropriate to address the credit risk posed by such a community bank. The Agencies believe covered swap entities currently apply this approach as part of their credit risk management practices.

The proposed rule defines material swaps exposure as an average daily aggregate notional amount of non-cleared swaps, non-cleared security-based swaps, foreign exchange forwards and foreign exchange swaps with all counterparties for June, July, and August of the previous calendar year that exceeds $3 billion, where such amount is calculated only for business days.

The proposed rule would require a covered swap entity to exchange daily variation margin with a community bank, regardless of whether the community bank had material swaps exposure. However, the covered swap entity would only be required to collect variation margin from a community bank when the amount of both initial margin and variation margin required to be collected daily exceeded $650,000. The Agencies expect that the vast majority of community banks will have a daily margin requirement that is below this amount.

The Agencies seek comment on the potential impact that this proposed rule might have on community banks.

E. The Proposed Rule and Farm Credit System Institutions

Similar to community banks, the proposed rule will have a minimal impact on the Farm Credit System. Currently, no FCS institution, including Farmer Mac, engage in swap activity at the level necessary to meet the definition of a swap dealer, major swap participant, security-based swap dealer, or a major security-based swap participant. For this reason, no FCS institution, including Farmer Mac, would fall within the proposed definition of a covered swap entity and, therefore, become directly subject to this rule. Furthermore, an overwhelming majority of FCS institutions do not currently engage in non-cleared swaps at or near the level that they would have a material swaps exposure. Therefore, a majority of FCS institutions would not be required by this rule to exchange initial margin with a covered swap entity. For those few FCS institutions that currently have a material swaps exposure, initial margin exchange would be mandated only when non-cleared swap transactions with an individual counterparty and its affiliates exceed the $65 million threshold. All FCS institutions, including Farmer Mac, are financial end users and, therefore, they must exchange variation margin daily once the parties reach the $650,000 minimum transfer amount.

The Agencies also seek specific comments on the potential impact of this proposal on FCS institutions.

III. Section by Section Summary of Proposed Rule

A. Section __.1: Authority, Purpose, Scope, and Compliance Dates

Sections __.1(a)-(c) of the proposal are agency-specific. Section __.1(a) sets out each Agency's specific authority, and § __.1(b) describes the purpose of the rule, including the specific entities covered by each Agency's rule. Section __.1(c) of the proposal specifies the scope of the transactions to which the margin requirements apply. It provides that the margin requirements apply to

all

non-cleared swaps into which a covered swap entity enters. Each prudential regulator is proposing rule text for its Agency-specific version of § __.1(c) that specifies the entities to which that prudential regulator's rule applies. Section __.1(c) further states that the margin requirements apply only to swap and security-based swap transactions that are entered into on or after the relevant compliance date set forth in § __.1(d). This section also provides that nothing in this proposal is intended to prevent, and nothing in this proposal is intended to require, a covered swap entity from independently collecting margin in amounts greater than are required under this proposed rule.

1. Treatment of Swaps With Commercial End User Counterparties

Following passage of the Dodd-Frank Act, various parties expressed concerns regarding whether sections 731 and 764 of the Dodd-Frank Act authorize or require the CFTC, SEC, and Agencies to establish margin requirements with respect to transactions between a covered swap entity and a “commercial end user” (

i.e.,

a nonfinancial counterparty that is neither a swap entity nor a financial end user and engages in swaps to hedge commercial risk).

Pursuant to other provisions of the Dodd-Frank Act, nonfinancial end users that engage in swaps to hedge their commercial risks are exempt from the requirement that all swaps designated for clearing by the CFTC or SEC be cleared by a CCP, and, therefore they are exempt from the requirement to post initial margin and variation margin to the CCP. Commenters to the 2011 proposal argued that swaps with commercial end users should also be excluded from the scope of margin requirements imposed for non-cleared swaps under sections 731 and 764, asserting that commercial firms engaged in hedging activities pose a reduced risk to their counterparties and the stability of the U.S. financial system and that including these types of counterparties in the scope of the proposal would undermine the goals of excluding these firms from the clearing requirements.

Although the term “commercial end user” is not defined in the Dodd-Frank Act, it is generally understood to mean a company that is eligible for the exception to the mandatory clearing requirement for swaps under section 2(h)(7) of the Commodity Exchange Act and section 3C(g) of the Securities Exchange Act, respectively. This exception is generally available to a person that (i) is not a financial entity, (ii) is using the swap to hedge or mitigate commercial risk, and (iii) has notified the CFTC or SEC how it generally meets its financial obligations with respect to non-cleared swaps or security-based swaps, respectively.

See

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

Statements in the legislative history of sections 731 and 764 suggest that at least some members of Congress did not intend, in enacting these sections, to impose margin requirements on nonfinancial end users engaged in hedging activities, even in cases where they entered into swaps with swap entities.

See, e.g.,

156 Cong. Rec. S5904 (daily ed. July 15, 2010) (statement of Sen. Lincoln).

In formulating the proposed rule, the Agencies have carefully considered these concerns and statements. The plain language of sections 731 and 764 provides that the Agencies adopt rules for covered swap entities imposing margin requirements on

all non-cleared swaps.

Those sections do not, by their terms, exclude a swap with a counterparty that is a commercial end user. Importantly, sections 731 and 764 also direct the Agencies to adopt margin requirements that (i) help ensure the safety and soundness of the covered swap entity and (ii) are appropriate for the risk associated with the non-cleared swaps. Thus, the statute requires the Agencies to take a risk-based approach to establishing margin requirements. Further, the Dodd-Frank Act does not contain an express exemption for commercial end users from the margin requirements of sections 731 and 764 of the Dodd-Frank Act. The Agencies note that the application of margin requirements to non-cleared swaps with nonfinancial end users could be viewed as lessening the effectiveness of the clearing requirement exemption for these nonfinancial end users.

The 2011 proposal permitted a covered swap entity to adopt, where appropriate, initial and variation margin thresholds below which the covered swap entity would not be required to collect initial or variation margin from nonfinancial end users. The proposal noted the lesser risk posed by these types of counterparties to covered swap entities and financial stability with respect to exposures below these thresholds. The Agencies received many comments on this aspect of the 2011 proposal. In particular, commenters requested that swap transactions with nonfinancial end users and a number of other counterparties, including sovereigns and multilateral development banks, be explicitly excluded from the margin requirements.

The proposal takes a different approach to nonfinancial end users than the 2011 proposal. Like the 2011 proposal, this proposal follows the statutory framework and proposes a risk-based approach to imposing margin requirements. Unlike the 2011 proposal, this proposal does not require that the covered swap entity determine a specific, numerical threshold for each nonfinancial end user counterparty. Rather, the proposed rule does not require a covered swap entity to collect initial margin and variation margin from nonfinancial end users and certain other counterparties as a matter of course, but instead requires it to collect initial and variation margin at such times and in such forms and amounts (if any) as the covered swap entity determines would appropriately address the credit risk posed by swaps entered into with “other counterparties.”

The Agencies believe that this approach is consistent with current market practice as well as with well-established internal credit processes and standards of swap entities, based on safety and soundness, that require covered swap entities to use an integrated approach in evaluating the risk of their counterparties in extending credit, including in the form of a swap, and manage the overall credit exposure to the counterparty.

In the case of a nonfinancial end user with a strong credit profile, under current market practices, a swap dealer would likely not require margin—in essence, it would extend unsecured credit to the end user with respect to the underlying exposure. For counterparties with a weak credit profile, a swap dealer would likely make a different credit decision and require the counterparty to post margin.

The proposal takes a similar approach to margin requirements for transactions between covered swap entities and sovereign entities; multilateral development banks; the Bank for International Settlements; captive finance companies exempt from clearing pursuant to the Dodd-Frank Act; and Treasury affiliates exempt from clearing pursuant to the Dodd-Frank Act.

