Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants

Federal RegisterJan 6, 2016

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 23 and 140

RIN 3038-AC97

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Final rule and interim final rule.

SUMMARY:

The Commodity Futures Trading Commission (“Commission” or “CFTC”) is adopting regulations to implement a particular provision of the Commodity Exchange Act (“CEA”), as added by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). This provision requires the Commission to adopt initial and variation margin requirements for certain swap dealers (“SDs”) and major swap participants (“MSPs”). The final rules would establish initial and variation margin requirements for SDs and MSPs but would not require SDs and MSPs to collect margin from non-financial end users.

The Commission is also adopting and inviting comment on an interim final rule that will exempt certain uncleared swaps with certain counterparties from these margin requirements. This interim final rule implements Title III of the Terrorism Risk Insurance Program Reauthorization Act of 2015 (“TRIPRA”), which exempts from the margin rules for uncleared swaps certain swaps for which a counterparty qualifies for an exemption or exception from clearing under the Dodd-Frank Act.

DATES:

The rules will become effective April 1, 2016. Comments on the interim final rule (§ 23.150(b)) must be received on or before February 5, 2016.

ADDRESSES:

You may submit comments on the interim final rule by any of the following methods:

• CFTC Web site:

http://comments.cftc.gov

. Follow the instructions for submitting comments through the Comments Online process on the Web site.

• Mail: Send to Christopher Kirkpatrick, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581.

• Hand Delivery/Courier: Same as Mail, above.

• Federal eRulemaking Portal:

http://www.regulations.gov

. Follow the instructions for submitting comments.

Please submit your comments using only one of these methods.

All comments must be submitted in English, or if not, accompanied by an English translation. Comments will be posted as received to

http://www.cftc.gov

. You should submit only information that you wish to make available publicly. If you wish the Commission to consider information that may be exempt from disclosure under the Freedom of Information Act, a petition for confidential treatment of the exempt information may be submitted according to the procedures established in § 145.9 of the Commission's regulations.

17 CFR 145.9. Commission regulations referred to herein are found at 17 CFR Chapter I.

The Commission reserves the right, but shall have no obligation, to review, pre-screen, filter, redact, refuse or remove any or all of your submission from

www.cftc.gov

that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been redacted or removed that contain comments on the merits of the rulemaking will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under the Freedom of Information Act.

FOR FURTHER INFORMATION CONTACT:

John C. Lawton, Deputy Director, Division of Clearing and Risk, 202-418-5480,

jlawton@cftc.gov

; Thomas J. Smith, Deputy Director, Division of Swap Dealer and Intermediary Oversight, 202-418-5495,

tsmith@cftc.gov

; Rafael Martinez, Senior Financial Risk Analyst, Division of Swap Dealer and Intermediary Oversight, 202-418-5462,

rmartinez@cftc.gov

; Francis Kuo, Special Counsel, Division of Swap Dealer and Intermediary Oversight, 202-418-5695,

fkuo@cftc.gov

; Paul Schlichting, Assistant General Counsel, Office of General Counsel, 202-418-5884,

pschlichting@cftc.gov

; Stephen A. Kane, Research Economist, Office of the Chief Economist, 202-418-5911,

skane@cftc.gov

; or Lihong McPhail, Research Economist, Office of the Chief Economist, 202-418-5722,

lmcphail@cftc.gov

; Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. Statutory Authority

B. International Standards

C. Proposed Rules

D. Subsequent Amendment to Dodd-Frank

II. Final Rules

A. Overview

B. Products

C. Participants

D. Nature and Timing of Margin Requirements

E. Calculation of Initial Margin

F. Calculation of Variation Margin

G. Forms of Margin

H. Custodial Arrangements

I. Inter-Affiliate Trades

J. Implementation Schedule

III. Interim Final Rule

IV. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

V. Cost Benefit Considerations

Appendix A to the Preamble

Appendix B to the Preamble

I. Background

A. Statutory Authority

On July 21, 2010, President Obama signed the Dodd-Frank Act.

Title VII of the Dodd-Frank Act amended the CEA

to establish a comprehensive regulatory framework designed to reduce risk, to increase transparency, and to promote market integrity within the financial system by, among other things: (1) Providing for the registration and regulation of SDs and MSPs; (2) imposing clearing and trade execution requirements on standardized derivative products; (3) creating recordkeeping and real-time reporting regimes; and (4) enhancing the Commission's rulemaking and enforcement authorities with respect to all registered entities and intermediaries subject to the Commission's oversight.

See

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

7 U.S.C. 1

et seq.

Section 731 of the Dodd-Frank Act added a new section 4s to the CEA setting forth various requirements for SDs and MSPs. Section 4s(e) mandates the adoption of rules establishing margin requirements for uncleared swaps of SDs and MSPs.

Each SD and MSP for which there is a Prudential Regulator, as defined below, must meet margin requirements for their uncleared swaps established by the applicable Prudential Regulator, and each SD and MSP for which there is no Prudential Regulator must comply with the Commission's regulations governing margin.

Section 4s(e) also directs the Commission to adopt capital requirements for SDs and MSPs. The Commission proposed capital rules in 2011. Capital Requirements for Swap Dealers and Major Swap Participants, 76 FR 27802 (May 12, 2011). The Commission will address capital requirements in a separate release.

The term Prudential Regulator is defined in section 1a(39) of the CEA, as amended by Section 721 of the Dodd-

Frank Act. This definition includes the Federal Reserve Board (“FRB”); the Office of the Comptroller of the Currency (“OCC”); the Federal Deposit Insurance Corporation (“FDIC”); the Farm Credit Administration; and the Federal Housing Finance Agency.

The definition specifies the entities for which these agencies act as Prudential Regulators. These consist generally of federally insured deposit institutions, farm credit banks, federal home loan banks, the Federal Home Loan Mortgage Corporation, and the Federal National Mortgage Association. The FRB is the Prudential Regulator under section 4s not only for certain banks, but also for bank holding companies, certain foreign banks treated as bank holding companies, and certain subsidiaries of these bank holding companies and foreign banks.

