Margin and Capital Requirements for Covered Swap Entities

Federal RegisterNov 30, 2015

Ask Donna

What actually matters in this document.

Text

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 45

[Docket No. OCC-2011-0008]

RIN 1557-AD43

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:

Final rule.

SUMMARY:

The OCC, Board, FDIC, FCA, and FHFA (each an “Agency” and, collectively, the “Agencies”) are adopting a 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 final rule implements sections 731 and 764 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, as amended by the Terrorism Risk Insurance Program Reauthorization Act of 2015 (“TRIPRA”). Sections 731 and 764 require the Agencies to adopt rules jointly to establish capital requirements and initial and variation margin requirements for such entities 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:

The final rule is effective April 1, 2016.

FOR FURTHER INFORMATION CONTACT:

OCC:

Kurt Wilhelm, Director, Financial Markets Group, (202) 649-6437, or Carl Kaminski, Special Counsel, Legislative and Regulatory Activities Division, (202) 649-5490, 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, Associate Director, (202) 452-3760, or Elizabeth MacDonald, Manager, Division of Banking Supervision and Regulation, (202) 475-6316; Anna M. Harrington, Counsel, Legal Division, (202) 452-6406, or Victoria M. Szybillo, Counsel, Legal Division, (202) 475-6325, 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

, 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.

FCA:

J.C. Floyd, Associate Director, Finance & Capital Markets Team, Timothy T. Nerdahl, Senior Policy Analyst—Capital Markets, Jeremy R. Edelstein, Senior Policy 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.

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 20219. The telephone number for the Telecommunications Device for the Hearing Impaired is (800) 877-8339.

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 swaps, equity swaps, and credit default swaps) and “security-based swaps” (which are defined in section 761 of the Dodd-Frank Act to include a swap based on a single security or loan or on a narrow-based security index).

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 (“Securities Exchange Act”), respectively, which require registration with the U.S. Commodity Futures Trading Commission (the “CFTC”) of swap dealers and major swap participants and the U.S. Securities and Exchange Commission (the “SEC”) of 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 registered derivatives clearing organization or a registered clearing agency.

Swap entities that are prudentially regulated by one of the Agencies and therefore subject to this final 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”). The 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 (

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).

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 to their applicable 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). The CFTC issued a proposed rule imposing capital and margin requirements for swap dealers and major swap participants for which there is no prudential regulator on October 3, 2014.

See

79 FR 59898 (October 3, 2014). The CFTC proposal was substantially similar to the Agencies' proposal. More recently, the CFTC issued a cross-border proposed rule on margin that is also substantially similar to § _.9 of the Agencies' final rule.

See

80 FR 41376 (July 14, 2015); 17 CFR part 23. To date, the SEC has yet to finalize similar rules imposing capital and margin requirements for security-based swap dealers and major security-based swap participants. The SEC proposed margin rules in October 2012.

See

77 FR 70214 (Nov. 23, 2012).

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). Staffs of the Agencies have consulted with staff of the CFTC and SEC in developing the final 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, (1) help ensure the safety and soundness of the swap entity and (2) 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.

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, as amended 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 final rule, FHFA considered the differences as they relate to the above factors.

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. 1

et seq.,

12 U.S.C. 93a, 12 U.S.C. 1463, 12 U.S.C. 1464, 12 U.S.C. 1818, 12 U.S.C. 1828, 12 U.S.C. 1831p-1, 12 U.S.C. 3102(b) (OCC); 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. 1811

et seq.,

12 U.S.C. 1818 (FDIC); 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 registered derivatives clearing organization or clearing agency.

This requirement is consistent with the consensus of the G-20 leaders to clear derivatives through central counterparties (“CCPs”) 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, a particular swap may not be cleared either 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 exception or exemption from the mandatory clearing requirement. Such a swap is a “non-cleared” swap that 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 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. 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 derivatives with the goal of creating an international standard for non-cleared derivatives.

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

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

Following the publication of the 2013 international framework the Agencies published a re-proposal of the Agencies' rule in September 2014 (the “proposal,” “2014 proposal” or “proposed rule”).

The Agencies received over 55 comments in response to the proposal. The Agencies subsequently met with several commenters at their request to discuss their concerns with the proposal and summaries of these meetings may be found on each Agency's respective public Web site.

76 FR 27564 (May 11, 2011).

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

79 FR 57348 (Sept. 24, 2014). Comments on the 2011 proposal were discussed in detail in the 2014 proposal. In April 2014, the European Supervisory Authorities published a consultation paper with draft regulatory technical standards on risk-mitigation techniques for over-the-counter (“OTC”) derivative contracts not cleared by a CCP under Article 11(15) of the European Market Infrastructure Regulation (“EMIR”),

available at: https://www.eba.europa.eu/documents/10180/655149/JC+CP+2014+03+%28CP+on+risk+mitigation+for+OTC+derivatives%29.pdf

. On June 10, 2015, these European authorities released a reproposal

available at: https://eiopa.europa.eu/Publications/Consultations/JC-CP-2015-002%20JC%20CP%20on%20Risk%20Management%20vTechniques%20for%20OTC%20derivatives.pdf

. On July 3, 2014, the Financial Services Agency of Japan also published a proposal for OTC Derivatives regulation available at

http://www.fsa.go.jp/news/26/syouken/20140703-3.html

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

The applicability of the Agencies' 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 any prudentially-regulated entity that: (1) Is registered as a swap dealer or major swap participant with the CFTC, or as a security-based swap dealer, major security-based swap participant with the SEC; 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 final 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 swap entity and a security-based swap 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 final rule's requirements would apply to all of that swap dealer's non-cleared swaps and non-cleared security-based swaps.

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.

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” and “security-based swap.”

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 the Title VII margin requirements.

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 September 24, 2015, 104 entities have registered as swap dealers,

and two entities have registered as major swap participants. The SEC has also adopted rules for registering entities that meet the definition of “security-based swap dealer,” or “major security-based swap participant,” however, the compliance dates for registration have yet to occur.

The CFTC has adopted guidance addressing how the Commodity Exchange Act's swap requirements, will apply to “cross-border swaps.”

Similarly, the SEC published a final rule and interpretative guidance that addresses the application of the definitions of “security-based swap dealer” and “major security-based swap participant” in the cross-border context.

The SEC also recently proposed amendments and a re-proposed rule to address the application of certain provisions of the Securities Exchange Act to cross-border security-based swap activities.

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

Currently, all swap dealers are provisionally registered with the CFTC.

See

80 FR 48963 (August 14, 2015); 17 CFR parts 240 and 249; 17 CFR 240.15Fb1-1

et seq.

(effective October 15, 2015). The compliance date for the SEC registration requirements for security-based swap dealers and major security-based swap participants is the later of: (1) Six months after the date of publication in the

Federal Register

of a final rule establishing capital, margin, and segregation requirements for security-based swap dealers and major security-based swap participants; (2) the compliance date of final rules establishing recordkeeping and reporting requirements for security-based swap dealers and major security-based swap participants; (3) the compliance date of final rules establishing business conduct requirements under Securities Exchange Act sections 15F(h) and 15F(k); and (4) the compliance date for final rules establishing a process for registered security-based swap dealers and major security-based swap participants to make an application to the SEC to allow an associated person who is subject to a disqualification to effect or be involved in effecting security-based swaps on the security-based swap dealer's and major security-based swap participant's behalf.

In 2013, the CFTC issued guidance addressing the cross-border applicability of certain swap provisions.

See

78 FR 45292 (July 26, 2013); 17 CFR part 1. More recently, the CFTC issued a cross-border proposed rule for swap margin requirements.

See

80 FR 41376 (July 14, 2015); 17 CFR part 23.

See

79 FR 47278 (August 12, 2014); 17 CFR parts 240, 241, and 250.

See

80 FR 27444 (May 13, 2015); 17 CFR parts 240 and 242. The SEC published for comment proposed amendments and a re-proposed rule to address the application of certain provisions of the Securities Exchange Act that were added by Subtitle B of Title VII of the Dodd-Frank Act to cross-border security-based swap activities.

On January 12, 2015, the President signed into law TRIPRA. Title III of TRIPRA amends sections 731 and 764 of the Dodd-Frank Act to exempt certain transactions of certain counterparties from the Agencies' margin requirements as set out in this final rule.

Specifically, section 302 of Title III amends sections 731 and 764 of the Dodd-Frank Act to provide that the Agencies' rules on margin requirements under those sections shall not apply to a swap in which a counterparty: (1) Qualifies for an exception under section 2(h)(7)(A) of the Commodity Exchange Act, (2) qualifies for an exemption issued under section 4(c)(1) of the Commodity Exchange Act for cooperative entities as defined in such exemption, or (3) satisfies the criteria in section 2(h)(7)(D) of the Commodity Exchange Act, or a security-based swap in which a counterparty (1) qualifies for an exception under section 3C(g)(1) of the Securities Exchange Act or (2) satisfies the criteria in section 3C(g)(4) of the Securities Exchange Act.

Public Law 114-1, 129 Stat. 3.

Section 303 of TRIPRA requires that the Agencies implement the provisions of Title III by seeking comment on an interim final rule. The Agencies are adopting and, in a separate document published elsewhere in this

Federal Register

, are inviting comment on, an interim final rule that will implement these statutory exemptions by adding § __.1(d) (“the interim final rule”).

II. Overview of Final Rule

A. Margin Requirements

In the final rule, the Agencies are adopting a risk-based approach for initial and variation margin requirements for covered swap entities. Consistent with the statutory requirement, the final 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 final rule takes into account the risk posed by a covered swap entity's counterparties by 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 final 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.

The final rule also includes special provisions for inter-affiliate swaps between a covered swap entity and its affiliates. The requirements of this final rule will apply to non-cleared swaps with those counterparties to the extent they are not exempt pursuant to TRIPRA. Each of these four types of counterparties pose different levels of risk to the financial system, and the final rule adopts a risk-based approach to the margin requirements for the different types of counterparties, which reflect both the Agencies' safety and soundness concerns and the provisions of the Dodd-Frank Act.

See

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

Post and collect.

The initial and variation margin requirements generally apply to the posting and the collecting of minimum initial and variation margin amounts between a covered swap entity and its counterparties. While the Agencies believe that imposing requirements with respect to collecting the minimum amount of initial and variation margin 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 final 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, with certain exceptions, will be collecting and posting appropriate minimum margin amounts with respect to those transactions.