The Agencies believe that this approach is consistent with the statute, which requires the margin requirements to be risk-based, and is appropriate in light of the lower risks that these types of counterparties generally pose to the safety and soundness of covered swap entities and U.S. financial stability.

See

7 U.S.C. 2(h)(7)(C)(iii), 7 U.S.C. 2(h)(7)(D) and 15 U.S.C. 78c-3(g)(4).

2. Compliance Dates

Section __.1(d) of the proposal includes a set of compliance dates by which covered swap entities must comply with the minimum margin requirements for non-cleared swaps. The compliance dates of the proposal are consistent with the 2013 international framework. The proposed rule would be effective with respect to any swap to which a covered swap entity becomes a party on or after the relevant compliance date and would continue to apply regardless of future changes in the measured swaps exposure of the covered swap entity and its affiliates or the counterparty and its affiliates.

For variation margin, the compliance date is December 1, 2015 for all covered swap entities with respect to covered swaps with any counterparty. The Agencies believe that the collection of daily variation margin is currently a best practice and, as such, current swaps business operations for covered swap entities of all sizes will be able to achieve compliance with the proposed rule by December 1, 2015. Therefore, there is no phase-in for the variation margin requirements.

As reflected in the table below, for initial margin, the compliance dates range from December 1, 2015 to December 1, 2019 depending on the average daily aggregate notional amount of non-cleared swaps, non-cleared security-based swaps, foreign exchange forwards and foreign exchange swaps (“covered swaps”) of the covered swap entity and its counterparty for June, July and August of that year.

“Foreign exchange forward and foreign exchange swap” is defined to mean any foreign exchange forward, as that term is defined in section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)), and foreign exchange swap, as that term is defined in section 1a(25) of the Commodity Exchange Act (7 U.S.C. 1a(25)).

Compliance Date Schedule for Initial Margin

Compliance date

Initial margin requirements

December 1, 2015

Initial margin where both the covered swap entity combined with its affiliates and the counterparty combined with its affiliates have an average daily aggregate notional amount of covered swaps for June, July and August of 2015 that exceeds $4 trillion.

December 1, 2016

December 1, 2017

December 1, 2018

December 1, 2019

Initial margin for any other covered swap entity with respect to covered swaps with any other counterparty.

The Agencies expect that covered swap entities likely will need to make a number of operational and legal changes to their current swaps business operations in order to achieve compliance with the proposed rule, including potential changes to internal risk management and other systems, trading documentation, collateral arrangements, and operational technology and infrastructure. In addition, the Agencies expect that covered swap entities that wish to calculate initial margin using an initial margin model will need sufficient time to develop such models and obtain regulatory approval for their use. Accordingly, the compliance dates have been structured to ensure that the largest and most sophisticated covered swap entities and counterparties that present the greatest potential risk to the financial system comply with the requirements first. These swap market participants should be able to make the required operational and legal changes more rapidly and easily than smaller entities that engage in swaps less frequently and pose less risk to the financial system.

Section __.1(e) provides that once a covered swap entity and its counterparty must comply with the margin requirements for non-cleared swaps based on the compliance dates in § __.1(d), the covered swap entity and its counterparty shall remain subject to the margin requirements from that point forward. As an example, December 1, 2016 is the relevant compliance date where both the covered swap entity combined with its affiliates and its counterparty combined with its affiliates have an average aggregate daily notional amount of covered swaps that exceeds $3 trillion. If the notional amount of the swap activity for the covered swap entity or the counterparty drops below that threshold amount of covered swaps in subsequent years, their swaps would nonetheless remain subject to the margin requirements. On December 1, 2019, any covered swap entity that did not have an earlier compliance date becomes subject to the margin requirements with respect to non-cleared swaps entered into with any counterparty.

3. Treatment of Swaps Executed Prior to the Applicable Compliance Date under a Netting Agreement

The Agencies note that a covered swap entity may enter into swaps on or after the proposed rule's compliance date pursuant to the same master netting agreement that governs existing swaps entered into with a counterparty prior to the compliance date. As discussed below, the proposed rule permits a covered swap entity to (i) calculate initial margin requirements for swaps under an eligible master netting agreement (“EMNA”) with the counterparty on a portfolio basis in certain circumstances, if it does so using an initial margin model; and (ii) calculate variation margin requirements under the proposed rule on an aggregate, net basis under an EMNA with the counterparty. Applying the proposed rule in such a way would, in some cases, have the effect of applying it retroactively to swaps entered into prior to the compliance date under the EMNA. The Agencies expect that the covered swap entity will comply with the margin requirements with respect to all swaps governed by an EMNA, regardless of the date on which they were entered into, consistent with current industry practice.

A covered swap entity would need to enter into a separate master netting agreement for swaps entered into after the proposed rule's compliance date in order to exclude swaps entered into with a counterparty prior to the compliance date.

See

proposed rule §§ __.4(d) and __.8(b).

4. Non-Cleared Swaps Between Covered Swap Entities and Their Affiliates

The proposed rule prescribes margin requirements on all non-cleared swaps between a covered swap entity and its counterparties. In particular, the proposal generally would cover swaps between banks that are covered swap entities and their affiliates that are financial end users, including affiliates that are subsidiaries of a bank, such as operating subsidiaries, Edge Act subsidiaries, agreement corporation subsidiaries, financial subsidiaries, and lower-tier subsidiaries of such subsidiaries. The Agencies note that other applicable laws require transactions between banks and their affiliates to be on an arm's length basis. In particular, section 23B of the Federal Reserve Act provides that many transactions between a bank and its affiliates must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the bank as those prevailing at the time for comparable transactions with or involving nonaffiliated companies.

The requirements of section 23B generally would mean that a bank engaging in a swap with an affiliate should do so on the same terms (including the posting and collecting of margin) that would prevail in a swap between the bank and a nonaffiliated company. Since the proposed rule will apply to a swap between a bank and a nonaffiliated company, it will also apply to a swap between a bank and an affiliate.

12 U.S.C. 371c-1(a).

While section 23B applies to transactions between a bank and its financial subsidiary, it does not apply to transactions between a bank and other subsidiaries, such as an operating subsidiary, an Edge Act subsidiary, or an agreement corporation subsidiary. The proposed rule does not exempt a bank's swaps with these affiliates and would therefore impose margin requirements on all swaps between a bank and a subsidiary, including a subsidiary that is not covered by section 23B.

B. Section __.2: Definitions

Section __.2 of the 2011 proposal defined its key terms. In particular, the 2011 proposal defined the four types of swap counterparties that formed the basis of the 2011 proposal's risk-based approach to margin requirements. Section ___.2 also provided other key operative terms needed to calculate the amount of initial and variation margin required under other sections of the 2011 proposal.

1. Overview of 2011 Proposal and Comments on Swap Counterparty Definitions

The four types of counterparties defined in the 2011 proposal were (in order of highest to lowest risk): (i) Swap entities; (ii) high-risk financial end users; (iii) low-risk financial end users; and (iv) nonfinancial end users. The 2011 proposal defined “swap entity” as any entity that is required to register as a swap dealer, major swap participant, security-based swap dealer or major security-based swap participant.

See

2011 proposal § __.2(y) (2011).

Section __.2 of the 2011 proposal defined a financial end user largely based on the definition of a “financial entity” that is ineligible for the exemption from the mandatory clearing requirements of sections 723 and 763 of the Dodd-Frank Act, and also included foreign governments.

As noted above, the 2011 proposal also distinguished between margin requirements for high-risk and low-risk financial end users. Section __.2 of the 2011 proposal defined a financial end user counterparty as a low-risk financial end user only if (i) its swaps fall below a specified “significant swaps exposure” threshold; (ii) it predominantly uses swaps to hedge or mitigate the risks of its business activities; and (iii) it is subject to capital requirements established by a prudential regulator or state insurance regulator. The 2011 proposal defined a nonfinancial end user as any counterparty that is an end user but is not a financial end user.

See

7 U.S.C. 2(h)(7); 15 U.S.C. 78c-3(g).

See

2011 proposal § __.2(r) (2011).