The FRB is not, however, the Prudential Regulator for nonbank subsidiaries of bank holding companies, some of which are required to be registered with the Commission as SDs or MSPs. Therefore, the Commission is required to establish margin requirements for uncleared swaps for all registered SDs and MSPs that are not subject to a Prudential Regulator. These include, among others, nonbank subsidiaries of bank holding companies, as well as certain foreign SDs and MSPs.

Specifically, section 4s(e)(1)(B) of the CEA provides that each registered SD and MSP for which there is not a Prudential Regulator shall meet such minimum capital requirements and minimum initial margin and variation margin requirements as the Commission shall by rule or regulation prescribe.

Section 4s(e)(2)(B) provides that the Commission shall adopt rules for SDs and MSPs, with respect to their activities as an SD or an MSP, for which there is not a Prudential Regulator imposing (i) capital requirements and (ii) both initial and variation margin requirements on all swaps that are not cleared by a registered derivatives clearing organization (“DCO”).

Section 4s(e)(3)(A) provides that to offset the greater risk to the SD or MSP and the financial system arising from the use of swaps that are not cleared, the requirements imposed under section 4s(e)(2) shall (i) help ensure the safety and soundness of the SD or MSP and (ii) be appropriate for the risk associated with the uncleared swaps.

Section 4s(e)(3)(C) provides, in pertinent part, that in prescribing margin requirements the Prudential Regulator and the Commission shall permit the use of noncash collateral the Prudential Regulator or the Commission determines to be consistent with (i) preserving the financial integrity of markets trading swaps and (ii) preserving the stability of the United States financial system.

Section 4s(e)(3)(D)(i) provides that the Prudential Regulators, the Commission, and the Securities and Exchange Commission (“SEC”) shall periodically (but not less frequently than annually) consult on minimum capital requirements and minimum initial and variation margin requirements.

Section 4s(e)(3)(D)(ii) provides that the Prudential Regulators, Commission and SEC shall, to the maximum extent practicable, establish and maintain comparable minimum capital and minimum initial and variation margin requirements, including the use of noncash collateral, for SDs and MSPs.

B. International Standards

In October 2011, the Basel Committee on Banking Supervision (“BCBS”) and the International Organization of Securities Commissions (“IOSCO”), in consultation with the Committee on Payment and Settlement Systems (“CPSS”) and the Committee on Global Financial Systems (“CGFS”), formed a working group to develop international standards for margin requirements for uncleared swaps. Representatives of more than 20 regulatory authorities participated. From the United States, the CFTC, the FDIC, the FRB, the OCC, the Federal Reserve Bank of New York, and the SEC were represented.

In July 2012, the working group published a proposal for public comment.

In addition, the group conducted a Quantitative Impact Study (“QIS”) to assess the potential liquidity and other quantitative impacts associated with margin requirements.

BCBS/IOSCO, Consultative Document, Margin requirements for non-centrally cleared derivatives (July 2012).

BCBS/IOSCO, Quantitative Impact Study, Margin requirements for non-centrally cleared derivatives (November 2012).

After consideration of the comments on the proposal and the results of the QIS, the group published a near-final proposal in February 2013 and requested comment on several specific issues.

The group considered the additional comments in finalizing the recommendations set out in the report.

BCBS/IOSCO, Consultative Document, Margin requirements for non-centrally cleared derivatives (February 2013).

The final report was issued in September 2013.

This report (the “2013 international framework”) articulates eight key principles for non-cleared derivatives margin rules, which are described below. These principles represent the minimum standards approved by BCBS and IOSCO and their recommendations to the regulatory authorities in member jurisdictions of these organizations.

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

C. Proposed Rules

The Commission initially proposed margin requirements for SDs and MSPs in 2011. In response to the 2013 international framework, the Commission re-proposed margin requirements in September 2014.

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 79 FR 59898 (Oct. 3, 2014).

In developing the proposed rules, the Commission staff worked closely with the staff of the Prudential Regulators.

In most respects, the proposed rules would establish a framework for margin requirements similar to the Prudential Regulators' proposal. The proposed rules were consistent with the 2013 international framework. In some instances, as contemplated in the framework, the proposed rules provided more detail than the framework. In a few other instances, the proposed rules were stricter than the framework.

As required by section 4s of the CEA, the Commission staff also has consulted with the SEC staff.

D. Subsequent Amendment to Dodd-Frank

On January 12, 2015, the President signed Title III of TRIPRA. Title III amends sections 731 and 764 of the Dodd-Frank Act to exempt certain transactions of certain commercial end users and others from the Commission's capital and margin requirements.

Specifically, section 302 of Title III amends sections 731 and 764 of the Dodd-Frank Act to provide that the Commission's 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.

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

Section 303 of TRIPRA requires that the Commission 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 Commission is adopting § 23.150(b) as part of this final rule. These exemptions are

transaction-based, as opposed to counterparty-based. The Commission will be requesting comment, as required by TRIPRA. If necessary, the Commission will amend § 23.150(b) after receiving comments on the interim final rule.

II. Final Rules

A. Overview

The discussion below addresses: (i) The products covered by the proposed rules; (ii) the market participants covered by the proposed rules; (iii); the nature and timing of the margin obligations; (iv) the methods of calculating initial margin; (v) the methods of calculating variation margin; (vi) permissible forms of margin; (vii) custodial arrangements; (viii) documentation requirements; (ix) the treatment of inter-affiliate swaps;

and (x) the implementation schedule. The Commission received 59 written comments on the proposal.

They are discussed in the applicable sections.

Where appropriate, the preamble uses the term affiliate to mean a margin affiliate and the term subsidiary to mean margin subsidiary, as they are defined in § 23.151.

The written submissions from the public are available in the comment file on

www.cftc.gov

. They include, but are not limited to those listed in Appendix B. In citing these comments, the Commission used the abbreviations set forth in the Appendix B.