The final rule's margin provisions establish only

minimum

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

Initial margin.

For initial margin, the final 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 final 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 the criteria outlined in § __.8 of the final rule and that has been approved by the relevant prudential regulator.

See

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

When 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 final rule), the covered swap entity must collect at least the amount of initial margin required under the final 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 must collect at least the amount of initial margin required by the final rule and must post at least the amount of initial margin that the covered swap entity would be required by the final rule 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 if changes in portfolio composition or any other factors 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 final 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 final rule. 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 final rule, when entering into a swap transaction, the first collection and posting of initial margin must occur on or before the business day following the day of execution. 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, until the date the non-cleared swap terminates or expires.

The final rule permits a covered swap entity to adopt a maximum initial margin threshold amount of $50 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 amount applies on a consolidated basis, and applies both to the consolidated covered swap entity as well as to the consolidated counterparty.

See

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

Variation margin.

With respect to variation margin, the final rule generally requires a covered swap entity to collect or post variation margin for 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 final 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 final rule on at least a daily basis.

Covered swap entities, however, are not required to collect or post margin from or to any individual counterparty unless and until the combined amount of initial and variation margin that must be collected or posted under the final rule, but has not yet been exchanged with the counterparty, is greater than $500,000.

See

§ __.5 of the final rule.

See

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

Exempt transactions and “other counterparties.”

Under the interim final rule, certain transactions with certain nonfinancial end users and other financial counterparties are exempt from the Agencies' margin requirements. Specifically, under § __.1(d) as added by the interim final rule, the Agencies' margin requirements do not apply to a swap or security-based swap with a counterparty that: (1) Qualifies for an exception from clearing under section 2(h)(7)(A) of the Commodity Exchange Act or section 3C(g)(1) of the Securities Exchange Act (

i.e.,

a nonfinancial entity using the swap or security-based swap to hedge or mitigate commercial risk, certain small financial institutions, and captive finance companies);

(2) qualifies for an exemption from clearing under section 4(c)(1) of the Commodity Exchange Act for cooperative entities that would otherwise be subject to the requirement to clear;

or (3) satisfies the criteria for the affiliate exception from clearing pursuant to section 2(h)(7)(D) of the Commodity Exchange Act or section 3C(g)(4) of the Securities Exchange Act for treasury affiliates that act as agent.

Section 1(d), as added by the interim final rule published elsewhere in this

Federal Register

, implements the exemptions enacted in Title III of TRIPRA, which excludes these swaps from the statutory directive issued to the Agencies by section 4s of the Commodity Exchange Act and section 15F of the Securities Exchange Act to impose margin requirements for all non-cleared swaps.

See

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

See

7 U.S.C. 6(c)(1). The CFTC, pursuant to its authority under section 4(c)(1) of the Commodity Exchange Act, adopted 17 CFR 50.51 which exempts from required clearing certain swaps entered into by certain cooperatives.

See

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

Separate from the transactions exempt from the final rule as a result of the interim final rule, there are also swap transactions with “other counterparties” that are subject to this final rule, but that are not subject to specific, numerical minimum initial or variation margin requirements. As discussed below, these swaps include swaps with counterparties such as foreign sovereigns, as well as swaps with financial end users that do not have a material swaps exposure (with respect to the initial margin requirement). The final rule makes a covered swap entity's collection of margin from these “other counterparties” subject to the judgment of the covered swap entity. That is, under the final rule, a covered swap entity will not be required to collect initial and variation margin from these “other counterparties” as a matter of course.

Instead, 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 appropriate in its overall credit risk management of the covered swap entity's exposure to the customer. 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.”

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

See

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

Eligible collateral.

The final 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” or “discount,” during a severe economic downturn.

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, shares in certain pooled investment vehicles, and gold.

An asset-backed security guaranteed by a U.S. GSE is eligible collateral for purposes of initial margin (and variation margin for transactions with financial end users) only if the GSE is operating with capital support or another form of direct financial assistance from the U.S. government.

Eligible collateral for variation margin depends on the type of counterparty the covered swap entity is facing in its swap transaction. For swaps between a covered swap entity and another swap entity, eligible collateral for variation margin is limited to only immediately available cash funds denominated in U.S. dollars, another major currency, or the currency of settlement for the swap. When a covered swap entity faces financial end user counterparties, on the other hand, a covered swap entity may exchange variation margin in any of the same forms of collateral as the final rule permits for initial margin collateral.

When determining collateral value for purposes of satisfying the final rule's margin requirements, non-cash collateral is subject to an additional “haircut” or “discount” as determined using appendix B of the final rule.

The limits on eligible collateral and the haircuts under appendix B would not apply to margin collected or posted in excess of what is required by the rule. The Agencies believe that the eligibility of certain non-cash collateral, subject to the conditions and restrictions contained in the final rule, is consistent with the Dodd-Frank Act, because the use of such non-cash collateral is consistent with preserving the financial integrity of markets by trading swaps and preserving the stability of the U.S. financial system. The use of different types of eligible collateral pursuant to the requirements of the final rule should also incrementally increase liquidity in the financial system.

See

§ __.6 and appendix B of the final rule for a complete description of the eligible collateral requirements, including an additive 8 percent cross-currency haircut. The terms “haircut” and “discount” are used interchangeably.

Collateral segregation.

Under the final rule, a covered swap entity must require that any collateral other than variation margin that it posts to its counterparty (even collateral in excess of any required by the final rule) be segregated at one or more custodians that are not the covered swap entity or the counterparty nor affiliates of the covered swap entity or the counterparty (“third-party custodian”). The final rule would also require a covered swap entity to place the initial margin it collects (up to the amount required by the final 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 final rule would require that a custodial agreement prohibit certain actions with respect to any of the funds or other property that the custodian holds as initial margin. First, the custodial agreement must prohibit the custodian from rehypothecating, repledging, reusing, or otherwise transferring (through securities lending, securities borrowing, repurchase agreement, reverse repurchase agreement or other means) the funds or other property held by the custodian, except that cash collateral may be held in a general deposit account with the custodian if the funds in the account are used to purchase an asset described in § __.6(a)(2) or (b), such assets are segregated pursuant to § __.7(a) through (b), and such purchase takes place within a time period reasonably necessary to consummate such purchase after the cash collateral is posted as initial margin. Second, with respect to initial margin required to be posted or collected, the custodial agreement must prohibit the substituting or reinvesting of any funds or other property in any asset that would not qualify as eligible collateral under the final 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 final rule.

With the exception of collateral posted by a covered swap entity, funds or other property held by a third-party custodian in excess of the amounts 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 final rule for a complete description of the segregation requirements.

Cross-border transactions.

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 adopting a specific approach to address cross-border non-cleared swap transactions. Under the final rule, foreign swaps of foreign covered swap entities would not be subject to the margin requirements of the final 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 or agencies 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 final rule.

This section would also allow any covered swap entity to post initial margin to its counterparty pursuant to a foreign regulator's swap margin requirements that are comparable to those of the final rule in certain circumstances. In addition, this section also addresses certain jurisdictions where inherent limitations in the legal or operational infrastructure make it impracticable for the covered swap entity and counterparty to post initial margin as required in § __.3(b) in compliance with the segregation requirements of § __.7 of this rule; in these circumstances, the final rule provides that a covered swap entity should collect initial margin in cash and post and collect variation margin in cash in such jurisdictions but would not require the covered swap entity to post initial margin to its counterparty.

See

§ __.9 of the final rule.

See

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

Affiliate transactions.

The final rule contains a special section for swaps with affiliates. This section provides that the requirements of the rule generally apply to a non-cleared swap with an affiliate unless the swap is excluded from coverage under § __.1(d) as added by the interim final rule published elsewhere in this

Federal Register

or a special rule applies. For instance, collection of initial margin is not addressed in this special section. As a result, a covered swap entity is required to collect initial margin from its affiliate pursuant to § _.3(a) under the final rule. Where a covered swap entity transacts with another covered swap entity that is an affiliate, this will

result in a collect and post regime for initial margin among affiliates.

The special rules for affiliates provide that a covered swap entity is not required to post initial margin to an affiliate that is not also a covered swap entity but must calculate the amount of initial margin that would be required to be posted to such an affiliate and provide documentation to each affiliate on a daily basis. In addition, each affiliate may be granted an initial margin threshold of $20 million. A covered swap entity that collects non-cash collateral from an affiliate may serve as the custodian for the collateral or have an affiliate serve as the custodian. In addition, a covered swap entity may use a holding period in its margin model equal to the shorter of five business days or the maturity of the portfolio for any swaps with an affiliate that are subject to an exemption from mandatory clearing, provided that the initial margin amount for these swaps are calculated separately from other swaps. In addition, a covered swap entity must collect and post variation margin with any affiliate counterparty as provided in § __.4 of the final rule.

The Agencies note the approach of the final rule is consistent with the approach of other applicable laws, which 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. 12 U.S.C. 371c-1(a).

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 banking organizations

meeting certain thresholds to calculate their capital requirements for trading positions through models approved by their primary Federal supervisor.

In addition, certain large, complex banking organizations 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 were 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 BCBS developed the first international banking capital framework in 1988, entitled

International Convergence of Capital Measurement and Capital Standards

Banking organizations include national banks, state member banks, state non-member banks, Federal savings associations, state savings associations, top-tier bank holding companies domiciled in the United States not subject to the Board's Small Bank Holding Company Policy Statement (12 CFR part 225, appendix C)), as well as top-tier savings and loan holding companies domiciled in the United States, other than (i) savings and loan holding companies subject to the Board's Small Bank Holding Company Policy Statement and (ii) certain savings and loan holding companies that are substantially engaged in insurance underwriting or commercial activities.

The banking agencies' market risk capital rules are at 12 CFR part 3, subpart F (national banks and federal savings associations), 12 CFR part 217, subpart F (state member banks, bank holding companies, and savings and loan holding companies), and 12 CFR part 324, subpart F (state nonmember banks and state savings associations). The rules apply to banking organizations 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, subpart E (national banks and federal savings associations), 12 CFR part 217, subpart E (state member banks, bank holding companies, and savings and loan holding companies), and 12 CFR part 324, subpart E (state nonmember banks and state savings associations). The advanced approaches rules apply to banking organizations with consolidated total assets equal to $250 billion or more or consolidated total on-balance sheet foreign exposures equal to $10 billion or more (advanced approaches banking organizations).