The Agencies requested comment on whether the 2011 proposal's categorization of various types of counterparties by risk, and the key definitions used to implement this risk-based approach, were appropriate, or whether alternative approaches or definitions would better reflect the purposes of sections 731 and 764 of the Dodd-Frank Act. As discussed above, many commenters argued that nonfinancial end users should not be subject to the margin requirements and urged that the language and intent of the statute did not require the imposition of margin on nonfinancial end users.

Many commenters also argued that particular types of entities should either be excluded from the term financial end user or be classified as a low-risk financial end user instead of a high-risk financial end user.

In particular, commenters argued that the following entities should be excluded from the definition of financial end user: (i) Foreign sovereigns; (ii) states and municipalities; (iii) multilateral development banks; (iv) captive finance companies; (v) Treasury affiliates; (vi) cooperatives exempt from clearing; (vii) pension plans; (viii) payment card networks; and (ix) special purpose vehicles. A few commenters contended that small financial end users should be treated as nonfinancial end users because these entities use swaps mostly to hedge risk.

As described further below, the proposal does not distinguish between high-risk and low-risk financial end users in this manner.

2. 2014 Proposal for Swap Counterparty Definitions

Section __.2 of the proposal defines key terms used in the proposed rule, including the types of counterparties that form the basis of the proposal's risk-based approach to margin requirements and other key terms needed to calculate the required amount of initial margin and variation margin.

As noted above, this proposal distinguishes among four separate types of counterparties:

(i) Counterparties that are themselves swap entities; (ii) counterparties that are financial end users with a material swaps exposure; (iii) counterparties that are financial end users without a material swaps exposure; and (iv) other counterparties, including nonfinancial end users, sovereigns, and multilateral development banks. Below is a general description of the significant terms defined in § __.2.

Initial margin means the collateral as calculated in accordance with § __.8 that is posted or collected in connection with a non-cleared swap.

See

proposed rule § __.2;

see also

proposed rule § __.4 (describing variation margin requirements).

Counterparty is defined to mean, with respect to any non-cleared swap or non-cleared security-based swap to which a covered swap entity is a party, each other party to such non-cleared swap or non-cleared security-based swap. Non-cleared swap means a swap that is not a cleared swap, as that term is defined in section 1a(7) of the Commodity Exchange Act (7 U.S.C. 1a(7)) and non-cleared security-based swap means a security-based swap that is not, directly or indirectly, submitted to and cleared by a clearing agency registered with the SEC. Clearing agency is defined to have the meaning specified in section 3(a)(2) of the Securities Exchange Act (15 U.S.C. 78c(a)(23)) and derivatives clearing organization is defined to have the meaning specified in section 1a(15) of the Commodity Exchange Act (7 U.S.C. 1a(15)).

See

proposed rule § __.2.

The term “nonfinancial end user” is not used in the proposal. Nonfinancial end users would be treated as “other counterparties” in the proposal.

See

proposed rule § __.3(d) & __.4(c).

a. Swap Entity

Similar to the 2011 proposal, this proposal defines “swap entity” by reference to the Securities Exchange Act and the Commodity Exchange Act to mean a security-based swap dealer, a major security-based swap participant, a swap dealer, or a major swap participant.

b. Financial End User

The proposal's definition of financial end user takes a different approach than the 2011 proposal, which, as noted above, was based on the definition of a “financial entity” that is ineligible for the exemption from mandatory clearing requirements of sections 723 and 763 of the Dodd-Frank Act. In order to provide certainty and clarity to counterparties as to whether they would be financial end users for purposes of this proposal, the financial end user definition provides a list of entities that would be financial end users as well as a list of entities excluded from the definition. This approach would mean that covered swap entities would not need to make a determination regarding whether their counterparties are predominantly engaged in activities that are financial in nature, as defined in section 4(k) of the Bank Holding Company Act of 1956, as amended (the “BHC Act”).

In contrast to the 2011 proposal, the Agencies now are proposing to rely, to the greatest extent possible, on the counterparty's legal status as a regulated financial entity.

The financial entity definition in the 2011 proposal includes a person predominantly engaged in activities that are in the business of banking, or in activities that are financial in nature, as defined in section 4(k) of the BHC Act.

See

7 U.S.C. 2(h)(7); 15 U.S.C. 78c-3(g). The Agencies requested comment on how covered swap entities should make this determination, and whether they should use an approach similar to that developed by the Board for purposes of Title I of the Dodd-Frank Act.

See

68 FR 20756 (April 5, 2013). Section 4(k) of the BHC Act includes conditions that do not define whether an activity is itself financial but were imposed on bank holding companies to ensure that the activity is conducted by bank holding companies in a safe and sound manner or to comply with another provision of law. Staff of the Agencies recognize that by simply choosing not to comply with the conditions imposed on the manner in which those activities must be conducted by bank holding companies, a firm could avoid being considered to be engaged in activities that are financial in nature.

Under the proposal, financial end user includes a counterparty that is not a swap entity but is:

• A bank holding company or an affiliate thereof; a savings and loan holding company; a nonbank financial institution supervised by the Board of Governors of the Federal Reserve System under Title I of the Dodd-Frank

Wall Street Reform and Consumer Protection Act (12 U.S.C. 5323);

• A depository institution; a foreign bank; a Federal credit union, State credit union as defined in section 2 of the Federal Credit Union Act (12 U.S.C. 1752(1) & (6)); an institution that functions solely in a trust or fiduciary capacity as described in section 2(c)(2)(D) of the Bank Holding Company Act (12 U.S.C. 1841(c)(2)(D)); an industrial loan company, an industrial bank, or other similar institution described in section 2(c)(2)(H) of the Bank Holding Company Act (12 U.S.C. 1841(c)(2)(H));

• An entity that is state-licensed or registered as a credit or lending entity, including a finance company; money lender; installment lender; consumer lender or lending company; mortgage lender, broker, or bank; motor vehicle title pledge lender; payday or deferred deposit lender; premium finance company; commercial finance or lending company; or commercial mortgage company; but excluding entities registered or licensed solely on account of financing the entity's direct sales of goods or services to customers;

• A money services business, including a check casher; money transmitter; currency dealer or exchange; or money order or traveler's check issuer;

• A regulated entity as defined in section 1303(20) of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (12 U.S.C. 4502(20)) and any entity for which the Federal Housing Finance Agency or its successor is the primary federal regulator;

• Any institution chartered and regulated by the Farm Credit Administration in accordance with the Farm Credit Act of 1971, as amended, 12 U.S.C. 2001 et seq.;

• A securities holding company; a broker or dealer; an investment adviser as defined in section 202(a) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-2(a)); an investment company registered with the SEC under the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.); or a company that has elected to be regulated as a business development company pursuant to section 54(a) of the Investment Company (15 U.S.C. 80a-53);

• A private fund as defined in section 202(a) of the Investment Advisers Act of 1940 (15 U.S.C. 80-b-2(a)); an entity that would be an investment company under section 3 of the Investment Company Act of 1940 (15 U.S.C. 80a-3) but for section 3(c)(5)(C); or an entity that is deemed not to be an investment company under section 3 of the Investment Company Act of 1940 pursuant to Investment Company Act Rule 3a-7 of the Securities and Exchange Commission (17 CFR 270.3a-7);

• A commodity pool, a commodity pool operator, or a commodity trading advisor as defined in, respectively, sections 1a(10), 1a(11), and 1a(12) of the Commodity Exchange Act (7 U.S.C. 1a(10), 7 U.S.C. 1a(11), 7 U.S.C. 1a(12)); or a futures commission merchant;

• An employee benefit plan as defined in paragraphs (3) and (32) of section 3 of the Employee Retirement Income and Security Act of 1974 (29 U.S.C. 1002);

• An entity that is organized as an insurance company, primarily engaged in writing insurance or reinsuring risks underwritten by insurance companies, or is subject to supervision as such by a State insurance regulator or foreign insurance regulator;

• An entity that is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in loans, securities, swaps, funds or other assets for resale or other disposition or otherwise trading in loans, securities, swaps, funds or other assets;

• An entity that would be a financial end user as described above or a swap entity, if it were organized under the laws of the United States or any State thereof; or

• Notwithstanding the specified exclusions described below, any other entity that [Agency] has determined should be treated as a financial end user.