The rules adopted herein essentially provide for the same treatment as the rules recently adopted by the Prudential Regulators

with a few exceptions. The areas where there are differences are (i) the anti-evasion provision in the definition of margin affiliate, (ii) the model approval process, (iii) the calculation of variation margin and related documentation requirements, and the (iv) treatment of inter-affiliate trades. Each of these differences is discussed in the applicable section below.

Margin and Capital Requirements for Covered Swap Entities, 80 FR 74840 (Nov. 30, 2015).

The Prudential Regulators also issued a provision addressing cross-border application of their margin rule. The Commission will address this aspect of the rule in a separate rulemaking.

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 80 FR 41376 (July 14, 2015).

B. Products

1. Proposal

As noted above, section 4s(e)(2)(B)(ii) of the CEA directs the Commission to establish both initial and variation margin requirements for certain SDs and MSPs “on all swaps that are not cleared.” As a result, the Commission's proposal covered swaps that are uncleared swaps

and that are executed after the applicable compliance date.

The term uncleared swap is defined in proposed Regulation 23.151.

A schedule of compliance dates is set forth in proposed Regulation 23.160.

The term “cleared swap” is defined in section 1a(7) of the CEA to include any swap that is cleared by a DCO registered with the Commission. The Commission notes, however, that SDs and MSPs also clear swaps through foreign clearing organizations that are not registered with the Commission. The Commission believes that a clearing organization that is not a registered DCO must meet certain basic standards in order to avoid creating a mechanism for evasion of the uncleared margin requirements. Accordingly, the Commission proposed to include in the definition of cleared swaps certain swaps that have been accepted for clearing by an entity that has received a no action letter or other exemptive relief from the Commission to clear such swaps for U.S. persons without being registered as a DCO.

As a result of the determination by the Secretary of the Treasury to exempt foreign exchange swaps and foreign exchange forwards from the definition of swap,

under the proposal the following transactions would not be subject to the requirements: (i) Foreign exchange swaps; (ii) foreign exchange forwards; and (iii) the fixed, physically settled foreign exchange transactions associated with the exchange of principal in cross-currency swaps.

Determination of Foreign Exchange Swaps and Foreign Exchange Forwards Under the Commodity Exchange Act, 77 FR 69694 (Nov. 20, 2012).

In a cross-currency swap, the parties exchange principal and interest rate payments in one currency for principal and interest rate payments in another currency. The exchange of principal occurs upon the inception of the swap, with a reversal of the exchange of principal at a later date that is agreed upon at the inception of the swap. The foreign exchange transactions associated with the fixed exchange of principal in a cross-currency swap are closely related to the exchange of principal that occurs in the context of a foreign exchange forward or swap. Accordingly, the Commission proposed to treat that portion of a cross-currency swap that is a fixed exchange of principal in a manner that is consistent with the treatment of foreign exchange forwards and swaps. This treatment of cross-currency swaps was limited to cross-currency swaps and did not extend to any other swaps such as non-deliverable currency forwards.

2. Comments

The Commission received several comments involving products. Commenters expressed support for the Commission's decision to exempt foreign exchange forwards and swaps

and swaps cleared by an exempt derivatives clearing organization from margin requirements.

One commenter asked for clarification that commodity trade options are not subject to the margin requirements.

See

GFXD (initial margin should not apply to physically-settled foreign exchange swaps and forwards and variation margin should be applied via supervisory guidance or national regulation) and CPFM.

See

ISDA and Sifma (any swap cleared by a derivatives clearing organization whether registered or not should be exempt from margin requirements).

See

BP. To the extent that any financial instrument is an uncleared swap, it will be covered under the final rule.

3. Discussion

The Commission is adopting this aspect of the final regulations substantially as proposed. The Commission is modifying the definition of uncleared swap to eliminate the reference to no-action letters and to require that any exemptive relief be provided by Commission order.

Under sections 4s(e), the Commission is directed to impose initial and variation margin requirements on all swaps that are not cleared by a registered derivatives clearing organization. The Commission is interpreting this statutory language to mean all swaps that are not cleared by a registered derivatives clearing organization or a derivatives clearing organization that the Commission has exempted from registration as provided under the CEA.

In particular, the CEA 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 Commission as a derivatives clearing organization or exempt from registration. Section 5b(h) of the CEA allows the Commission to exempt, conditionally or unconditionally, a DCO from registration for the clearing of swaps, where the DCO is subject to “comparable, comprehensive supervision and regulation” by the appropriate government authorities in its home country. The Commission has granted, by order, relief from registration to derivatives clearing organizations pursuant to section 5b(h)

and is considering whether to

grant relief to other derivatives clearing organizations before the implementation date of these rules. Accordingly, the Commission is excluding from the definition of uncleared swap, those swaps that are cleared by a derivatives clearing organization that is either registered with or has received an exemption by order or rule from registration.

See

In the Matter of the Petition of ASX Clear (Futures) Pty Limited for Exemption from

Registration as a Derivatives Clearing Organization (Aug. 18, 2015); In the Matter of the Petition of Japan Securities Clearing Corporation (JSCC) for Exemption from Registration as a Derivatives Clearing Organization (Oct 26, 2015); In the Matter of the Petition of Korea Exchange, Inc (KRX) for Exemption from Registration as a Derivatives Clearing Organization (Oct. 26, 2015).

C. Participants

1. Proposal

Section 4s(e)(3)(A)(2) states that the margin requirements must be “appropriate to the risks associated with” the swaps. Because different types of counterparties can pose different levels of risk, the proposed rules established three categories of counterparty: (i) SDs and MSPs, (ii) financial end users,

and (iii) non-financial end users.

The nature of an SD/MSP's obligations under the rules differed depending on the nature of the counterparty.

This term is defined in Regulation 23.151.

This term is defined in Regulation 23.151 to include entities that are not SDs, MSPs, or financial entities.