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” (Basel III framework).

The revised capital framework includes the capital requirements for OTC derivatives contracts, which are defined to include transactions that would also meet the definition of swaps described above, as well as a minimum supplementary leverage ratio for advanced approaches banking organizations that is reflective of their on- and off-balance sheet activities, including derivatives activities. 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 the Basel III 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.

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 view that the reference to existing capital rules is sufficient to address the risks arising from swap transactions and activities of the Enterprises.

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.

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

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.

See

79 FR 52814 (Sept. 4, 2014).

As described below, the final 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 will 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. The Final Rule and Community Banks

The Agencies expect that the final rule likely will have minimal impact on community banks. The Agencies anticipate that community banks will not engage in swap activity to the level that would require them to register as a swap dealer, major swap participant, security-based swap dealer, or major security-based swap participant; and therefore, are unlikely to fall within the definition of a covered swap entity.

Because the final 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 will not be required to apply to those swaps the final rule's requirements for initial margin or variation margin.

At the time the Agencies adopted this final rule, no community banks had registered in any of these capacities.

The TRIPRA also excluded certain swaps with community banks from the margin requirements of this rule.

In particular, section 2(h)(7)(A) of the Commodity Exchange Act excepts from clearing any swap where one of the counterparties is not a financial entity, is using the swap to hedge or mitigate commercial risk, and notifies the CFTC how it generally meets its financial obligations associated with entering into non-cleared swaps.

As authorized by the Dodd-Frank Act, the CFTC has excluded depository institutions, FCS institutions, and credit unions with total assets of $10 billion or less, from the definition of “financial entity,” thereby permitting those institutions to avail themselves of the clearing exception for end users.

Non-cleared swaps with those entities would be eligible for the TRIPRA exemption in the Agencies' margin rules, provided they met the other requirements for the clearing exception. As a consequence of TRIPRA, if a community bank with total assets of $10 billion or less enters into a swap with a covered swap entity that meets the requirements of the exception from clearing, that swap will not be subject to the margin requirements of this rule. As of June 30, 2015, of the 6,348 insured depository institutions, all but 111 institutions had total assets of $10 billion or less.

The TRIPRA exceptions are reflected in § __.1(d), which is added by the interim final rule.

A “financial entity” is defined to mean (i) a swap dealer; (ii) a security-based swap dealer; (iii) a major swap participant; (iv) a major security-based swap participant; (v) a commodity pool; (vi) a private fund as defined in section 202(a) of the Investment Advisers Act of 1940; (vii) an employee benefit plan as defined in sections 3(3) and 3(32) of the Employment Retirement Income Security Act of 1974; (viii) 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 Bank Holding Company Act of 1956.

See

7 U.S.C. 2(h)(7)(C)(i).

See

7 U.S.C. 2(h)(7)(C)(ii) and 77 FR 42560 (July 19, 2012); 77 FR 20536 (April 5, 2012).

FDIC Quarterly Banking Profile, Second Quarter 2015, p. 7.

https://www5.fdic.gov/qbp/2015jun/qbp.pdf

. Of the 6,237 insured depository institutions with total assets of $10 billion or less as of June 30, 2015, 5,646 institutions had total assets of $1 billion or less and 591 institutions had total assets between $1 billion and $10 billion.

When a community bank with total assets greater than $10 billion enters into a swap with a covered swap entity, the covered swap entity will be required to post and collect initial margin pursuant to the rule only if the community bank had a material swaps exposure and is not otherwise exempt pursuant to TRIPRA.

Further, if a community bank with total assets above $10 billion does not engage in swaps activities that would exceed its initial margin threshold amount, the final rule will 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 final 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 $8 billion, where such amount is calculated only for business days.

The final rule requires a covered swap entity to exchange daily variation margin with a community bank with total assets below $10 billion, regardless of whether the community bank has material swaps exposure, provided the swap is not otherwise exempt pursuant to TRIPRA. In addition, the final rule requires a covered swap entity to exchange daily variation margin with a community bank with total assets above $10 billion, regardless of whether the community bank has material swaps exposure. However, the covered swap entity will 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 exceeds the minimum transfer amount of $500,000, as provided for in § __.5(b) of the final rule.

D. The Final Rule and Farm Credit System Institutions

The final rule should have a minimal impact on the FCS. Currently, no FCS institution, including Farmer Mac, engages in swap activity at the level that would require them to register as 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 definition of a covered swap entity and, therefore, become directly subject to this rule. Further, almost all swaps of FCS institutions are exempt from clearing and the margin requirements of this final rule as a result of TRIPRA. Most FCS institutions have total assets of less than $10 billion and, therefore, they may elect an exception from clearing under a CFTC regulation, 17 CFR 50.50(d), which implements section 2(h)(7)(C)(ii) of the Commodity Exchange Act.

Separately, FCS banks and associations, regardless of size, may elect not to clear swaps that (1) they enter into in connection with loans to their members; or (2) hedge or mitigate risks related to loans with their members, pursuant to 17 CFR 50.51.

Furthermore, TRIPRA exempts financial cooperatives from exchanging initial and variation margin on all their swaps that are subject to the exemption from clearing provided by the CFTC. Farmer Mac is the only FCS institution that does not have an exception or exemption from mandatory clearing because it has total assets that exceed $10 billion, and it is not a cooperative. For this reason, Farmer Mac is a financial end user and is subject to the initial margin requirements of this final rule to the extent its non-cleared swap transactions exceed the material swaps exposure or initial margin thresholds. Farmer Mac would also be subject to the variation margin requirements of this final rule.

The SEC has not yet enacted a comparable rule granting small deposit institutions, FCS institutions, and credit unions, an exemption from clearing.

The CFTC enacted 17 CFR 50.51 pursuant to its authority under section 4(c)(1) of the Commodity Exchange Act.

III. Section by Section Summary of Final Rule

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

As in the proposal, §§ __.1(a) through (c) of the final rule are Agency-specific. Section __.1(a) of the final rule 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 final rule specifies the scope of the transactions to which the margin requirements apply. Under § __.1(c), the margin requirements apply to

all

non-cleared swaps into which a covered swap entity enters. Each Agency has set forth text for its Agency-specific version of § __.1(c) that specifies the entities to which that Agency's rule applies. Section __.1(c) further states that the margin requirements apply only to non-cleared swaps and non-cleared security-based swaps that are entered into on or after the relevant compliance dates set forth in § _.1(e). Section _.1(c) also provides that nothing in this final rule is intended to prevent, nor is it intended to require, a covered swap entity from independently collecting margin in amounts greater than the amounts required under this final rule. Section __.1(d), as added by the interim final rule, provides for exemptions from the rule for certain swaps and security-based swaps with certain commercial end users and others as described above and in the companion interim final rule. Section __.1(e) sets forth compliance dates. Section 1(f) provides that once a covered swap entity and its counterparty become subject to the margin requirements based on the compliance dates set forth in § __.1(e), the covered swap entity and its counterparty shall remain subject to the final rule. Section __.1(g) of the final rule specifies how the margin requirements apply in the event a covered swap entity's counterparty changes its status (for example, if the counterparty is a financial end user without material swaps exposure and thereafter becomes a financial end user with material swaps exposure).

1. Treatment of Swaps With Commercial End Users and Other “Low-Risk” Counterparties

Section _.1(d), as added by the interim final rule published elsewhere in this

Federal Register

, which is the same for all the Agencies, implements the provisions of TRIPRA and provides for exemptions from the rule for certain swaps with certain commercial end users and certain other counterparties. These exemptions are discussed further in the Agencies' interim final rule and request for comment, published elsewhere in the

Federal Register

The proposal applied to all swaps and security-based swaps, consistent with the original provisions of sections 731 and 764 of the Dodd-Frank Act. For certain swaps, however, such as those 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),

the Agencies proposed a reduced, risk-based, approach to margin. For those counterparties, which the proposal treated as “other counterparties,” the proposal would have required only that a covered swap entity collect margin in such forms and amounts (if any) that the covered swap entity determined appropriately addressed the credit risk posed by the counterparty and the risks of the swap.

Although the term “commercial end user” is not defined in the Dodd-Frank Act, it is used in this preamble to mean a company that is eligible for the exception to the mandatory clearing requirement for swaps under section 2(h)(7)(A) of the Commodity Exchange Act and section 3C(g)(1) of the Securities Exchange Act, respectively. This exception is generally available to a person that (1) is not a financial entity, (2) is using the swap to hedge or mitigate commercial risk, and (3) 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)(A) and 15 U.S.C. 78c-3(g)(1).

See

discussion below of §§ __.3(d) and __.4(c) of the proposed rule.

As discussed earlier, TRIPRA, which was enacted on January 12, 2015, amends sections 731 and 764 of the Dodd-Frank Act to exempt certain transactions of certain financial and nonfinancial end users from the Agencies' margin requirements set out in this final rule.

Specifically, section 302 of TRIPRA amends sections 731 and 764 so that initial and variation margin requirements will not apply to a swap or security-based swap of a counterparty (to a covered swap entity) in which a counterparty is:

Pub. L. 114-1, 129 Stat. 3.

(1) A nonfinancial entity, including a captive finance company, that qualifies for the clearing exception under section 2(h)(7)(A) of the Commodity Exchange Act or section 3C(g)(1) of the Securities Exchange Act;

See

7 U.S.C. 2(h)(7)(A); 15 U.S.C. 78c-3(g)(1). A “captive finance company” is an entity whose primary business is providing financing, and uses derivatives for the purpose of hedging underlying commercial risks related to interest rate and foreign currency exposures, 90 percent or more of which arise from financing that facilitates the purchase or lease of products, 90 percent or more of which are manufactured by the parent company or another subsidiary of the parent company.

See

7 U.S.C. 2(h)(7)(C)(iii). Section 2(h)(7)(C)(ii) of the Commodity Exchange Act and section 3C(g)(3)(B) of the Securities Exchange Act authorize the CFTC and the SEC, respectively, to exempt small depository institutions, small FCS 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)(C)(ii) and 15 U.S.C. 78c-3(g)(3)(B). The CFTC has exempted these small institutions by rule, and therefore swaps entered into to hedge or mitigate commercial risk by those institutions are also exempt from this final rule by operation of TRIPRA.