In developing this definition of financial end user, the Agencies sought to provide certainty and clarity to covered swap entities and their counterparties regarding whether particular counterparties would qualify as financial end users and be subject to the margin requirements of the proposed rule. The Agencies tried to strike a balance between the desire to capture all financial counterparties, without being overly broad and capturing commercial firms and sovereigns. Financial firms present a higher level of risk than other types of counterparties because the profitability and viability of financial firms is more tightly linked to the health of the financial system than other types of counterparties. Because financial counterparties are more likely to default during a period of financial stress, they pose greater systemic risk and risk to the safety and soundness of the covered swap entity. In case the list of financial end users in the proposal does not capture a particular entity, the last part of this definition would allow an Agency to require a covered swap entity to treat a counterparty as a financial end user for margin purposes, where appropriate for safety and soundness purposes or to address systemic risk.

In developing the list of financial entities, the Agencies sought to include entities subject to Federal statutes that impose registration or chartering requirements on entities that engage in specified financial activities, such as deposit taking and lending, securities and swaps dealing, or investment advisory activities; as well as asset management and securitization entities. For example, certain securities investment funds as well as securitization vehicles are covered, to the extent those entities would qualify as private funds defined in section 202(a) of the Investment Advisers Act of 1940, as amended (the “Advisers Act”). In addition, certain real estate investment companies would be included as financial end users as entities that would be investment companies under section 3 of the Investment Company Act of 1940, as amended (the “Investment Company Act”), but for section 3(c)(5)(C), and certain other securitization vehicles would be included as entities deemed not to be investment companies pursuant to Rule 3a-7 of the Investment Company Act.

Because Federal law largely looks to the States for the regulation of the business of insurance, the proposed definition broadly includes entities organized as insurance companies or supervised as such by a State insurance regulator. This element of the proposed definition would extend to reinsurance and monoline insurance firms, as well as insurance firms supervised by a foreign insurance regulator.

The Agencies are also proposing to cover, as financial end users, the broad variety and number of nonbank lending and retail payment firms that operate in the market. To this end, the Agencies are proposing to include State-licensed or registered credit or lending entities and money services businesses, under proposed regulatory language incorporating an inclusive list of the types of firms subject to State law.

However, the Agencies recognize that the licensing of nonbank lenders in some states extends to commercial firms

that provide credit to the firm's customers in the ordinary course of business. Accordingly, the Agencies are proposing to exclude an entity registered or licensed solely on account of financing the entity's direct sales of goods or services to customers. The Agencies request comment on whether this aspect of the proposed rule adequately maintains a distinction between financial end users and commercial end users.

The Agencies expect that state-chartered financial cooperatives that provide financial services to their members, such as lending to their members and entering into swaps in connection with those loans, would be treated as financial end users, pursuant to this aspect of the proposed rule's coverage of credit or lending entities.

Under the proposed rule, those cooperatives that are financial institutions, such as credit unions, FCS banks and associations, and other financial cooperatives

are financial end users because their sole business is lending and providing other financial services to their members, including engaging in swaps in connection with such loans.

Cooperatives that are financial end users may qualify for an exemption from clearing,

and therefore, they may enter into non-cleared swaps with covered swap entities that are subject to the proposed rule.

The National Rural Utility Cooperative Finance Cooperation is an example of another financial cooperative.

Most cooperatives are producer, consumer, or supply cooperatives and, therefore, they are not financial end users. However, many of these cooperatives have financing subsidiaries and affiliates. These financing subsidiaries and affiliates would not be financial end users under this proposal if they qualify for an exemption under sections 2(h)(7)(C)(iii) or 2(h)(7)(D) of the Commodity Exchange Act or section 3C(g)(4) of the Securities Exchange Act of 1934.

Section 2(h)(7)(c)(ii) of the Commodity Exchange Act and section 3C(g)(4) of the Securities Exchange Act of 1934 authorize the CFTC and the SEC, respectively, to exempt small depository institutions, small Farm Credit System institutions, and small credit unions with total assets of $10 billion or less from the mandatory clearing requirements for swaps and security-based swaps.

See

7 U.S.C. 2(h)(7) and 15 U.S.C. 78c-3(g). Additionally, the CFTC, pursuant to its authority under section 2(h)(1)(A) of the Commodity Exchange Act, enacted 17 CFR part 50, subpart C, section 50.51, which allows cooperative financial entities, including those with total assets in excess of $10 billion, to elect an exemption from mandatory clearing of swaps that: (1) They enter into in connection with originating loans for their members; or (2) hedge or mitigate commercial risk related to loans or swaps with their members.

The Agencies remain concerned, however, that now or in the future, one or more types of financial entities might escape classification under the specific Federal or State regulatory regimes included in the proposed definition of a financial end user. The Agencies have accordingly included two additional prongs in the definition. First, the Agencies have included language that would cover an entity that is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in loans, securities, swaps, funds or other assets for resale or other disposition or otherwise trading in loans, securities, swaps, funds or other assets. The Agencies request comment on the extent to which there are (or may be in the future) pooled investment vehicles that are not captured by the other prongs of the definition (such as the provisions covering private funds under the Advisers Act or commodity pools under the Commodity Exchange Act). The Agencies also request comment on whether this aspect of the definition of financial end user provides sufficiently clear guidance to covered swap entities and market participants as to its intended scope, and whether it adequately maintains a distinction between financial end users and commercial end users.

Second, as previously explained, the proposed rule would allow an Agency to require a covered swap entity to treat an entity as a financial end user for margin purposes, as appropriate for safety and soundness purposes, or to mitigate systemic risks. In such case, consistent with the Agency's supervisory procedures, the Agency that is the covered swap entity's prudential regulator would notify the covered swap entity in writing of the regulator's intention to require treatment of the counterparty as a financial end user, and the date by which such treatment is to be implemented.

The Agencies' procedures would generally provide an adequate opportunity for the covered swap entity to raise objections to the Agency's proposed action and for the Agency to respond.

To address the classification of foreign entities as financial end users, the Agencies are proposing to require the covered swap entity to determine whether a foreign counterparty would fall within another prong of the financial end user definition if the foreign entity was organized under the laws of the United States or any State. The Agencies recognize that this approach would impose upon covered swap entities the difficulties associated with analyzing a foreign counterparty's business activities in light of a broad array of U.S. regulatory requirements. The alternative, however, would require covered swap entities to gather a foreign counterparty's financial reporting data and determine the relative amount of enumerated financial activities in which the counterparty is engaged over a rolling period.

The Agencies request comment on whether some other method or approach would adequately assure that the rule's objectives with respect to covered swap entity safety and soundness and reductions of systemic risk can be achieved, in a fashion that can be more readily operationalized by covered swap entities.

See, e.g.,

68 FR 20756 (April 5, 2013).

Unlike the 2011 proposal, the proposal excludes certain types of counterparties from the definition of financial end user. In particular, the proposal states that the term “financial end user” does not generally include any counterparty that is:

• A sovereign entity;

Sovereign entity is defined to mean a central government (including the U.S. government) or an agency, department, or central bank of a central government.

See

proposed rule § _.2. A sovereign entity would include the European Central Bank for purposes of this exclusion.

• A multilateral development bank;

Multilateral development bank is defined to mean the International Bank for Reconstruction and Development, the Multilateral Investment Guarantee Agency, the International Finance Corporation, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the European Bank for Reconstruction and Development, the European Investment Bank, the European Investment Fund, the Nordic Investment Bank, the Caribbean Development Bank, the Islamic Development Bank, the Council of Europe Development Bank, and any other entity that provides financing for national or regional development in which the U.S. government is a shareholder or contributing member or which the [AGENCY] determines poses comparable credit risk.