2. Comments

Commenters generally urged the Commission to exclude certain entities from the definition of “financial end user.” For example, commenters urged the Commission to exclude foreign funds

and employee benefit plans such as pension plans,

structured finance special purpose vehicles,

certain captive finance units,

entities guaranteed by a foreign sovereign,

small financial institutions (such as small banks) that qualify for an exemption from clearing,

certain financial cooperatives,

covered bond issuers,

and multilateral banks (

e.g.

, International Monetary Fund and World Bank Group).

Commenters also urged the Commission to exclude from margin requirements certain other entities that are exempt from clearing.

One commenter also supported the exclusion of certain payment card networks and payment solution providers from the definition of a “financial end user.”

See

ISDA (contending that it will be difficult for a non-U.S. entity to determine which Investment Company Act exemption would apply if it were organized in the U.S.).

See

ABA (pension plans should not be subject to margin and should be treated as non-financial end users); AIMA (benefit plans should not be subject to margin and there is ambiguity involving whether non-U.S. public and private employee benefit plans would be financial end users); JBA (securities investment funds should be exempt from variation margin).

See

ISDA (structured finance vehicles should be excluded because they do not pose systemic risk, have credit support arrangements to protect counterparties, and lack ready access to liquid collateral for initial and variation margin), JBA (securities investment funds and securitization vehicles are not set up to exchange variation margin and should be treated as non-financial end users), JFMC, Sifma-AMG, SFIG, and Sifma.

See also

FSR (the Commission should explore conditions to minimize risk rather than impose variation margin).

See

SFIG and Sifma (requesting the Commission to exclude structured finance vehicles from the payment of variation margin).

See

CDEU (wholly owned centralized treasury units of non-financial end users that execute swaps on behalf of those non-financial end users should not be treated as financial end users for margin purposes).

See

KfW and ICO (entities backed by the full faith and credit and irrevocable guarantee of a sovereign nation should be either within the definition of a sovereign entity or excluded from the definition of a financial end user and hence not subject to margin requirements).

See also

FMS-WM (legacy portfolio entity backed by the full faith and credit of a sovereign government should be included in the definition of a sovereign).

See

ABA (small banks that qualify for the clearing exemption should be excluded from margin requirements as subjecting them to margin requirements would incentivize them to clear their trades while imposing monitoring costs on them to ensure that they do not have material swaps exposure).

See

CFC.

See

ISDA (arguing 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 Commission's proposal).

See

Sifma (the Commission should align the definition of multilateral banks in the margin regulations to the definition in the clearing exemption and specify that the United Nations and International Monetary Fund are included among multilateral banks) and MFX (MFX contends that it, as a fund, should be considered a multilateral development bank because the U.S. government is a shareholder through the Overseas Private Investment Corporation's involvement in the fund, the fund poses a similar risk profile as that of a multilateral development bank, and the fund engages in the same types of activities as a multilateral development bank).

See

W&C (initial and variation margin should not apply to an eligible treasury affiliate as defined in Commission No-Action Letter No. 13-22); ABA; CFC (entities that are exempt from clearing such as exempt cooperatives should be exempt from margin requirements); and CDEU (special purpose vehicles that are subsidiaries of captive finance companies that are exempt from clearing should be exempt from margin).

But see

AFR (cautioning against the scope of the exemption provided to non-financial end users in the proposal and urging the Commission to separate the clearing and margin exemptions).

See

MasterCard.

Commenters pointed out 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 Commission has issued a no-action letter effectively exempting such entities from clearing.

See

CEWG; Sifma; W&C.

See

CFTC No-Action Letter No. 13-22 (June 4, 2013).

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 leverage 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 Commission 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 the Employee Retirement Income and Security Act of 1974 (“ERISA”) (29 U.S.C. 1002). Another commenter argued that current market practice is not to require initial margin for pension plans.

A number of commenters also requested that the Commission 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 swap markets since these vehicles generally do not have ready access to liquid collateral. These commenters contended that it is impossible for the vast majority of these entities to exchange margin, including variation margin, and that subjecting them to margin requirements would severely restrict the ability of securitization vehicles to hedge interest rate risk and currency risk.

Moreover, commenters argued that covered swap entities, as defined below, that enter a swap may be protected by other means—

e.g.,

a security interest granted in the assets of a securitization SPV. Commenters also noted 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 vehicles to post and collect variation margin.

These commenters urged the Commission 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. 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 Commission's proposal. Commenters similarly urged the Commission to follow the EU margin proposal which provided a special set of criteria for covered bond issuers and requested that the Commission develop rules that would permit covered bond issuers to use other forms of collateral arrangements. One commenter, however, argued that requiring SPVs and other asset-backed security issuers to post full margin against all swap contracts would defuse commonly used “flip clauses” and decrease the loss exposure of investors in asset-backed securities.

See

William J. Harrington.

A few commenters urged the Commission to remove a provision in the proposal allowing the Commission to designate entities as financial end users due to concerns that it would allow the Commission to re-categorize nonfinancial entities as financial end users.

These commenters argued that in order for an entity to be treated as a financial end user, the Commission would have to provide adequate notice and propose an amendment to the rule to address such concerns.

See

CDEU; Joint Associations; IECA.

See

CDEU.

Commenters also pointed out miscellaneous concerns with the proposal. They have asked for clarification with respect to the process for determining whether an entity is a financial end user,

suggested that the change in status of a counterparty over the life of a swap should not affect the classification of the counterparty,

and urged the Commission to align its definition of “financial end user” with the definition put forth by the Prudential Regulators regarding business development companies.

With respect to foreign counterparties, a few commenters argued that the test in the proposal concerning whether a foreign counterparty would be a financial end user if it were organized under the laws of the U.S. or any State 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.

Finally, a commenter commended the Commission on its definition of financial end user.

See

CDEU.

See

ISDA and Sifma.

See

JBA.