See

77 FR 42560 (July 19, 2012); 77 FR 20536 (April 5, 2012). On December 21, 2010, the SEC proposed to exempt security-based swaps used by small depository institutions, small FCS institutions, and small credit unions with total assets of $10 billion or less from clearing. 75 FR 79992 (December 21, 2010).

(2) A cooperative entity that qualifies for an exemption from the clearing requirements issued under section 4(c)(1) of the Commodity Exchange Act;

See

7 U.S.C. 6(c)(1). The CFTC, pursuant to its authority under section 4(c)(1) of the Commodity Exchange Act, adopted 17 CFR 50.51, which allows certain 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 or arising from certain swaps with members.

(3) An affiliate that satisfies the criteria for an exception from clearing in section 2(h)(7)(D) of the Commodity Exchange Act or section 3C(g)(4) of the Securities Exchange Act.

See

7 U.S.C. 2(h)(7)(D) and 15 U.S.C. 78c-3(g)(4). This exception applies to an affiliate of a person that qualifies for an exception from clearing (including affiliate entities predominantly engaged in providing financing for the purchase of the merchandise or manufactured goods of the person), only if the affiliate, acting on behalf of the person and as an agent, uses the swap to hedge or mitigate the commercial risk of the person or other affiliate of the person that is not a financial entity. This exception does not apply to a person that is a swap dealer, security-based swap dealer, major swap participant, major security-based swap participant, an issuer that would be an investment company, as defined in section 3 under the Investment Company Act but for paragraphs (c)(1) or (c)(7), a commodity pool, or a bank holding company with over $50 billion in consolidated assets.

The Agencies have implemented the TRIPRA exemptions in § __.1(d) of the interim final rule. These exemptions are transaction-based, as opposed to counterparty-based. For example, if a commercial end user enters into a non-cleared swap with a covered swap entity and the transaction is

not

for hedging purposes, then the covered swap entity would treat the swap in accordance with the “other counterparties” provisions in §§ __.3 and ___.4 of this final rule.

Finally, the Agencies note that the exception or exemption of a transaction from the margin requirements in no way prohibits a

covered swap entity from requiring initial and/or variation margin on such transactions but does not impose initial or variation margin requirements as a regulatory matter.

See

discussion below of §§ __.3(d) and __.4(c) of the final rule.

Section 303 of TRIPRA requires that the Agencies implement the provisions of Title III, “Business Risk Mitigation and Price Stabilization Act of 2015,” by promulgating an interim final rule, and seeking public comment on the interim final rule. The Agencies are adopting § __.1(d) as part of a companion interim final rule, and will be requesting comment, as required by TRIPRA, in a separate publication in the

Federal Register

. If necessary, the Agencies will amend § __.1(d) after receiving comments on the interim final rule.

2. Compliance Dates

Section __.1(e) of the final rule sets forth the compliance dates by which covered swap entities must comply with the minimum margin requirements for non-cleared swaps that are entered into on or after the applicable compliance date. The compliance dates are consistent with the modified compliance dates associated with the 2013 international framework.

See

BCBS and IOSCO “Margin requirements for non-centrally cleared derivatives,” (March 2015),

available at https://www.bis.org/bcbs/publ/d317.htm.

, which extends the original compliance dates set out in the 2013 international framework by nine months.

Under the 2014 proposal, the implementation of both initial and variation margin requirements would have started on December 1, 2015. With respect to initial margin requirements, the requirements would have been phased-in between December 1, 2015 and December 1, 2019. Variation margin requirements for all covered swap entities with respect to covered swaps with any counterparty would have been effective as of December 1, 2015. This proposed set of compliance dates was consistent with those set forth in the 2013 international framework. On March 18, 2015, the BCBS and IOSCO issued a press release announcing that the implementation of the 2013 international framework would be delayed by nine months.

This announcement was in response to the fact that to date in March 2015, no jurisdiction had yet finalized rules for margin requirements for non-centrally cleared derivatives. Accordingly, the final rule has been revised to delay the implementation of both initial and variation margin requirements by nine months from the compliance schedule set forth in the 2014 proposal. This delay results in a uniform approach with respect to compliance dates across the final rule and the international framework.

http://www.bis.org/bcbs/publ/d317.htm

The changes to the proposed compliance dates in the final rule should help address concerns raised by commenters. For example, the proposal was revised, in part, to respond to commenters who stated that, to the extent practicable, there should be international harmonization of implementation dates for margin and capital requirements. While one commenter supported the proposed compliance date schedules set out in the 2014 proposal, a number of commenters argued that compliance with the final rule should be delayed for 18 months to two years in order to allow for operational changes that will be required for covered swaps entities to comply with the rule. With respect to phasing-in the implementation of the initial margin requirements, a commenter stated that the phase-in provisions should be revised to apply only to non-cleared swaps between covered swap entities. The commenter further stated that non-covered swap entities should not be required to comply with the initial margin requirements until December 2019. The Agencies also received a comment stating that the implementation of the compliance date schedule should not coincide with code freezes—

i.e.,

periods like year-end when companies typically do not change their information technology systems in anticipation of certain reporting deadlines.

The Agencies agree that the international harmonization of margin and capital requirements is prudent. In light of the concerns raised by the commenters and the delay of the implementation of the 2013 international framework, the Agencies have incorporated into the final rule provisions reflecting the implementation schedule for the 2013 international framework that was recently set out by the BCBS and IOSCO.

a. Compliance Date Schedule for Initial Margin.

For purposes of initial margin, as reflected in the table below, the compliance dates range from September 1, 2016, to September 1, 2020, 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 (accounting for their respective affiliates) for each business day in March, April and May of that year.

“Foreign exchange forward” and “foreign exchange swap” are 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

Initial margin requirements

September 1, 2016

Initial margin where both the covered swap entity combined with all its affiliates and its counterparty combined with all its affiliates have an average daily aggregate notional amount of covered swaps for March, April and May of 2016 that exceeds $3 trillion.

September 1, 2017

September 1, 2018

September 1, 2019

September 1, 2020

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

In calculating the amount of covered swaps as set forth in the table above, the final rule provides that a covered swap entity shall count the average daily aggregate notional amount of a non-cleared swap, a non-cleared security-

based swap, a foreign exchange forward or a foreign exchange swap between the entity and an affiliate only one time, and shall not count a swap or security-based swap that is exempt from the Agencies' margin requirements under § __.1(d), as added by the interim final rule.

These provisions were not included in the proposed rule. The purpose of the first provision in the final rule is to prevent double counting of covered swaps between affiliates, a concern raised by a number of commenters, which could artificially increase a covered swap entity's average daily aggregate notional amount. The purpose of the second provision is to ensure that swaps that have been exempted from the margin requirements are fully exempted and do not influence other aspects of the rule such as whether an entity maintains a material swaps exposure.

See

§ __.1(e) of the final rule.

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 provisions of the final rule relating to the initial margin requirements, 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.

b. Compliance Date Schedule for Variation Margin.

For purposes of variation margin, the compliance dates are September 1, 2016 and March 1, 2017. As set out in the table below, these compliance dates also depend on the average daily aggregate notional amount of covered swaps of the covered swap entity combined with its affiliates and each of its counterparties (combined with that counterparty's affiliates) for each business day in March, April and May of that year (the “calculation period”).

Thus, a given covered swap entity may have multiple compliance dates depending on both the combined average daily aggregate notional amount of covered swaps of the covered swap entity and its affiliates during the calculation period as well as the combined average daily notional amount of covered swaps of each of its counterparties and that counterparty's affiliates during the calculation period.

See

§ __.1(e) of the final rule.

Compliance date

Variation margin requirements

September 1, 2016

Variation margin where both the covered swap entity combined with all its affiliates and its counterparty combined with all its affiliates have an average daily aggregate notional amount of covered swaps for March, April and May of 2016 that exceeds $3 trillion.

March 1, 2017

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

Calculating the amount of covered swaps set forth in the table above for the purposes of determining variation margin is done in the same manner as calculating the amount of covered swaps for purposes of determining initial margin.

A covered swap entity shall count the average daily aggregate notional amount of a non-cleared swap, a non-cleared security-based swap, a foreign exchange forward or a foreign exchange swap between the entity and an affiliate only one time, and shall not count a swap or security-based swap that is exempt from the Agencies' margin requirements under § __.1(d), as added by the interim final rule.

As a specific example of the calculation, consider a U.S.-.based 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 $1 trillion on each business day of March, April and May of 2016. Furthermore, suppose that a foreign exchange forward is added to the entity's portfolio at the end of the day on April 29, 2016, and that its notional value is $1 trillion on every business day of May 2016. On each business day of March and April of 2016, the aggregate notional amount of non-cleared swaps, security-based swaps and foreign exchange forwards and swaps is $3 trillion. Beginning on May 1, 2016, the aggregate notional amount of non-cleared swaps, security-based swaps and foreign exchange forwards and swaps is $4 trillion. The daily average aggregate notional value for March, April and May 2016 is then (23x$3 trillion +21x$3 trillion + 21x$4 trillion)/(23+21+21)=$3.3 trillion, in which case this entity would have a gross notional exposure that would result in its compliance date beginning on September 1, 2016.

The final rule adopts a phase-in arrangement for variation margin requirements that is different from the 2014 proposal. Several commenters urged that the compliance date for variation margin requirements be phased in, in a manner similar to the compliance dates for the initial margin requirements. These commenters argued, among other things, that the phase-in of the variation margin requirements would allow covered swap entities the time to re-document all necessary swap contracts at one time. One commenter stated that variation margin requirements should be phased in based on decreasing notional amount thresholds over a two-year period commencing upon the latter of the publication of the margin rules for OTC derivatives in the United States, the EU and Japan or the publication of the Agencies' comparability determinations with respect to the EU and Japan. In response to these comments, the Agencies believe that a phase-in of variation margin requirements similar to the phase-in of initial margin requirements is not necessary because the collection of daily variation margin is currently an industry best practice and will not require many changes in current swaps business operations for covered swaps entities. However, the Agencies have revised the 2014 proposal to include the phase-in of compliance dates for variation margin as set forth above to align with the dates suggested by the BCBS and IOSCO on March 18, 2015.

c. The meaning of Swaps Entered Into After the Compliance Date

The rule's margin requirements apply to non-cleared swaps entered into on or after the applicable compliance date. Certain commenters also requested that the Agencies consider the following swaps as entered into prior to the compliance date: (1) swaps entered into prior to the applicable compliance date (legacy swaps) that are amended in a non-material manner; (2) novations; and (3) new derivatives that result from portfolio compression of legacy

derivatives. These commenters urged that if a general exclusion for novated legacy swaps is not provided, there should be an exclusion for novated swaps between affiliates resulting from organizational restructuring or regulatory requirements such as the swaps push-out rule.