See

proposed rule § _.2.

• The Bank for International Settlements;

• A captive finance company that qualifies for the exemption from clearing under section 2(h)(7)(C)(iii) of the Commodity Exchange Act and implementing regulations; or

• A person that qualifies for the affiliate exemption from clearing pursuant to section 2(h)(7)(D) of the Commodity Exchange Act or section 3C(g)(4) of the Securities Exchange Act and implementing regulations.

The Agencies note the exclusion for sovereign entities, multilateral development banks and the Bank for International Settlements is generally consistent with the 2013 international framework which recommended that margin requirements not apply to sovereigns, central banks, multilateral development banks or the Bank for International Settlements. The last two categories that are excluded from the financial end user definition were excluded by Title VII of the Dodd-Frank Act from the definition of financial entity subject to mandatory clearing. The Agencies also believe that this approach is appropriate as these entities generally pose less systemic risk to the financial system in addition to posing less counterparty risk to a swap entity. Thus, the Agencies believe that application of the margin requirements

to swaps with these counterparties is not necessary to achieve the objectives of this rule.

The Agencies note that States would not be excluded from the definition of financial end user, as the term “sovereign entity” includes only central governments. The categorization of a State or particular part of a State as a financial end user depends on whether that part of the State is otherwise captured by the definition of financial end user. For example, a State entity that is a “governmental plan” under the Employment Retirement Income Security Act of 1974, as amended, would meet the definition of financial end user.

The Agencies believe that the proposal addresses many of the commenters' concerns about the definition of “financial end user” contained in the 2011 proposal. Entities that are neither financial end users nor swap entities are treated as “other counterparties” in this proposal.

The Agencies seek comment on all aspects of the financial end user definition including whether the definition has succeeded in capturing all entities that should be treated as financial end users. The Agencies request comment on whether there are additional entities that should be included as financial end users and, if so, how those entities should be defined. Further, the Agencies also request comment on whether there are additional entities that should be excluded from the definition of financial end user and why those particular entities should be excluded. The Agencies also request comment on whether another approach to defining financial end user (

e.g.,

basing the financial end user definition on the financial entity definition as in the 2011 proposal) would provide more appropriate coverage and clarity, and whether covered swap entities could operationalize such an approach as part of their regular procedures for taking on new counterparties.

As is further discussed below, these entities excluded from the definition of “financial end users,” as well as nonfinancial counterparties, are treated as “other counterparties” with respect to the proposed variation margin requirements. With respect to the proposed initial margin requirements, the “other counterparties” category also includes financial end users that do not have a material swaps exposure.

c. Material Swaps Exposure

The proposal differs from the 2011 proposal by distinguishing between swaps with financial end user counterparties that have a material swaps exposure and swaps with financial end user counterparties that do not have a material swaps exposure. “Material swaps exposure” for an entity is defined to mean that the entity and its affiliates have an average daily aggregate notional amount of non-cleared swaps, non-cleared security-based swaps, foreign exchange forwards and foreign exchange swaps with all counterparties for June, July and August of the previous year that exceeds $3 billion, where such amount is calculated only for business days. The Agencies believe that using the average daily aggregate notional amount during June, July, and August of the previous year, instead of a single as-of date, is appropriate to gather a more comprehensive assessment of the financial end user's participation in the swaps market, and address the possibility that a market participant might “window dress” its exposure on an as-of date such as year-end, in order to avoid the Agencies' margin requirements. Material swaps exposure would be calculated based on the previous year. For example, on January 1, 2015, an entity would determine whether it had a material swaps exposure in June, July and August of 2014 that exceeded $3 billion.

As a specific example of the calculation for material swaps exposure, consider a financial end user (together with its affiliates) with a portfolio consisting of two non-cleared swaps (e.g., an equity swap, an interest rate swap) and one non-cleared security-based credit swap. Suppose that the notional value of each swap is exactly $10 billion on each business day of June, July, and August of 2015. Furthermore, suppose that a foreign exchange forward is added to the entity's portfolio at the end of the day on July 31, 2015, and that its notional value is $10 billion on every business day of August 2015. On each business day of June and July 2015, the aggregate notional amount of non-cleared swaps, security-based swaps and foreign exchange forwards and swaps is $30 billion. Beginning on August 1, 2015 the aggregate notional amount of non-cleared swaps, security-based swaps and foreign exchange forwards and swaps is $40 billion. The daily average aggregate notional value for June, July and August of 2015 is then (22 × $30 billion +23 × $30 billion + 21 × $40 billion)/(22 + 23 + 21) = $33.18 billion, in which case this entity would be considered to have a material swaps exposure for every date in 2016.

d. Other Definitions

The proposal also defines a number of other terms that were not defined in the 2011 proposal. The Agencies believe that these definitions will help provide additional clarity regarding the application of the margin requirements contained in the proposed rule.

i. Affiliate

The proposal defines “affiliate” to mean any company that controls, is controlled by, or is under common control with another company. This definition of affiliate is the same as that in the BHC Act and consequently should be familiar to market participants.

The proposal also defines subsidiary to mean a company that is controlled by another company, which is similar to the definition in the BHC Act and the Board's Regulation Y.

See

section 2(k) of the Bank Holding Company Act, 12 U.S.C. 1841(k).

See

section 2(d) of the Bank Holding Company Act, 12 U.S.C. 1841(d); 12 CFR 225.2(o).

The term affiliate is used in the definition of initial margin threshold amount which means a credit exposure of $65 million that is applicable to non-cleared swaps between a covered swap entity and its affiliates with a counterparty and its affiliates. The inclusion of affiliates in this definition is meant to make clear that the initial margin threshold amount applies to an entity and its affiliates. Similarly, the term “affiliate” is also used in the definition of “material swaps exposure,” as material swaps exposure takes into account the exposures of an entity and its affiliates.

ii. Control

The definitions of “affiliate” and “subsidiary” use the term “control,” which is also a defined term in the proposal.

The proposal provides that control of another company means: (i) Ownership, control, or power to vote 25 percent or more of a class of voting securities of the company, directly or indirectly or acting through one or more other persons; (ii) ownership or control of 25 percent or more of the total equity of the company, directly or indirectly or acting through one or more other persons; or (iii) control in any manner of the election of a majority of the directors or trustees of the company. This definition of control is similar to the definition under the BHC Act and consequently should be familiar to many market participants.

The term subsidiary is used in § __.9 to describe certain entities that are eligible for substituted compliance.

See, e.g.,

section 2(a)(2) of the Bank Holding Company Act, 12 U.S.C. 1841(a)(2).

The Agencies seek comment on the definition of control in this proposal. In particular, the Agencies request comment on this definition of control as it relates to advised and sponsored funds and sponsored securitization vehicles. The Agencies believe that advised and sponsored funds and sponsored securitization vehicles would not be affiliates of the investment adviser or sponsor unless the adviser or sponsor meets the definition of control (

e.g.,

owning 25 percent or more of the voting securities or total equity or controlling the election of the majority

of the directors or trustees). The 2013 international framework states that investment funds that are managed by an investment adviser are considered distinct entities that are treated separately when applying the threshold as long as the funds are distinct legal entities that are not collateralized by or otherwise guaranteed or supported by other investment funds or the investment adviser in the event of fund insolvency or bankruptcy. The intent of the Agencies is to follow the approach of the 2013 international framework for investment funds and securitization vehicles, including with respect to guarantees and other collateral support arrangements. The Agencies request comment on whether the proposal's definition of control would allow investment funds and securitization vehicles to be treated separately in the manner described in the 2013 international framework.

iii. Cross-Currency Swap

The proposal defines a cross-currency swap as a swap in which one party exchanges with another party principal and interest rate payments in one currency for principal and interest rate payments in another currency, and the exchange of principal occurs upon the inception of the swap, with a reversal of the exchange at a later date that is agreed upon at the inception of the swap. As explained in greater detail below, the proposal provides that the proposed initial margin requirements for cross-currency swaps do not apply to the portion of the swap that is the fixed exchange of principal. This treatment of cross-currency swaps is consistent with the treatment recommended in the 2013 international framework. This treatment of cross-currency swaps also aligns with the determination by the Secretary of the Treasury to exempt foreign exchange swaps from the definition of swap as explained further below. Non-deliverable forwards would not be treated as cross-currency swaps for purposes of the proposal, and thus would be subject to the margin requirements set forth under the proposed rule.

iv. Major Currencies

Major currencies is defined to mean: (i) United States Dollar (USD); (ii) Canadian Dollar (CAD); (iii) Euro (EUR); (iv) United Kingdom Pound (GBP); (v) Japanese Yen (JPY); (vi) Swiss Franc (CHF); (vii) New Zealand Dollar (NZD); (viii) Australian Dollar (AUD); (ix) Swedish Kronor (SEK); (x) Danish Kroner (DKK); (xi) Norwegian Krone (NOK); and (xii) any other currency as determined by the relevant Agency.