See

ISDA (contending that it will be difficult for a non-U.S. entity to determine which Investment Company Act exemption would apply if it were organized in the U.S.);

see also

AIMA (arguing that there is ambiguity regarding whether non-U.S. public and private pension plans would be treated as financial end users).

See

MasterCard (the definition in the margin regulations is commendable because it is narrower than the definition in Commission Regulation 50.50. Entities that engage in financial activities within the meaning of Section 4(k) of the Bank Holding Company Act that are not a financial end user should be allowed to rely on the end user exception).

3. Discussion

a. Covered Swap Entities

As noted above, section 4s(e)(2)(B) of the CEA directs the Commission to impose margin requirements on SDs and MSPs for which there is no Prudential Regulator. These entities are defined in proposed § 23.151 as “covered swap entities” or “CSEs.” The final rule adopts the definition as set forth in the proposal. The final rule also includes special provisions for inter-affiliate swaps between a CSE and its affiliates. The following sections provide a discussion of other significant market participants and applicable standards set forth in the final rule.

b. Financial End Users

(i) Definition

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 Commission is relying, to the greatest extent possible, on the counterparty's legal status as a regulated financial entity. The definition lists numerous entities whose business is financial in nature.

In developing the definition, the Commission sought to provide clarity to CSEs and their counterparties about whether particular counterparties would be financial end users and subject to the margin requirements of the final rule. The definition is an attempt to capture all financial counterparties without being overly broad and capturing commercial firms and sovereigns.

The Commission believes that this approach is consistent with the risk-based approach of the final rule, as financial firms generally present a higher level of risk than other types of counterparties because their profitability and viability are more tightly linked to the health of the financial system than other types of counterparties. Because financial counterparties are more likely to default during a period of financial stress, they pose greater systemic risk and risk to the safety and soundness of the CSE.

In developing the list of financial entities, the Commission 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 Commission notes that an entity or person would be classified as a financial end user based on the nature of the activities of that entity or person regardless of the source of the funds used to finance such activities. For example, an entity or person would be a financial entity if it raises money from investors, uses its own funds, or accepts money from clients or customers to predominately engage in investing, dealing, or trading in loans, securities, or swaps.

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 Commission intends to cover, as financial end users, a broad variety and number of nonbank lending and retail payment firms that operate in the market. To this end, the Commission has 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 Commission recognizes 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 Commission is 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, Farm Credit System 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 the uncleared 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 uncleared swaps also would qualify for an exemption from margin requirements under § 23.150(b) of the final rule. Uncleared swaps of financial cooperatives that do not qualify for an exemption would be treated as uncleared swaps of financial end users under the final rule.

The Commission expects 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 Regulation 50.51, 17 CFR 50.51, and as a result, their uncleared swaps would also be exempt from the margin requirements of the final rule pursuant to Regulation 23.150(b).

The preamble more fully discusses the status of Farm Credit System 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 Commission exempt swaps entered into by nonprofit cooperatives from the margin requirement to the extent they that are already exempt from clearing requirements. Regulation 23.150(b) of the 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 CEA. Moreover, certain swaps of these entities may be exempt pursuant to TRIRA and Regulation 23.150(b) of the final rule.

Section 2(h)(7)(C)(ii) of the CEA authorizes the Commission to exempt small depository institutions, small Farm Credit System institutions, and small credit unions with total assets of $10 billion or less from the mandatory clearing requirements for swaps.

See

7 U.S.C. 2(h)(7) and 15 U.S.C. 78c-3(g). Additionally, the Commission, pursuant to its authority under section 4(c)(1) of the CEA, 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.

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 Commission 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 Commission is 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 uncleared swaps with a CSE, 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 response to the commenters request to align its definition of financial end user with the Prudential Regulators' definition, the Commission also added business development companies in subparagraph (vi) of the definition of financial end user.

The Commission also has added three entities registered with the Commission to the enumerated list of financial end users: floor brokers, floor traders, and introducing brokers. As defined in section 1a(22) of the CEA, a floor broker generally provides brokering services on an exchange to clients in purchasing or selling any future, securities future, swap, or commodity option. As defined in section 1a(23) of the CEA, a floor trader generally purchases or sells on an exchange solely for that person's account, any future, securities future, swap, or commodity option. As defined in section 1a(31) of the CEA, 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 Commission as an introducing broker.

In deciding to add these entities to the definition of financial end user, the Commission 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. In this vein, the Commission is also adding to the list of financial end user security-based swap dealers and major security-based swap participants. The Commission believes that by including these financial entities in the definition of financial end user, the definition provides additional clarity to CSEs when engaging in uncleared swaps with these entities. As noted above, financial entities are considered more systemic than non-financial entities and as such, the Commission believes that these entities, whose activities, services, and sources of income are financial in nature, should be included in the definition of financial end user. The Commission notes, however, that if a commercial end user falls within the definition of financial end user under this rule because of, for example, its registration as a floor broker or otherwise, so long as its swaps qualify for an exemption under TRIPRA, those swaps will not be subject to the margin requirements of these rules.

In the proposal, the Commission 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 Commission 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 Commission is broadening section (xi) of the definition of a “financial end user” 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 Commission believes that the enumerated list in the proposal of financial end users was under-inclusive, not covering certain entities that provide or engage in services and activities that are financial in nature. Specifically, the Commission is concerned that the proposed definition did not cover certain financial entities that are not organized as pooled investment vehicles and that trade or invest their own or client funds (

e.g.,

high frequency trading firms) or that provide other financial services to their clients. The Commission's approach also addresses 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 “financial end user.”

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 Commission has determined should be treated as a financial end user. The Commission will monitor the margin arrangements of swap transactions of CSEs to determine if certain types of counterparties, in fact, are financial entities that are not covered by the definition of “financial end user” in the final rule. In the event that the Commission finds that one or more types of financial entities escape classification as financial end users under the final rule, the Commission may consider another rulemaking that would amend the definition of “financial end user” so it covers such entities.

In the proposal, the Commission stated that “[f]inancial 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, it is crucial that the definition of financial end user include the types of firms that engage in the activities described above.