Notwithstanding these comments, the Agencies believe that classifying new swap transactions as “swaps entered into prior to the compliance date” could create significant incentives to engage in amendments and novations for the purpose of evading the margin requirements. Moreover, limiting the extension to “material” amendments or “legitimate” novations is difficult to effect within the final rule as the specific motivation for an amendment or novation is generally not observable. Finally, the Agencies believe that classifying some new swap transactions as transactions entered into prior to the compliance date would make the process of identifying those swaps to which the rule applies overly complex and non-transparent. Accordingly, the Agencies have elected not to extend the meaning of swaps entered into prior to the compliance date as was requested by some commenters.

d. Ongoing Applicability and Implementation of the Margin Requirements.

Section __.1(f) 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 set forth in § __.1(e), the covered swap entity and its counterparty shall remain subject to the margin requirements from that point forward. For example, September 1, 2017 is the relevant compliance date where both the covered swap entity combined with all its affiliates and its counterparty combined with all its affiliates have an average aggregate daily notional amount of covered swaps that exceed $2.25 trillion must comply with these margin requirements. 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 September 1, 2020, any covered swap entity/counterparty combination that did not have an earlier compliance date will become subject to the initial margin requirements with respect to any non-cleared swaps.

One commenter urged that, during the phase-in period, only entities whose swap volume currently exceeds the applicable threshold should be subject to the margin requirements. The commenter stated that, if the swap activity of either party to a swap declines below the applicable threshold, that party should cease being subject to the initial margin requirements until such time as it exceeds the applicable threshold. The Agencies have declined to make this change to the final rule. The Agencies believe that allowing entities' coverage status to change over time results in additional complexity with little benefit since all entities will in any event be subject to the rule as of September 1, 2020. Accordingly, allowing an entity's coverage status to fluctuate would only be consequential for a limited period of time.

One commenter asked how the margin requirements would apply in the event of a change in status of the counterparty. The Agencies have added § __.1(g) to the final rule to clarify the applicability of the margin requirements in the event a covered swap entity's counterparty changes its status (for example, if the counterparty is a financial end user without material swaps exposure and becomes a financial end user with material swaps exposure).

Under § __.1(g)(1), in the event a counterparty changes its status such that a non-cleared swap or non-cleared security-based swap with that counterparty becomes subject to stricter margin requirements, then the covered swap entity shall comply with the stricter margin requirements for any non-cleared swap or non-cleared security-based swap entered into with that counterparty after the counterparty changes its status. Section __.1(g)(2) states that in the event a counterparty changes its status such that a non-cleared swap or non-cleared security-based swap with that counterparty becomes subject to less strict margin requirements (such as when a counterparty changes status from a financial end user with material swaps exposure to a financial end user without material swaps exposure), then the covered swap entity may comply with the less strict margin requirements for any swap or security-based swap entered into with that counterparty after the counterparty changes its status as well as for any outstanding non-cleared swap or non-cleared security-based swap entered into after the applicable compliance date in § ___.1(e) and before the counterparty changed its status. As a specific example, if a covered swap entity's counterparty transitioned from a financial end user with material swaps exposure to a financial end user without material swaps exposure, initial margin that had been previously collected could be returned if agreed to by both parties since the rule would not require an exchange of initial margin on pre-existing or future non-cleared swaps.

This could apply in other circumstances as well—

e.g.,

if an entity that is exempt pursuant to TRIPRA no longer qualifies for an exception or exemption.

e. Treatment of Swaps Executed Prior to the Applicable Compliance Date Under a Netting Agreement

As discussed in further detail below in § ___.5, a covered swap entity may enter into swaps on or after the final 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. The final rule permits a covered swap entity to (1) 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 (2) calculate variation margin requirements under the final rule on an aggregate, net basis under an EMNA with the counterparty. Applying the final 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 received several comments expressing concern that the 2014 proposal might require swaps entered into before the compliance dates to be documented under a different EMNA than swaps entered into after the compliance dates in order for the margin requirements not to apply to the pre-compliance dates swaps. As described further in § ___.5, the Agencies have revised the final rule to allow for the establishment of separate netting sets under a single ENMA to avoid this outcome.

3. Numerical Amounts Expressed in U.S. Dollar Terms in the Final Rule and Their Relation to Numerical Amounts Expressed in Euros in the 2013 International Framework

The 2014 proposal contained a number of numerical amounts that are expressed in U.S. dollar terms. The amounts include the effective date phase-in thresholds, the initial margin threshold amount, the material swaps exposure amount, and the minimum transfer amount. These numerical amounts are expressed in the 2013 international framework in terms of Euros. In the 2014 proposal, the Agencies translated the Euro amounts from the 2013 international framework

using a Euro-U.S. Dollar exchange rate that was broadly consistent with the exchange rate that prevailed at the time of the proposal's publication.

In the proposal, the Agencies sought comment on how to deal with fluctuations in exchange rates and how such fluctuations may create inconsistencies in the numerical amounts that are established across differing jurisdictions. One commenter suggested using an average exchange rate calculated over a period of time. Another commenter suggested that the Agencies should periodically recalibrate these amounts in response to broad movements in underlying exchange rates.

The Agencies believe that persistent and significant fluctuations in exchange rates could result in significant differences across jurisdictions that would complicate cross-border transactions and create competitive inequities. The Agencies do not agree, however, that the final rule's numerical amounts should be mechanically linked to either prevailing exchange rates or average exchange rates over a period of time as short term fluctuations in exchange rates would result in high frequency changes that would create significant operational and logistical burdens. Rather, and consistent with the view of one commenter, the Agencies expect to consider periodically the numerical amounts expressed in the final rule and their relation to amounts denominated in other currencies in differing jurisdictions. The Agencies will then propose adjustments, as appropriate, to these amounts.

In the final rule, the Agencies are adjusting the numerical amounts described above in light of significant shifts in the Euro-U.S. Dollar exchange rates since the publication of the 2014 proposal. Specifically, the Agencies are reducing the value of each numerical quantity expressed in dollars to be consistent with a one-for-one exchange rate with the Euro. As a specific example, the amount of the initial margin threshold is being changed from $65 million in the 2014 proposal to $50 million in the final rule. This change will align the U.S dollar denominated numerical amounts in the final rule with those in the 2013 international framework, will be consistent with amounts that have been proposed in margin rules by the European and Japanese authorities and will be more consistent with the Euro-U.S. Dollar exchange rate prevailing at the time the final rule is published.

B. Section __.2: Definitions

Section __.2 of the final rule defines its key terms.

1. Swap Counterparty Definitions

Section __.2 defines key terms used in the final rule, including the types of counterparties that form the basis of the rule'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, the final rule, like the 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 to the extent their swaps do not qualify for an exemption from clearing pursuant to § __.1(d) as added by the interim final rule.

Below is a general description of the significant terms defined in § __.2 of the final rule.

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

See

§ __.2 of the final rule;

see also

§ __.4 of the final rule (describing variation margin requirements). The final rule's definition of “variation margin” and “variation margin amount” are described in § __.4.

“Counterparty” is defined to mean, with respect to any non-cleared swap or non-cleared security-based swap to which a person is a party, each other party to such non-cleared swap or non-cleared security-based swap. This definition is modified slightly from the proposal to make clear that either party to the swap may be referred to as the counterparty.

The treatment of other counterparties in the final rule thus is only relevant with respect to non-cleared swaps and non-cleared security-based swaps that are not exempt under § __.1(d) of the final rule.

The term “nonfinancial end user” is not used in the final rule. Nonfinancial end users would be treated as “other counterparties” to the extent their swaps do not qualify for an exemption.

See

§§§ __.1(d), __.3(d) and __.4(c) of the final rule.

a. Swap Entity

In the final rule, the Agencies have revised the definition of “swap entity” to clarify that the term applies to persons that have registered with the CFTC as a swap dealer or major swap participant or with the SEC as a security-based swap dealer or major security-based swap participant. The term “swap entity” is used in the final rule in the definition of “covered swap entity” to refer to such an entity that is supervised by one of the Agencies. The term “swap entity” is also used in describing requirements that apply when a covered swap entity engages in non-cleared swaps with a counterparty that is registered with the CFTC or SEC as a dealer or major participant in non-cleared swaps or security-based swaps but is not supervised by one of the Agencies.

The registration status with the CFTC or SEC is central to the scope of the rule's applicability to an entity that is supervised by one of the Agencies. The Commodity Exchange Act requires that “each registered swap dealer and major swap participant for which there is a prudential regulator shall meet such minimum capital requirements and minimum initial and variation margin requirements as the prudential regulator shall by rule or regulation prescribe . . . .”

The Securities Exchange Act imposes a similar requirement for each registered security-based swap dealer and major security-based swap participant.

7 U.S.C. 6s(e)(1)(A). The Commodity Exchange Act imposes registration requirements on a “person” that acts as a swap dealer or security-based swap dealer, defining “person” to “import[ing] the plural or singular, and includ[ing] individuals, associations, partnerships, corporations, and trusts.” 7 U.S.C. 1a(38), 6s(a).

15 U.S.C. 78o-10(e)(1)(A). The Securities Exchange Act imposes registration requirements on a “person” that acts as a security-based swap dealer or major security-based swap participant, defining “person” to mean “a natural person, company, government, or political subdivision, agency, or instrumentality or a government.” 15 U.S.C. 78c(a)(9), 78o-10(a).

For a person that meets the qualitative elements of one or more of the dealer or major participant definitions, whether it is required to register with the applicable Commission will require an application of the minimum thresholds that the Commissions established in their joint regulation. For purposes of this margin rule, “swap entity” refers only to those persons that have actually registered with the applicable Commission as a dealer or major participant in non-cleared swaps or security-based swaps.