Major currencies are eligible collateral for initial margin as described further in § __.6.

See

the CFTC's regulation of Off-Exchange Retail Foreign Exchange Transactions and Intermediaries for this list of major currencies, 75 FR 55410 at 55412 (September 10, 2010).

v. Prudential Regulator

The proposal defines prudential regulator to have the meaning specified in section 1a(39) of the Commodity Exchange Act.

See

7 U.S.C. 1a(39).

vi. Eligible Master Netting Agreement

Qualifying master netting agreement (“QMNA”) was defined in the 2011 proposal, based on the definition of the term in the Federal banking agencies' risk-based capital rules applicable to derivatives positions held by insured depository institutions and bank holding companies.

A few commenters expressed concern with the 2011 proposal's definition of QMNA. These commenters argued that a requirement providing that any exercise of rights under the agreement will not be stayed or avoided under applicable law and would not allow for rights to be stayed as required under certain bankruptcy, receivership or liquidation regimes.

See

76 FR 27564 at 27576 (May 11, 2011).

Since the 2011 proposal, the Federal banking agencies have modified the definition of QMNA used in their risk-based capital rules.

The proposal contains a revised definition based on the new QMNA definition in the risk-based capital rules. However, the proposal uses the term “eligible master netting agreement” (“EMNA”) to avoid confusion with and distinguish from the term used under the capital rules. The Agencies believe that the modifications to the definition address the concerns raised by commenters.

See

12 CFR part 3.2, 12 CFR part 217.2, and 12 CFR part 324.2.

The proposal defines EMNA as any written, legally enforceable netting agreement that creates a single legal obligation for all individual transactions covered by the agreement upon an event of default (including receivership, insolvency, liquidation, or similar proceeding) provided that certain conditions are met. These conditions include requirements with respect to the covered swap entity's right to terminate the contract and liquidate collateral and certain standards with respect to legal review of the agreement to ensure it meets the criteria in the definition. The legal review must be sufficient so that the covered swap entity may conclude with a well-founded basis that, among other things, the contract would be found legal, binding, and enforceable under the law of the relevant jurisdiction and that the contract meets the other requirements of the definition.

The Agencies believe that the revised EMNA definition addresses commenters' concerns regarding certain insolvency regimes where rights can be stayed. In particular, the second criteria has been modified to provide that any exercise of rights under the agreement will not be stayed or avoided under applicable law in the relevant jurisdictions, other than (i) in receivership, conservatorship, or resolution by an Agency exercising its statutory authority, or similar laws in foreign jurisdictions that provide for limited stays to facilitate the orderly resolution of financial institutions, or (ii) in a contractual agreement subject by its terms to any of the foregoing laws.

See

proposed rule § __.2.

The Agencies request comment on whether the proposed definition of EMNA provides sufficient clarity regarding the laws of foreign jurisdictions that provide for limited stays to facilitate the orderly resolution of financial institutions or whether additional specificity should be provided regarding additional factors required in order for a foreign law to qualify under the EMNA definition. For example, should the definition include a limitation of the duration of the limited stay? If so, what should such limitation be (

e.g.,

one or two-business days)? The Agencies also seek comment regarding whether the provision for a contractual agreement made subject by its terms to limited stays under resolution regimes adequately encompasses potential contractual agreements of this nature or whether this provision needs to be broadened, limited, clarified or modified in some manner.

vii. State

State is defined in the proposal to mean any State, commonwealth, territory, or possession of the United States, the District of Columbia, the Commonwealth of Puerto Rico, the Commonwealth of the Northern Mariana

Islands, American Samoa, Guam, or the United States Virgin Islands. The purpose of this definition is to make clear these regions would be included as States for purposes of § __.9 that addresses the cross-border application of margin requirements.

viii. U.S. Government-Sponsored Enterprises

The 2011 proposal did not specifically define U.S. Government-sponsored enterprises, although it allowed the securities of these entities to be pledged as eligible collateral. Under the 2014 proposal, U.S. Government-sponsored enterprise means an entity established or chartered by the U.S. government to serve public purposes specified by Federal statute, but whose debt obligations are not explicitly guaranteed by the full faith and credit of the United States. U.S. Government-sponsored enterprises currently include Farm Credit System banks, associations, and service corporations, Farmer Mac, the Federal Home Loan Banks, Fannie Mae, Freddie Mac, the Financing Corporation, and the Resolution Funding Corporation. In the future, Congress may create new U.S Government-sponsored enterprises, or terminate the status of existing U.S. Government-sponsored entities. This term is used in the definition of eligible collateral as described further in § __.6.

ix. Entity Definitions

The Agencies are including a number of other definitions including “bank holding company,” “broker,” “dealer,” “depository institution,” “foreign bank,” “futures commission merchant,” “savings and loan holding company,” and “securities holding company” that are defined by cross-reference to the relevant statute. Many of these terms are also used in the definition of “financial end user” or “market intermediary,” which is defined to mean a securities holding company, a broker, a dealer, a futures commission merchant, a swap dealer, or a security-based swap dealer.

C. Section __.3: Initial Margin

1. Overview of 2011 Proposal and Public Comments

Section __.3 of the 2011 proposal set out the initial margin amounts for a covered swap entity to collect from its counterparty for its non-cleared swaps. The 2011 proposal specified, among other things, the manner in which a covered swap entity must calculate the initial margin requirements applicable to its non-cleared swaps. These initial margin requirements applied only to the amount of initial margin that a covered swap entity would be required to

collect

from its counterparties. In general, these requirements did not address whether, or in what amounts, a covered swap entity must

post

initial margin to a counterparty.

As previously discussed, § __.11 of the FHFA and FCA versions of the 2011 proposal required all institutions supervised by FHFA and the FCA to collect initial and variation margin from their swap entity counterparties.

The 2011 proposal requested comment on whether the rule should incorporate two-way margining. A number of commenters stated that the Agencies should require covered swap entities to post margin. Commenters raised a number of concerns regarding the lack of any requirement for covered swap entities to post both initial margin and variation margin to their counterparties. For example, one commenter argued that covered swap entities that do not post collateral present a risk to the system in the event that such covered swap entities experience financial distress. Commenters also said that by requiring two-way margining, overall leverage exposure would be reduced to an appropriate level.

Under the 2011 proposal, a covered swap entity would have been permitted to select from two alternatives to calculate its initial margin requirements. A covered swap entity could calculate its initial margin requirements using a standardized “look-up” table that specified the minimum initial margin that was required to be collected. Alternatively, a covered swap entity could calculate its minimum initial margin requirements using an internal margin model that met certain criteria and that had been approved by the relevant prudential regulator.