79 FR at 57360 (September 24, 2014).

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. In its proposal, the Commission included in the definition of “financial end user” 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 CSE to analyze a foreign counterparty's business activities in light of a broad array of U.S. regulatory requirements.

The Commission has not modified this provision in the final rule. The Commission acknowledges that the test imposes a greater incremental burden in classifying foreign counterparties than it does in identifying U.S. financial end users. The burdens associated with classifying counterparties as financial or non-financial has been a recurring theme during the rulemaking. To reduce the burden, in this instance, the Commission believes that CSEs may rely on good faith representations from their counterparties as to whether they are financial end users under the final rule. The Commission believes the approach in the final rule captures the kinds of entities whose profitability and viability are most tightly linked to the health of the financial system.

In this respect, the Commission's 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 Commission believes it is appropriate to require a CSE 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 Commission has 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 U.S. but acts as a swap entity in a foreign jurisdiction would be treated as a financial end user under the final rule.

As noted above, the Commission believes 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 Commission has 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. The definition of financial entities

excludes the government of any country, central banks, multilateral development banks,

the Bank for International Settlements, captive finance companies,

and agent affiliates.

The exclusion for sovereign entities, multilateral development banks and the Bank for International Settlements is consistent with the 2013 international framework and the definition of the Prudential Regulators.

Regulation 23.151.

Some commenters requested additional clarity that certain entities would be included as multilateral development banks.

See

SIFMA; MFX. The definition in the final rule includes an enumerated list of entities in addition to 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.

A captive finance company is an entity that is excluded from the definition of financial entity under section 2(h)(7)(c)(iii) of the CEA for purposes of the requirement to submit certain swaps for clearing. That section describes it as “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.”

An agent affiliate is an entity that is an affiliate of a person that qualifies for an exception from the requirement to submit certain trades for clearing. Under section 2(h)(7)(D) of the CEA, “an affiliate of a person that qualifies for an exception under subparagraph (A) (including affiliate entities predominantly engaged in providing financing for the purchase of the merchandise or manufactured goods of the person) may qualify for the exception 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.”

As discussed below, captive finance companies and agent affiliates are excluded by TRIPRA from the definition of financial entity.

The Commission believes that this approach is appropriate as these entities generally pose less systemic risk to the financial system as their activities generally have a different purpose in the financial system leading to a lower risk profile in addition to posing less counterparty risk to a swap entity. Thus, the Commission believes that application of the margin requirements that would apply for financial end users to swaps with these counterparties is

not necessary to achieve the objectives of this rule.

The Commission notes that States would not be excluded from the definition of financial end user, 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 ERISA would meet the definition of financial end user.

As noted above, commenters requested that the Commission exclude a number of other entities from the definition of financial end user including small banks that qualify for an exception from clearing,

certain financial cooperatives,

pension plans,

structured finance vehicles,

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. The interim final rule addresses the comments raised regarding the uncleared swaps of small banks and certain financial cooperatives by providing an exemption for such swaps that qualify for an exemption from clearing. The uncleared swaps of small banks or financial cooperatives that do not qualify for the exemptive treatment would be treated as swaps of financial end users under the final rule.

See

ABA.

See

CFC.

See

ABA; AIMA. These commenters generally argued that pension 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.

See

FSR; ISDA; JBA; JFMC; SIFMA AMG; SFIG. 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.

See

The Commission has not modified the definition of financial end user to exclude pension plans, structured finance vehicles, or covered bonds issuers.

Congress explicitly listed an employee benefit plan as defined in paragraph (3) and (32) of section 3 of the 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 used swaps to hedge or mitigate commercial risk. The Commission believes that, similarly, when a pension plan enters into an uncleared swap with a CSE, 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 the 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 Commission believes that these broad definitions would cover all pension plans regardless of whether the pension plan is subject to the 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.

The Commission believes that all of these entities should qualify 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 Commission notes that the increase in the size of positions necessary to constitute 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.

(ii) Small Banks

As noted above, banks would be financial end users under the final rule. They would be subject to initial margin requirements if they entered into uncleared swaps with CSEs and, as discussed below, had material swaps exposure. However, TRIPRA also excluded certain swaps with small 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 Commission how it generally meets its financial obligations associated with entering into uncleared swaps.

As authorized by the Dodd-Frank Act, the Commission has excluded depository institutions, Farm Credit System 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.

Uncleared swaps with those entities would be eligible for the TRIPRA exemption in the Commission's margin rules, provided they meet other requirements for the clearing exception. As a consequence of TRIPRA, if a small bank with total assets of $10 billion or less enters into a swap with a CSE that meets the requirements of the exception from clearing, that swap will not be subject to the margin requirements of these rules.

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).

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

The final rule requires a CSE to exchange daily variation margin with a bank with total assets above $10 billion, regardless of whether the bank has material swaps exposure. However, the CSE will only be required to collect variation margin from a bank when the amount of both initial margin and variation margin required to be collected exceeds the minimum transfer amount of $500,000.

The final rule defines material swaps exposure as an average daily aggregate notional amount of uncleared swaps, uncleared 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.

(iii) Multilateral Development Banks

The proposed definition of the term “multilateral development bank,” includes a provision encompassing “[a]ny 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 Commission determines poses comparable credit risk.”

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.

(iv) Material Swaps Exposure

The Commission proposed a “material swaps exposure” level of $3 billion. This threshold is lower than the guidelines contained in WGMR and also in the EU's consultation paper. The Commission proposed a lower threshold based on data it analyzed concerning the required margin on cleared swaps.

A number of commenters argued that the Commission 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.

A commenter suggested that adopting different exposure levels may result in the failure of an international framework.

Commenters suggested that the Commission conduct further studies on the uncleared swaps markets before adopting a threshold.

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.