An entity that is supervised by one of the Agencies that fails to register with the applicable Commission as a dealer or major participant in non-cleared swaps or security-based swaps would be subject to enforcement action by the applicable Commission as well as by the Agency that is its prudential regulator.

b. Financial End User

In order to provide certainty and clarity to counterparties as to whether they would be financial end users for purposes of this final rule, 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. In the final rule, as under the proposed rule, the Agencies are relying, to the greatest extent possible, on the counterparty's legal status as a regulated financial entity.

Under the final rule, 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 U.S. intermediate holding company established or designated for purposes of compliance with 12 CFR 252.153; 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, a 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, as amended (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 in accordance with the Farm Credit Act of 1971, as amended, 12 U.S.C. 2001

et seq.

that is regulated by the Farm Credit Administration;

As discussed elsewhere in this preamble, FCS institutions are financial end users, although TRIPRA exempts almost all of the non-cleared swaps of all FCS institutions, except Farmer Mac, from the initial and variation requirements of this final rule.

• 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 U.S. Securities and Exchange Commission 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 Act of 1940 (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 of 1936 (7 U.S.C. 1a(10), 7 U.S.C. 1a(11), 7 U.S.C 1a(12)); a floor broker, a floor trader, or introducing broker as defined, respectively, in 1a(22), 1a(23) and 1a(31) of the Commodity Exchange Act of 1936 (7 U.S.C. 1a(22), 1a(23), and 1a(31)); or a futures commission merchant as defined in 1a(28) of the Commodity Exchange Act of 1936 (7 U.S.C. 1a(28));

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

• An entity that is or would be a financial end user or swap entity, if it were organized under the laws of the United States or any State.

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 final 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. This approach is consistent with the risk-based approach of the final rule, as 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 is the case for 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.

As noted above, TRIPRA also exempts certain swaps of nonfinancial end users and certain other counterparties from the requirements of this rule.

In developing the list of financial entities, the Agencies sought to include entities that engage in financial activities that give rise to Federal or State registration or chartering requirements, such as deposit taking and lending, securities and swaps dealing, or investment advisory activities. The list also includes asset management and securitization entities. For example, certain 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 definition of financial end user in the final rule broadly includes entities organized as insurance companies or supervised as such by a State insurance regulator. This element of the final rule's definition would extend to reinsurance and monoline insurance firms, as well as insurance firms supervised by a foreign insurance regulator.

The Agencies intend 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 have included State-licensed or registered credit or lending entities and money services businesses under the final rule's provision 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 excluding an entity registered or licensed solely on account of financing the entity's direct sales of goods or services to customers.

Under the final 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.

The treatment of non-cleared swaps of these financial cooperatives may differ under the final rule due to TRIPRA, which became law after the proposal was issued. More specifically, almost all swaps of the cooperatives that are financial end users qualify for an exemption from clearing if certain conditions are met,

and therefore, these non-cleared swaps also would qualify for an exemption from the initial and variation margin requirements under § __.1(d) of the interim final rule. Non-cleared swaps of such financial cooperatives that do not qualify for an exemption would be treated as non-cleared swaps of financial end users under the final rule.

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 final rule's coverage of credit or lending entities. However, these cooperatives could elect an exemption from clearing under a CFTC regulation, 17 CFR 50.51, and as a result, their non-cleared swaps would also be exempt from the margin requirements of the final rule pursuant to § __.1(d), as added by the interim final rule.

Section IID of the preamble to § __.1 more fully discusses the status of FCS institutions as financial end users and their exemptions from clearing and the margin requirements.

The National Rural Utility Cooperative Finance Cooperation (“CFC”) is an example of another financial cooperative. The CFC's comment letter requested that the Agencies exempt swaps entered into by nonprofit cooperatives from the margin requirement to the extent they that are already exempt from clearing requirements. Section __.1(d)), as added by the interim final rule, responds to the CFC's concerns.

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 final rule 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. Moreover, certain swaps of these entities may be exempt pursuant to TRIPRA and § __.1(d)), as added by the interim final rule.

Section 2(h)(7)(C)(ii) of the Commodity Exchange Act and section 3C(g)(4) of the Securities Exchange Act authorize the CFTC and the SEC, respectively, to exempt small depository institutions, small FCS 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 4(c)(1) of the Commodity Exchange Act, enacted 17 CFR part 50, subpart C, § 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.

In order to address concerns, now or in the future, that one or more types of financial entities might escape classification under the specific Federal or State regulatory regimes included in the definition of a “financial end user,” the Agencies have inserted language that would cover an entity, person, or arrangement that is, or holds itself out as an entity, person or arrangement that raises money from investors, accepts money from clients, or uses its own money primarily for the purpose of investing or trading or facilitating the investing or trading 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 final rule's definition of “financial end user” is largely similar to the proposed definition, with a few modifications. In the final rule, the Agencies added as a financial end user a U.S. intermediate holding company (“IHC”) established or designated for purposes of compliance with the Board's Regulation YY (12 CFR 252.153). Pursuant to Regulation YY, a foreign banking organization with U.S. non-branch assets of $50 billion or more must establish a U.S. IHC and transfer its ownership interest in the majority of its U.S. subsidiaries to the IHC by July 1, 2016. As not all IHCs will be bank holding companies, the Agencies are explicitly identifying IHCs in the list of financial end users to clarify that they are included. To the extent an IHC that is not itself registered as a swap entity enters into non-cleared swaps with a covered swap entity, the IHC would be treated as a financial end user like other types of holding companies that are not swap entities (

e.g.,

bank holding companies and saving and loan holding companies).

In order to address concerns raised by commenters, the final rule removes the provision in the definition of “financial end user” that included any other entity that the relevant Agency has determined should be treated as a financial end user. A few commenters urged the Agencies to remove this provision due to concerns that it created uncertainty. In response to this concern, the Agencies have removed this provision from the final rule's definition of “financial end user.” The Agencies will monitor the margin arrangements of swap transactions of covered swap entities to determine if certain types of counterparties, in fact, are financial entities that some reason are not covered by the definition of “financial end user” in the final rule. In the event that the Agencies find that one or more types of financial entities escape classification as financial end users under the final rule, the Agencies may consider another rulemaking that would amend the definition of “financial end user” to cover such entities.

Many of the provisions in the financial end user definitions rely on whether an entity's financial activities trigger Federal or State registration or chartering requirements. The Agencies proposed to include foreign financial entities that are not subject to U.S. law but are engaged in the same types of activities as U.S. financial end users. The proposed definition of “financial end user” included any entity that would be a financial end user if it were organized under the laws of the United States or any State. A few commenters argued that the proposed test is difficult to apply because it would require a covered swap entity to analyze a foreign counterparty's business activities in light of a broad array of U.S. regulatory requirements.

The Agencies have not modified this provision of the final rule in response to these concerns raised by commenters. Although the Agencies acknowledge that the proposed test imposes a greater

incremental burden in classifying foreign counterparties than it does in identifying U.S. financial end users, the Agencies have retained it in the final rule. On balance, the Agencies believe the approach in the final rule is the best alternative to capture the kinds of entities whose profitability and viability is most tightly linked to the health of the financial system. In this respect, the Agencies' financial end user definition is broad by design. Exclusion from the financial end user definition for any enterprise engaged extensively in financial and market activities should, as a practical matter, be the exception rather than the rule. The Agencies believe it is appropriate to require a covered swap entity that seeks to exclude a foreign financial enterprise from the rule's margin requirements to ascertain the basis for that exclusion under the same laws that apply to U.S. entities. The Agencies have included in the final rule not only an entity that is or would be a financial end user but also an entity that is or would be a swap entity, if it were organized under the laws of the United States or any State. Since a financial end user is defined as “a counterparty that is not a swap entity,” the purpose of this addition is to make clear that an entity that is not a registered swap entity in the United States but acts as a swap entity in a foreign jurisdiction would be treated as a financial end user under the final rule.

As explained above, in an attempt to provide a level of certainty to financial participants and to clarify the definition of a financial end user, the Agencies proposed an enumerated list which included several CFTC-registered entities. In the final rule, the Agencies have added three other CFTC-registered entities to the enumerated list, floor brokers, floor traders, and introducing brokers.

As defined in section 1a(22) of the Commodity Exchange Act, a floor broker generally provides brokering services on an exchange to clients in purchasing or selling any future, security future, swap, or commodity option. As defined in section 1a(23) of the Commodity Exchange Act, a floor trader generally purchases or sells on an exchange solely for that person's account, any future, security future, swap, or commodity option. As defined in section 1a(31) of the Commodity Exchange Act, an introducing broker generally means any person who engages in soliciting or in accepting orders for the purchase and sale of any future, security future, commodity option, or swap. In addition, it also includes anyone that is registered with the CFTC as an introducing broker.

In deciding to add these entities to the definition of financial end-user, the Agencies determined that these entities' services and activities are financial in nature and that these entities provide services, engage in activities, or have sources of income that are similar to financial entities already included in the definition. The Agencies believe that by including these financial entities in the definition of financial end user, the definition provides additional clarity to covered swap entities when engaging in non-cleared swaps with these entities. As noted above, financial entities are considered to pose greater systemic risk than nonfinancial entities and as such, the Agencies believe that these entities, whose activities, services, and sources of income are financial in nature, should be included in the definition of financial end user.

In the proposal, the Agencies included in the definition of a financial end user “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.” In addition to asking whether the definition was too broad or narrow, as noted above, the Agencies asked questions as to whether this prong of the definition was broad enough to capture other types of pooled investment vehicles that should be treated as financial end users.

After reviewing all comments, the Agencies are broadening this prong of the definition to include other types of entities and persons that primarily engage in trading, investing, or in facilitating the trading or investing in loans, securities, swaps, funds or other assets. In broadening the definition, the Agencies believe that the enumerated list in the proposal of financial end users was not inclusive enough to cover certain financial entities that were not organized as pooled investment vehicles but that traded or invested their own or client funds (

e.g.,

high frequency trading firms) or that provided other financial services to their clients.

As noted above, the Agencies believe that 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. Accordingly, the Agencies have adopted a definition of financial end user that includes the types of firms that engage in the activities described above.

The final rule, like the proposal, excludes certain types of counterparties from the definition of financial end user. In particular, the final rule 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

§ __.2 of the final rule. A sovereign entity would include the European Central Bank for purposes of this exclusion. At least one commenter expressed support for the exclusion of sovereign entity from the financial end user definition.