In the 2011 proposal, the Agencies proposed initial margin threshold amounts, which varied based on the relative risk posed by the counterparty; high-risk financial end users were subject to lower threshold amounts than low-risk financial end users; and nonfinancial end users were subject to thresholds that were set according to the covered swap entity's internal credit policies. Commenters expressed varying views on the proposed thresholds. For example, one commenter stated that establishing thresholds by counterparty type was too broad and did not appropriately reflect risk. Another commenter suggested that low-risk financial end users should not be subject to a threshold, while a third commenter stated that dollar threshold amounts were arbitrary and should be eliminated altogether.

Under the 2011 proposal, a covered swap entity was required to collect initial margin on or before the date it entered into a swap. Some commenters indicated that this requirement was operationally infeasible due to timing cutoffs and time differences between time zones, and for this reason, commenters requested that the Agencies permit covered swap entities to collect initial margin one to three days after entering into the transaction.

2. 2014 Proposal

a. Collecting and Posting Initial Margin

Consistent with the 2013 international framework and comments received relating to the 2011 proposal, the Agencies are proposing that swap entities that are transacting in non-cleared swaps with one another or with financial end users with material swaps exposure collect

and

post initial margin with respect to those non-cleared swaps. Assuming all swap entities will be subject to an Agency, CFTC, or SEC margin rule that requires collection of initial margin, the proposed rule will result in a collect-and-post system for all non-cleared swaps between swap entities. Under this proposal, a covered swap entity transacting with a financial end user with material swaps exposure must (i) calculate its initial margin collection amount using an approved internal model or the standardized look-up table, (ii) collect an amount of initial margin that is at least as large as the initial margin collection amount less any permitted initial margin threshold amount (which is discussed in more detail below), and (iii) post at least as much initial margin to the financial end user with material swaps exposure as the covered swap entity would be required to collect if it were in the place of the financial end user with material swaps exposure.

b. Calculation Alternatives

Similar to the 2011 proposal, the proposed rule permits a covered swap entity to select from two methods (the standardized look-up table or the internal margin model) for calculating its initial margin requirements. In all cases, the initial margin amount required under the proposed rule is a minimum requirement; covered swap entities are not precluded from collecting additional initial margin (whether by contract or subsequent agreement with the counterparty) in such forms and amounts as the covered swap entity believes is appropriate. These methods are discussed further below under Appendix A and § __.8,

respectively. Section __.8 also addresses the use of EMNAs for initial margin.

c. Initial Margin Thresholds

As part of the proposed rule's initial margin requirements and consistent with the 2013 international framework, a covered swap entity using either calculation method may adopt an initial margin threshold amount of up to $65 million, below which the covered swap entity need not collect or post initial margin from and to a swap entity or financial end user with a material swaps exposure.

This feature of the proposed threshold serves two purposes. First, covered swap entities would be able to make greater use of their own internal credit assessments when making a threshold determination as to the credit and other risks presented by a specific counterparty. Covered swap entities dealing with counterparties that are judged to be of high credit quality may determine a counterparty-specific threshold (of up to $65 million) so credit extensions made by covered swap entities can be more flexible and better informed by granular, internal credit determinations. Second, allowing the use of initial margin thresholds, to the extent prudently applied by covered swap entities, may reduce the potential liquidity burden of the proposed margin requirements. A number of commenters on the 2011 proposal indicated that the liquidity costs of the proposed requirements were inappropriately high. Unlike the 2011 proposal, the current proposal requires both collection and posting of initial margin. Moreover, the Agencies anticipate that allowing for the use of initial margin thresholds of up to $65 million will provide relief to smaller and less systemically risky counterparties while ensuring that initial margin is collected from those counterparties that pose the greatest systemic risk to the financial system.

This credit exposure limit is defined in the proposed rule as the initial margin threshold amount.

See

proposed rule §§ __.2, __.3(a). A covered swap entity that has established an initial margin threshold amount for a counterparty need only collect initial margin if the required amount exceeds the initial margin threshold amount, and in such cases is only required to collect the excess amount.

The proposed initial margin threshold of $65 million would be applied on a consolidated entity level, and therefore, would apply across all non-cleared swaps between a covered swap entity and its affiliates and the counterparty and its affiliates. For example, suppose that a firm engages in separate swap transactions, executed under separate legally enforceable EMNAs, with three counterparties, all belonging to the same larger consolidated group, such as a bank holding company. Suppose further that the initial margin requirement is $100 million for each of the firm's netting sets with each of the three counterparties. The firm dealing with these three affiliates must collect at least $235 million (235 = $100 + $100 + $100 − $65) from the consolidated group. Exactly how the firm allocates the $65 million threshold among the three netting sets is subject to agreement between the firm and its counterparties. The firm may not extend the $65 million threshold to each netting set so that the total amount of initial margin collected is only $105 million (105 = 100 − 65 + 100 − 65 + 100 − 65). The requirement to apply the threshold on a fully consolidated basis applies to both the counterparty to which the threshold is being extended and the counterparty that is extending the threshold.

Applying this threshold on a consolidated entity level precludes the possibility that covered swap entities and their counterparties would create legal entities and netting sets that have no economic basis and are constructed solely for the purpose of applying additional thresholds to evade margin requirements.

Suppose that in the example set out above, the firm is organized into three subsidiaries (A, B, and C) and each of these subsidiaries engages in non-centrally cleared swaps with the counterparties. In this case, the extension of the $65 million threshold by the firm to the counterparties is considered across the entirety of the firm, including the affiliates A, B and C, so that all affiliates of the firm extend in the aggregate no more than $65 million in an initial margin threshold to all of the counterparties.

The Agencies' preliminary view is that the proposed initial margin threshold of $65 million is appropriate and reflects a risk-based approach to the margin requirements. However, the Agencies seek comment on the use of such a threshold in the margin requirements and the proposed size of $65 million. Importantly, the Agencies recognize that allowing for a significant initial margin threshold subjects covered swap entities and their counterparties to credit risk that may materialize quickly in the event of a significant period of financial stress. Is the proposed use of an initial margin threshold appropriate in light of the risks associated with its use? Does the proposed level of the threshold appropriately balance the need to limit the liquidity impact of the requirements with the need to limit credit exposures in non-cleared swaps markets? Are there other approaches that could be taken in this regard that would be more effective than the proposed initial margin threshold approach?

d. Material Swaps Exposure

Under the proposed rule and consistent with the 2013 international framework, covered swap entities are required to collect and post initial margin only with financial end user counterparties that have a material swaps exposure. The Agencies do not propose to require the exchange of initial margin with financial end users with small exposures, as it is assumed that these entities, in most circumstances, would have an initial margin requirement that is significantly less than the proposed $65 million threshold amount.

Requiring covered swap entities to subject financial end users with exposures that would generally result in initial margin requirements substantially below $65 million could create significant operational burdens, as the initial margin collection amounts would need to be calculated on a daily basis even though no initial margin would be expected to be collected given that these amounts would be below the permitted initial margin threshold of $65 million.

To be consistent, both “initial margin threshold” and “material swaps exposure” are defined to include the counterparty and its affiliates.

Under the proposed rule and consistent with the 2013 international framework, the Agencies have adopted a simple and transparent approach to defining material swaps exposure that depends on a counterparty's gross notional derivative exposure for non-cleared swaps. The Agencies' preliminary view is that this approach is appropriate as gross notional derivative exposure is broadly related to a counterparty's overall size and risk exposure and provides for a simple and transparent measurement of exposure that presents only a modest operational burden. Under the proposed rule, a covered swap entity would not be required to collect or post initial margin to or from a financial end user counterparty without a material swaps exposure, that is, if its average daily aggregate notional amount of covered swaps over a defined period exceeds $3 billion.

This amount differs from that set forth in the 2013 international framework, which defines smaller financial end users as those counterparties that have a gross aggregate amount of covered swaps below €8 billion, which, at current exchange rates, is approximately equal to $11 billion.

The definition of “material swaps exposure” can be found in § __.2 of the proposed rule.