See

ABA; AIMA; CEWG, CPFM; CCMR; FHLB; FSR; GPC; IFM, ISDA; ICI; IIB; JBA; MFA: Sifma AMG; Sifma; Shell TRM; NERA; and Vanguard. By contrast, one commenter suggested reducing the threshold below $3 billion. CME. Another commenter expressed concerns that entities below $3 billion could have considerable exposures. AFR. One commenter cautioned against the aggressive use of thresholds to manage liquidity. Barnard.

See

JBA (financial institutions will abide by different rules depending on their counterparties' jurisdiction).;

see also

MFA (competitive discrepancies may result).

See

IFM; Sifma; ABA.

See also

ISDA (Commission's calculations assume that a covered swap counterparty has all its swaps with one party).

For example, one commenter acknowledged data described by the Commission in the proposed rule indicating that bilateral initial margin exposures between one CSE 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 Commission to shift its 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 Commission 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.

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 CSEs 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.

Commenters also commented on the method for calculating material swaps exposure. A few commenters suggested that a daily aggregate notional measure was burdensome and the Commission should use a month-end notional amount like the EU proposal and consistent with the international framework.

Commenters urged the Commission to make clear that inter-affiliate swaps would not be included for purposes of determining the material swaps exposure.

Certain of these commenters also argued that the proposal could require an entity to double-count inter-affiliate swaps in assessing material swaps exposure.

See

JBA; Sifma.

See

ABA; CEWG; CDEU; FSR; GPC; ICI; ISDA: Sifma AMG; Sifma; Shell TRM; Vanguard.

Commenters also 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.

Other commenters argued that hedging positions should not be counted toward material swaps exposure.

A commenter argued that the material swaps exposure calculation should not include swaps of all affiliates of a financial end user.

See

ICI; ABA; ISDA; GPC; Sifma; Sifma AMG; Vanguard. 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

Regulation 23.151.

See

GPC; CFC.

See

CDEU (many non-financial end users have financial end users as affiliates, and certain of their swaps should be excluded).

A few commenters urged the Commission to make clear that a CSE may rely on representations of its counterparties in assessing whether it is transacting with a financial end user with material swaps exposure.

One commenter urged the Commission to clarify what happens when a financial end user counterparty that had a material swaps exposure falls below the threshold.

See

ABA; FHLB: IFM; ISDA; BP; Shell TRM; CEWG;

see also

GPC; SIFMA.

See

FHLB.

The final rule increases the level of the aggregate notional amount of transactions that gives rise to material swaps exposure to $8 billion. 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 the EU and Japanese proposals. In the proposal, the Commission had calibrated the proposed $3 billion threshold to the size of a potential swap portfolio between a CSE and a financial end user for which the initial margin amount would often exceed the proposed initial margin threshold amount of $65 million, reducing the burden of calculating initial margin amounts for smaller portfolios.

The material swaps exposure threshold of $8 billion in the final rule has been calibrated relative to the €8 billion established by the 2013 international framework in the manner described below. At this time, the Commission believes the better course is to calibrate the final rule's material swaps exposure threshold to the higher 2013 international framework 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 Commission notes 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.

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 uncleared swaps, uncleared 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's definition also provides that an entity shall count the average daily aggregate notional amount of an uncleared swap, an uncleared security-based swap, a foreign exchange forward or a foreign exchange swap between the entity and an affiliate only one time. In addition, as discussed below, the calculation does not include a swap or security-based swap that is exempt pursuant to TRIPRA.

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 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 under the proposal. The Commission believes that using the average daily aggregate notional amount

during June, July, and August of the previous year, instead of a single as-of date, is appropriate to gather a more comprehensive assessment of the financial end user's participation in the swaps market, and 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 Commissions' margin requirements. Material swaps exposure would be calculated based on 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.

A few commenters suggested that a daily aggregate notional measure was burdensome and that the Commission should use a month-end notional amount like the EU proposal and consistent with the international framework. JBA; SIFMA. The Commission has maintained the daily aggregate notional amount.

As a specific example of the calculation for material swaps exposure, consider a financial end user (together with its affiliates) with a portfolio consisting of two uncleared swaps (

e.g.,

an equity swap, an interest rate swap) and one uncleared 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 uncleared swaps, security-based swaps and foreign exchange forwards and swaps is $30 billion. Beginning on June 1, 2016, the aggregate notional amount of uncleared swaps, security-based swaps and foreign exchange forwards and swaps is $40 billion. The daily average aggregate notional value for June, July, August 2016 is then (22 × $30 billion + 23 × $30 billion + 21 × $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 contains a number of other changes from the proposed definition. Commenters urged the Commission to make clear that inter-affiliate swaps would not be included for purposes of determining the material swaps exposure.

Certain of these commenters also argued that the proposal could require an entity to double-count inter-affiliate swaps in assessing material swaps exposure.

See

ABA; WGCEF; FSR; GPC; ICI; ISDA: SIFMA AMG; SIFMA; Vanguard.

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 an uncleared swap, an uncleared security-based swap, a foreign exchange forward or a foreign exchange swap between the entity and an affiliate only one time.

The Commission also believes 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 an affiliate's swaps in determining material swaps exposure.

The Commission made a similar change to the definition of “initial margin threshold amount” as described in Regulation 23.151.

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

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 § 23.150(b).

This change is consistent with the statutory exemptions provided by Congress in TRIPRA 2015 and ensures that exempt swaps do not count toward determining whether an entity has material swaps exposure.

The Commission made a similar change to the definition of “initial margin threshold amount” as described in Regulation 23.151.

As the material swaps exposure is designed to measure the overall derivatives exposure of an entity, the final rule's calculation of material swaps exposure continues to include foreign exchange swaps and foreign exchange forwards as well as swaps used to hedge. The final rule also does not make a distinction between uncleared swaps entered into prior to and after the effective dates for mandatory clearing. The Commission believes 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, the material swaps exposure threshold is intended to identify entities that engage in significant derivatives activity in order to determine whether their swaps activity should be subject to initial margin requirements under the final rule.