• 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 relevant Agency determines poses comparable credit risk.

See

§ __.2 of the final rule.

• 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 of 1936 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 of 1936 or section 3C(g)(4) of the Securities Exchange Act of 1934 and implementing regulations.

The Agencies 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 covered swap entity. Thus, the Agencies believe that the application of margin requirements to swaps with these counterparties is not necessary to achieve the safety and soundness objectives of this rule.

100

Rather, the Agencies have included provisions in the final rule that would require covered swap entities to subject these “other counterparties” to margin requirements to the extent that their

own internal risk management procedures would require that these counterparty relationships be margined.

100

As further discussed below, the final rule specifically excludes these entities from the definition of “financial end users.” Instead, they are treated as “other counterparties” with respect to the rule's initial and variation margin requirements to the extent the swaps they enter into with covered swap entities are not otherwise exempt from the requirements of this rule. With respect to the initial margin requirements, the “other counterparties” category also includes financial end users that do not have a material swaps exposure.

A few commenters argued that the exclusion from financial end user for a person that qualifies for the affiliate exemption from clearing pursuant to section 2(h)(7)(D) of the Commodity Exchange Act requires an entity to be acting

as agent

for an affiliate and thus would not capture equivalent entities that act

as principal

for an affiliate. These commenters contended that many such entities act as principal for an affiliate and that the CFTC has issued no-action letters, effectively exempting such entities from clearing.

101

As noted above, the Agencies intend to align the exclusions from the definition of financial end user as much as possible with statutory exceptions as well as exclusions implemented by the CFTC by rule. The Agencies note that to the extent the CFTC acts to exempt such entities from clearing by rule, these entities would also be excluded from the definition of financial end user for purposes of this rule.

101

See

CFTC No-Action Letter No. 13-22 (June 4, 2013); CFTC No-Action Letter No. 14-144 (Nov. 26, 2014).

A few commenters requested that the Agencies exclude from the definition of financial end user those entities guaranteed by a foreign sovereign or multilateral development bank.

102

As described above, the final rule excludes from the definition of financial end user a “sovereign entity” defined to mean a central government (including the U.S. government) or an agency, department, or central bank of a central government. An entity guaranteed by a sovereign entity is not explicitly excluded from the definition of financial end user in the final rule, unless that entity qualifies as a central government agency, department, or central bank. The existence of a government guarantee does not in and of itself exclude the entity from the definition of financial end user.

102

Some commenters requested additional clarity that certain entities would be included as multilateral development banks. The definition in the final rule includes 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 relevant Agency determines poses comparable credit risk. Entities that meet this part of the definition would be treated as multilateral development banks for purposes of the final rule.

Similarly, the Agencies note that States would not be excluded from the definition of financial end user in the final rule, as the term “sovereign entity” includes only central governments. This does not mean, however, that States are categorically classified as financial end users. Whether a State or particular part of a State (

e.g.,

counties, municipalities, special administrative districts, agencies, instrumentalities, or corporations) would be 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 (“ERISA”), as amended, (29 U.S.C. 1002), would meet the definition of financial end user. Commenters requested that the Agencies exclude a number of other financial entities from the requirements of the final rule including certain small depository institutions that qualify for an exception from clearing, certain financial cooperatives, employee benefit plans (such as pension plans), and covered bond issuers. Depository institutions, financial cooperatives, employee benefit plans, structured finance vehicles, and covered bond issuers are financial end users for purposes of the final rule. However, as discussed earlier, § __.1(d), as added by the interim final rule published elsewhere in this

Federal Register

, addresses some of the commenters' concerns by exempting the non-cleared swaps of certain small depository institutions and financial cooperatives from the margin requirements of the final rule because these entities already qualify for exemption from clearing. The non-cleared swaps of small depository institutions and financial cooperatives that do not qualify for the exemptive treatment would be treated as swaps of financial end users under the final rule.

With respect to employee benefit plans, commenters generally argued that these plans should not be subject to margin requirements because they are highly regulated, highly creditworthy, have low leveraged and are prudently managed counterparties whose swaps are used primarily for hedging and, as such, pose little risk to their counterparties or the broader financial system. One commenter urged the Agencies to exclude both U.S. and non-U.S. public and private employee benefit plans where swaps are hedging risk. This commenter also contended that there may be ambiguity whether certain pension plans are financial end users if they are not subject to ERISA. Another commenter argued that current market practice is not to require initial margin for pension plans. The Agencies have considered these comments in light of the purpose and intent of the statute and continue to believe that pension plans should be covered as financial end users under the final rule. Congress explicitly listed an employee benefit plan as defined in paragraph (3) and (32) of section 3 of ERISA in the definition of “financial entity” in the Dodd-Frank Act, meaning that a pension plan would not benefit from an exclusion from clearing even if the pension plan uses swaps to hedge or mitigate commercial risk. The Agencies believe that, similarly, when a pension plan enters into a non-cleared swap with a covered swap entity, the pension plan should be treated as a financial end user and subject to the requirements of the final rule.

The definition of employee benefit plan in the final rule is the same as in the proposal and is defined by reference to paragraphs (3) and (32) of ERISA. Paragraph (3) provides that the term “employee benefit plan” or “plan” means an employee welfare benefit plan or an employee pension benefit plan or a plan which is both an employee welfare benefit plan and an employee pension benefit plan. Paragraph (32) describes certain governmental plans. In response to concerns raised by commenters, the Agencies believe that these broad definitions would cover all pension plans regardless of whether the pension plan is subject to ERISA. In addition, non-U.S. employee benefit plans would be included as an entity that would be a financial end user, if it were organized under the laws of the United States or any State thereof.

A number of commenters also requested that the Agencies exclude from financial end user structured finance vehicles including securitization special purpose vehicles (“SPVs”) and covered bond issuers. These commenters argued that imposing margin requirements on structured finance vehicles would restrict their ability to hedge interest rate and currency risk and potentially force these vehicles to exit swaps markets since these vehicles generally do not have ready access to liquid collateral. Certain of these commenters also expressed concerns about consistency with the treatment under the EU proposal. One commenter stated that the EU proposal has special criteria for covered bond issuers and that covered bond issuers should be able to use collateral arrangements other than the requirements in the Agencies' proposal. Moreover, commenters argued that covered swap entities that enter into a swap may be protected by other means—

e.g.,

a security interest granted in the assets of a securitization SPV. Commenters also urged that these types of entities make payments on a monthly payment cycle using collections

received on the underlying assets during the previous month and would not be able to make daily margin calls. These commenters argued that significant structural changes would be necessary for securitization SPVs to post and collect variation margin. These commenters urged the Agencies to follow the approach of the proposed European rules, under which securitization vehicles would be defined as non-financial entities and would not be required to exchange initial or variation margin. With respect to covered bond issuers, commenters similarly urged the Agencies to follow the EU margin proposal which provided a special set of criteria for covered bond issuers and requested that the Agencies develop rules that would permit covered bond issuers to use other forms of collateral arrangements.

The Agencies have not modified the definition of financial end user to exclude structured finance vehicles or covered bonds issuers. The Agencies believe that all of these entities should be classified as financial end users; their financial and market activities comprise the same range of activities as the other entities encompassed by the final rule's definition of financial end user. The Agencies note that the increased material swaps exposure in the final rule should address some of the concerns raised by these commenters with respect to the applicability of initial margin requirements.

c. Material Swaps Exposure

The final rule, like the proposal, distinguishes between swaps with financial end user counterparties depending on whether the counterparty has a “material swaps exposure.” In the final rule, “material swaps exposure” for an entity means that an 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 calendar year that exceeds $8 billion, where such amount is calculated only for business days.

103

The final rule's definition also provides that an entity shall count the average daily aggregate notional amount of a non-cleared swap, a non-cleared security-based swap, a foreign exchange forward or a foreign exchange swap between the entity and an affiliate only one time and that, for purposes of this calculation, an entity shall not count a swap or security-based swap that is exempt pursuant to § __.1(d), as added by the interim final rule.

103

The final rule also includes a new definition of “business day” that means any day other than a Saturday, Sunday, or legal holiday. This definition is described further below.

The final rule increases the level of the aggregate notional amount of transactions that gives rise to material swaps exposure to $8 billion from the proposed level of $3 billion. A number of commenters argued that the Agencies should raise the level of material swaps exposure to the threshold of €8 billion set out in the 2013 international framework to be consistent with the EU and Japanese proposals.

104

In the 2014 proposal, the Agencies had calibrated the proposed $3 billion threshold to the size of a potential swap portfolio between a covered swap entity and a financial end user for which the initial margin amount would often exceed the proposed initial margin threshold amount of $65 million, with an eye towards reducing the burden of calculating initial margin amounts for smaller portfolios. However, some commenters expressed the view that the international implementation of material swaps exposure threshold treats the threshold more as a scope provision, to define the group of financial firms in the swaps market whose activities rise to a level appropriate to the exchange of initial margin as a policy matter.

105

While commenters representing public interest groups and CCPs expressed policy concerns about whether the $3 billion threshold was conservative enough, focusing on the collective systemic risk posed by all smaller counterparties in the aggregate, other commenters representing covered swap entities and financial end users expressed concerns about the additional initial margin they would be required to exchange compared to foreign firms, and the associated competitive impacts.

104

See supra

note 20.

105

For example, one commenter acknowledged data described by the Agencies in the proposed rule indicating that bilateral initial margin exposures between one covered swap entity and a financial end user could exceed $50 million for a portfolio with a gross notional value well below the USD-equivalent of the international €8 billion threshold. But the commenter urged the Agencies to shift their focus from the $65 million amount, as a bilateral constraint, and recognize that a financial end user will often use multiple dealers. Accordingly, the commenter urged the Agencies to treat the material swaps exposure threshold as a focus on a financial end user's multilateral exposures with all its dealers, which provides the rationale for the higher international threshold.

The material swaps exposure threshold of $8 billion in the final rule is broadly consistent with the €8 billion established by the 2013 international framework and has been calibrated relative to this level in the manner described previously. At this time, the Agencies believe the better course is to calibrate the final rule's material swaps exposure threshold to the higher international amount, in recognition of each financial end user's overall potential future swaps exposure to the market rather than its potential future exposure to one dealer. In this regard, the Agencies note that variation margin will still be exchanged without any threshold, and further that the $8 billion threshold may warrant further discussion among international regulators in future years, if implementation of the threshold proves to create concerns about market coverage for initial margin.