The Agencies' preliminary view is that defining material swaps exposure

as a gross notional exposure of $3 billion, rather than $11 billion, is appropriate because it reduces systemic risk without imposing undue burdens on covered swap entities, and therefore, is consistent with the objectives of the Dodd-Frank Act. This view is based on data and analyses that have been conducted since the publication of the 2013 international framework.

Specifically, the Agencies have reviewed actual initial margin requirements for a sample of cleared swaps. These analyses indicate that there are a significant number of cases in which a financial end user counterparty would have a material swaps exposure level below $11 billion but would have a swap portfolio with an initial margin collection amount that significantly exceeds the proposed permitted initial margin threshold amount of $65 million. The intent of both the Agencies and the 2013 international framework is that the initial margin threshold provide smaller counterparties with relief from the operational burden of measuring and tracking initial margin collection amounts that are expected to be below $65 million. Setting the material swaps exposure threshold at $11 billion appears to be inconsistent with this intent, based on the recent analyses.

The table below summarizes actual initial margin requirements for 4,686 counterparties engaged in cleared interest rate swaps. Each counterparty represents a particular portfolio of cleared interest rate swaps. Each counterparty had a swap portfolio with a total gross notional amount less than $11 billion and each is a customer of a CCP's clearing member (

no customer

is itself a CCP clearing member). Column (1) displays the initial margin amount as a percentage of the gross notional amount. Column (2) reports the initial margin, in millions of dollars that would be required on a portfolio with a gross notional amount of $11 billion.

Initial Margin Amounts on 4,686 Cleared Interest Rate Swap Portfolios

Column (1)

Initial margin amount as percentage of gross notional amount

(%)

Column (2)

Initial margin amount on an $11 billion gross notional

portfolio ($MM)

Average

2.1

231

25th Percentile

0.6

50th Percentile

1.4

154

75th Percentile

2.7

297

As shown in the table above, the average initial margin rate across all 4,686 counterparties, reported in Column (1), is 2.1 percent, which would equate to an initial margin collection amount, reported in Column (2), of $231 million on an interest rate swap portfolio with a gross notional amount of $11 billion. This average initial margin collection amount significantly exceeds the proposed permitted threshold amount of $65 million. Seventy-five percent of the 4,686 cleared interest rate swap portfolios exhibit an initial margin rate in excess of 0.6 percent, which equates to an initial margin amount on a cleared interest rate swap portfolio of $66 million (approximately equal to the proposed permitted threshold amount).

The data above represent actual margin requirements on a sample of interest rate swap portfolios that are cleared by a single CCP. Some CCPs also provide information on the initial margin requirements on specific and representative swaps that they clear. The Chicago Mercantile Exchange (“CME”), for example, provides information on the initial margin requirements for cleared interest rate swaps and credit default swaps that it clears. This information does not represent actual margin requirements on actual swap portfolios that are cleared by the CME but does represent the initial margin that would be required on specific swaps if they were cleared at the CME. The table below presents the initial margin requirements for two swaps that are cleared by the CME.

Initial Margin Amounts on CME Cleared Interest Rate and Credit Default Swaps

Column (1)

Initial margin amount as percentage of gross notional amount

(%)

Column (2)

Initial margin amount on an $11 billion gross notional

portfolio

($MM)

5 year, receive fixed and pay floating rate interest rate swap

2.0

216

5 year, sold CDS protection on the CDX IG Series 20 Version 22 Index

1.9

213

According to the CME, the initial margin requirement on the interest rate swap and the credit default swap are both roughly two percent of the gross notional amount. This initial margin rate translates to an initial margin amount of roughly $216 million on a swap portfolio with a gross notional amount of $11 billion. Accordingly, this data also indicates that the initial margin collection amount on a swap portfolio with a gross notional size of $11 billion could be significantly larger than the proposed permitted initial margin threshold of $65 million.

In addition to the information provided in the tables above, the Agencies' preliminary view is that additional considerations suggest that the initial margin collection amounts associated with non-cleared swaps could be even greater than those reported in the tables above. The tables above represent initial margin requirements on cleared interest rate and credit default index swaps. Non-cleared swaps in other asset classes, such as single name equity or single name credit default swaps, are likely to be riskier and hence would require even more initial margin. In addition, non-cleared swaps often contain complex features, such as nonlinearities, that

make them even riskier and would hence require more initial margin. Finally, non-cleared swaps are generally expected to be less liquid than cleared swaps and must be margined, under the proposed rule, according to a ten-day close-out period rather than the five-day period required for cleared swaps. The data presented above pertains to cleared swaps that are margined according to a five-day and not a ten-day close-out period. The requirement to use a ten-day close-out period would further increase the initial margin requirements of non-cleared versus cleared swaps.

In light of the data and considerations noted above, the Agencies' preliminary view is that it is appropriate and consistent with the intent of the 2013 international framework to identify a material swaps exposure with a gross notional amount of $3 billion rather than $11 billion (€8 billion) as is suggested by the 2013 international framework. Identifying a material swaps exposure with a gross notional amount of $3 billion is more likely to result in an outcome in which entities with a gross notional exposure below the material swaps exposure amount would be likely to have an initial margin collection amount below the proposed permitted initial margin threshold of $65 million. The Agencies do recognize, however, that even at the lower amount of $3 billion, there are likely to be some cases in which the initial margin collection amount of a portfolio that is below the material swaps exposure amount will exceed the proposed permitted initial margin threshold amount of $65 million. The Agencies' preliminary view is that such instances should be relatively rare and that the operational benefits of using a simple and transparent gross notional measure to define the material swaps exposure amount are substantial.

The Agencies seek comment on the use and definition of material swaps exposure. In particular, is the proposed $3 billion level of the material swaps exposure appropriate? Should the amount be higher or lower and if so, why? Are there alternative measurement methodologies that do not rely on gross notional amounts that should be used? Does the proposed rule's use and definition of the material swaps exposure raise any competitive equity issues that should be considered? Are there any other aspects of the material swaps exposure that should be considered by the Agencies?

d. Timing

The proposed rule establishes the timing under which a covered swap entity must comply with the initial margin requirements set out in §§ __.3(a) and (b). Under the proposed rule, a covered swap entity, with respect to any non-cleared swap to which it is a party, must, on a daily basis, comply with the initial margin requirements for a period beginning on or before the business day following the day it enters into the transaction and ending on the date the non-cleared swap is terminated or expires. This requirement will cause covered swap entities to recalculate their initial margin requirements per their internal margin models or the standardized look-up table each business day. As a result, covered swap entities may need to adjust the amount of initial margin they collect or post on a daily basis.

Under the 2011 proposal, a covered swap entity was required to collect initial margin on or before the date it entered into a non-cleared swap. In the proposed rule, the Agencies have changed the timing provision in § _.3 to require a covered swap entity to comply with the initial margin requirements beginning on or before the business day following the day it enters into the swap. Providing an additional day is intended to address the operational concerns raised by the commenters to the 2011 proposal.

e. Other Counterparties

Under the proposed rule, a covered swap entity is not required as a matter of course to collect initial margin with respect to any non-cleared swap with a counterparty other than a financial end user with material swaps exposure or a swap entity, but shall collect initial margin at such times and in such forms and amounts (if any) that the covered swap entity determines appropriately address the credit risk posed by the counterparty and the risks of such swaps. Thus, the specific provisions of the Agencies' rules on initial margin requirements, documentation, and eligible collateral would not apply to non-cleared swaps between covered swap entities and these “other counterparties.” These “other counterparties” would include nonfinancial end users, entities that are excluded from the definition of financial end user, and financial end users without material swaps exposure. The Agencies' preliminary view is that this treatment of “other counterparties” is consistent with the Dodd-Frank Act's risk-based approach to establishing margin requirements. In particular, the Agencies intend for the proposed requirements with respect to “other counterparties” to be consistent with current market practice and understand that in many cases a covered swap entity would exchange little or no margin with these counterparty types. There may be circumstances, however, in which a covered swap entity finds it prudent to collect initial margin from these counterparty types, for example, if a covered swap entity chose

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