The time period for measuring material swaps exposure is June, July, and August of the previous calendar year under the final rule, the same period as in the proposal.

106

As discussed in the proposed rule, the Agencies believe that using the average daily aggregate notional amount

107

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 to 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. A covered swap entity would calculate material swaps exposure each year on January 1 based on June, July, and August of the previous year. For example, for the period January 1, 2017 through December 31, 2017, an entity would determine whether it had a material swaps exposure with reference to June, July and August of 2016.

108

106

One commenter suggested that the period to determine material swaps exposure should match the compliance date period. The Agencies have decided to use June, July and August of the previous year to determine material swaps exposure as these dates are close to year end but provide swap users with a period of time to gather and verify the required data before performing the required calculation at the end of the year.

107

A few commenters suggested that a daily aggregate notional measure was burdensome and that the Agencies should use a month-end notional amount like the EU proposal and consistent with the 2013 international framework.

108

As a specific example of the calculation for material swaps exposure, consider a U.S.-.based 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 2016. Furthermore, suppose that a foreign exchange forward is added to the entity's portfolio at the end of the day on July 31, 2016, and that its notional value is $10 billion on every business day

of August 2016. On each business day of June and July 2016, the aggregate notional amount of non-cleared swaps, security-based swaps and foreign exchange forwards and swaps is $30 billion. Beginning on August 1, 2016, 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 2016 is then (22x$30 billion +20x$30 billion + 23x$40 billion)/(22+20+23)=$33.5 billion, in which case this entity would be considered to have a material swaps exposure for every date in 2017.

The definition of “material swaps exposure” also clarifies questions raised about the treatment of affiliates in the proposed definition. Commenters urged the Agencies to make clear that inter-affiliate swaps would not be included for purposes of determining the material swaps exposure. Some of these commenters also expressed concern that the proposal could require an entity to double count inter-affiliate swaps in assessing material swaps exposure. In order to address concerns about double counting affiliate swaps, the final rule provides that an entity shall count the average daily aggregate notional amount of a non-cleared swap, a non-cleared security-based swap, a foreign exchange forward or a foreign exchange swap between the entity and an affiliate only one time. The purpose of this modification is to clarify that an entity should not double count swaps with an affiliate in calculating material swaps exposure.

109

The Agencies also believe that the revised definition of affiliate in the final rule (described below) should help mitigate some of the concerns raised by commenters about the inclusion of affiliate swaps in determining material swaps exposure.

110

109

The Agencies made a similar change to the definition of “initial margin threshold amount” as described in § __.3.

110

For example, the revised definition of “affiliate” generally would not treat investment funds that share an investment adviser or investment manager as affiliates unless they otherwise meet the definition of affiliate.

The final rule's definition of material swaps exposure also states that for purposes of this calculation, an entity shall not count a swap that is exempt pursuant to § __.1(d), as added by the interim final rule.

111

This change is consistent with the statutory exemptions provided by Congress in TRIPRA and ensures that exempt swaps do not count toward determining whether an entity has material swaps exposure.

111

The Agencies made a similar change to the definition of “initial margin threshold amount” as described in § __.3.

Commenters argued that certain other swaps should not be counted for purposes of the material swaps exposure calculation. A few commenters argued that foreign exchange swaps and foreign exchange forwards that are exempt from the definition of swap by Treasury determination should not be included for purposes of determining material swaps exposure.

112

Other commenters argued that hedging positions should not be counted toward material swaps exposure. One commenter urged that swaps entered into before the effective dates for mandatory clearing should not be counted for determining material swaps exposure. The Agencies are not incorporating requests by commenters to alter the calculation of the threshold amount in these or other related ways.

113

Although commenters advanced various rationales for each of the requested changes, all the changes had the effect of excluding certain portions of a financial end user's derivatives portfolio from the threshold. The Agencies believe the final rule's approach is appropriate since it strikes a reasonable balance between assessing a swap counterparty's overall size and risk exposure and providing for a simple and transparent measurement of exposure that presents only a modest operational burden. The Agencies believe that the increase in the level of the material swaps exposure to $8 billion in the final rule should address many of the concerns raised by commenters about the inclusion of particular categories of swaps. Moreover, given that the Agencies are viewing the final rule's material swaps exposure as an indicator of a financial end user's overall exposure in the market and revising the threshold upward to $8 billion, the Agencies believe the inclusiveness of the calculation adopted in the final rule is appropriate. A few commenters urged the Agencies to make clear that a covered swap entity may rely on representations of its counterparties in assessing whether it is transacting with a financial end user with material swaps exposure. Although the final rule does not explicitly provide how a covered swap entity should determine if a financial end user counterparty has material swaps exposure, the Agencies believe that it would be reasonable for a covered swap entity to rely in good faith on reasonable representations of its counterparty in making such assessments.

112

Some of these commenters expressed heightened concern about the impact of the Agencies' approach on financial end users that engage in significant foreign exchange transactions that are not subject to margin requirements together with relatively few marginable swaps. The final rule defines “foreign exchange forward and foreign exchange swap” 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)).

See

§ __.2 of the final rule.

113

For example, one commenter urged the Agencies to conform with the 2013 international framework where material swaps exposure is based on derivatives (not swaps). Another commenter urged the Agencies to exclude registered swap dealers from the material swaps exposure calculation as this could cause affiliates of the swap dealer to exceed the material swaps exposure threshold. The final rule does not exclude registered swap dealers from the material swaps exposure threshold. The Agencies believe that financial affiliates of a registered swap dealer should be treated as having a material swaps exposure based on their level of risk.

One commenter urged the Agencies to clarify what happens when a financial end user counterparty that had a material swaps exposure falls below the threshold. Because the material swaps exposure determination applies to a financial end user for an entire calendar year, depending on whether the financial end user exceeded the threshold during the third calendar quarter of the previous year, it is possible for a covered swap entity to have a portfolio of swaps with a financial end user whose status under the material swaps exposure test changes from time to time. New § ___.1(g) of the final rule addresses this concern and explains what happens upon a change in counterparty status. For example, if a financial end user is moving below the threshold for the upcoming calendar year, the covered swap entity is not obligated under the final rule to exchange initial margin with that end user during that calendar year, either for new swaps entered into that year or existing swaps from a prior year. Financial end users without material swaps exposure are treated as “other counterparties” for purposes of the initial margin requirements in the final rule. Moreover, any margin that had previously collected while the counterparty had a material swaps exposure would not be required under the final rule for as long as the counterparty did not have a material swaps exposure. In addition, a covered swap entity's swaps with a financial end user without material swaps exposure would continue to be subject to the variation margin requirements of the final rule. If a financial end user is moving above the threshold for the upcoming calendar year, the treatment of the existing swaps and the new swaps is the same as described for swaps before and after the rule's compliance implementation date. As described in more detail below under § ___.5, the parties have the option to document the old and new swaps as separate portfolios for netting purposes under an EMNA, and exchange initial margin

only for the new portfolio of swaps entered into during the new calendar year after the financial end user triggered the material swaps exposure threshold determination.

d. Non-Cleared Swap and Non-Cleared Security-Based Swap

The requirements of this rule are, as a threshold matter, applicable to non-cleared swaps between covered swap entities and their counterparties. The final rule defines “non-cleared swap” to mean a swap that is not cleared by a derivatives clearing organization registered with the Commodity Futures Trading Commission pursuant to section 5b(a) of the Commodity Exchange Act of 1936 (7 U.S.C. 7a-1(a)) or by a clearing organization that the Commodity Futures Trading Commission has exempted from registration by rule or order pursuant to section 5b(h) of the Commodity Exchange Act of 1936 (7 U.S.C. 7a-1(h)). The final rule defines “non-cleared security-based swap” to mean a security-based swap that is not, directly or indirectly, submitted to and cleared by a clearing agency registered with the U.S. Securities and Exchange Commission pursuant to section 17A(b)(1) of the Securities Exchange Act of 1934 (15 U.S.C. 78q-1(b)(1)) or by a clearing agency that the U.S. Securities and Exchange Commission has exempted from registration by rule or order pursuant to section 17A(k) of the Securities Exchange Act of 1934 (15 U.S.C. 78q-1(k)).

In the proposal, the Agencies defined a “non-cleared swap” as a swap that is not a cleared swap as defined in section 1a(7) of the Commodity Exchange Act. Under section 1a(7) of the Commodity Exchange Act, the term “cleared swap” means any swap that is, directly or indirectly, submitted to and cleared by a derivatives clearing organization registered with the CFTC. “Non-cleared security-based swap” was defined in the proposal to mean a security-based swap that is not, directly or indirectly, submitted to and cleared by a clearing agency registered with the SEC.

114

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)).

A few commenters urged the Agencies to define non-cleared swaps and non-cleared security-based swaps to exclude swaps cleared through non-U.S. clearing organizations that are not registered with the CFTC or SEC. The Agencies have modified the definition of these terms in the final rule to address these comments.

Under sections 731 and 764, the Agencies are directed to impose initial and variation margin requirements on all swaps that are not cleared by a registered derivatives clearing organization and on all security-based swaps that are not cleared by a registered clearing agency. The Agencies are interpreting this statutory language to mean all swaps that are not cleared by a registered derivatives clearing organization or registered clearing agency or a derivatives clearing organization or clearing agency that the CFTC or SEC has exempted from registration as provided under the Commodity Exchange Act and Securities Exchange Act, respectively. In particular, the Commodity Exchange Act prohibits persons from engaging in a swap that is required to be cleared unless they submit such swaps for clearing to a derivatives clearing organization that is either registered with the CFTC as a derivatives clearing organization or exempt from registration. Section 5b(h) of the Commodity Exchange Act allows the CFTC to exempt, conditionally or unconditionally, a derivatives clearing organization from registration for the clearing of swaps, where the derivatives clearing organization is subject to “comparable, comprehensive supervision and regulation” by the appropriate government authorities in its home country. The Agencies understand that the CFTC has granted, by order, relief from registration to a derivatives clearing organization pursuant to section 5b(h)

115

and would consider granting relief to other derivatives clearing organizations bef

This text is long and has been trimmed here. Open the source document for the complete record.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.