The Commission believes the final rule's approach is appropriate in 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. This approach also is intended to achieve consistency with other jurisdictions based on the 2013 international framework which sets a threshold based on overall gross notional non-centrally cleared derivatives activity.

Moreover, given that the Commission is 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 Commission believes the inclusiveness of the calculation adopted in the final rule is appropriate.

One commenter urged the Commission to conform with the 2013 international framework where material swaps exposure is based on derivatives (not swaps).

See

ICI. Another commenter urged the Commission 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.

See

FSR. The final rule does not exclude registered swap dealers from the material swaps exposure threshold. The Commission believes that financial affiliates of a registered swap dealer should be treated as having a material swaps exposure based on their level of risk.

Although the final rule does not explicitly provide how a CSE should determine if a financial end user counterparty has material swaps exposure, the Commission believes that it would be reasonable for a CSE to rely on good-faith representations of its counterparty in making such assessments.

One commenter urged the Commission 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 CSE 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 § 23.161(c) 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 CSE 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. Any margin that had been 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 CSE'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, the parties have the option to document the old and new swaps as separate portfolios for netting purposes under an eligible master netting agreement, 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.

(v) Margin Affiliates and Margin Subsidiaries

The proposal defined an “affiliate” as any company that controls, is controlled by, or is under common control with another company.

The proposal defined the control of another company generally as the ownership or power to vote 25% or more of any class of voting securities of another entity; or the ownership of 25% or more of the total equity in any entity; or the power to elect a majority of the directors or trustees of an entity. An entity would be a subsidiary of another entity if it were controlled by that other entity.

The Commission notes that under the proposal the Commission used the terms affiliate and subsidiary; however in its final rule, it is using the term “margin affiliate” and “margin subsidiary”.

Commenters raised a number of concerns with the proposal's definitions of “affiliate,” “subsidiary” and “control.” While one commenter expressed support for the proposal's definition of control,

the vast majority of commenters argued for a modified definition of control that did not use the 25 percent threshold.

One commenter suggested that these terms should be defined by reference to whether an affiliate or subsidiary is consolidated under accounting standards.

A number of these commenters urged the Commission to use a majority ownership test (51 percent or more) for determining control.

Certain commenters expressed concern about the cross-border application of these definitions.

See

Better Markets.

See

ACLI; FSR; CEWG; the GPC; IIB; ISDA; JBA; MFA; Sifma AMG; Sifma; Vanguard. (One commenter argued that the definitions of affiliate and control should not include relationships with or through the U.S. government and its representatives.

See

Freddie.)

See

ISDA.

See

ACLI; Commercial Energy Working Group; IIB; JBA; IFM; SIFMA AMG; SIFMA; TIAA-CREF; Vanguard. For example, one commenter argued that applying the initial margin threshold would be difficult with a 25 percent control test and it would be hard to agree on allocation of the threshold among the parties. ACLI.

See

CCMR; IIB; SIFMA AMG. For example, one commenter argued that a 50 percent ownership threshold would conform to the EU Proposal.

See

IIB.

Commenters also expressed particular concerns about the application of these definitions in the proposal to investment funds, including during the seeding period. A number of commenters urged the Commission to use the same criteria as the 2013 international framework as the basis for determining whether or not an investment fund is an affiliate of a fund sponsor.

Commenters also argued that seed capital contributed by a fund sponsor should not be viewed as control even if the ownership by the fund sponsor exceeds 25 percent.

One commenter, for example, suggested that passive investors should be excluded even where they own more than 51 percent of the ownership interests.

A few commenters also suggested that registered funds may treat each separately managed “sleeve” of the fund as a separate registered fund.

See

AIMA; CCMR; ICI; SIFMA AMG; Vanguard; MFA. The 2013 international framework states that investment funds that are managed by an investment adviser are considered distinct entities that are treated separately when applying the threshold as long as the funds are distinct legal entities that are not collateralized by or otherwise guaranteed or supported by other investment funds or the investment adviser in the event of fund insolvency or bankruptcy. One commenter suggested an investment fund separateness to determine whether an investment fund is a separate legal entity. This commenter also urged the Commission to incorporate the concept of “effective control” as developed by the Financial Accounting Standards Board (“FASB”) to cover variable interest entities and special purpose entities.

See

Better Markets.

See

ACLI; Sifma; Sifma AMG. One commenter also urged the Commission to clarify that independently controlled accounts are separate counterparties.

See

Sifma.

See

Sifma AMG.

See

ICI; Sifma AMG.

Commenters also expressed particular concerns about how the definitions applied to pension funds. One commenter argued that the sponsor of a pension should not be an affiliate of the pension fund by virtue of appointing trustees or directors of the pension fund.

This commenter urged that pension plans should not be deemed to have any affiliates other than those entities to whom a CSE counterparty has recourse for relevant pension trades. Other commenters argued that pension plans should be exempted from the definition of affiliate which could conflict with fiduciary obligations under ERISA.

See

GPC (arguing this could foreclose pension plans from using third-party custodians).

See

FSR (arguing that how a swap entity allocates its initial margin threshold to the ERISA plan must be done in a way not to violate the fiduciary duty to the pension plan and that would requirement input from the Department of Labor).

The term affiliate is used in the definition of initial margin threshold amount which means a credit exposure of $50 million that is applicable to uncleared swaps between a CSE and its affiliates with a counterparty and its affiliates. The inclusion of affiliates in this definition is meant to make clear that the initial margin threshold amount applies to an entity and its affiliates.

Similarly, the term “affiliate” is also used in the definition of “material swaps exposure,” as material swaps exposure takes into account the exposures of an entity and its affiliates. The term “affiliate” is also used for determining the compliance date for a CSE and its counterparty in § 23.161.

Using financial accounting as the trigger for affiliation, rather than a legal control test, should address many of the concerns raised by commenters. In addition, the Commission believes that this approach reflects a more accurate method for discerning whether an entity has control over another entity. Although consolidation tests under any other accounting standard that the entity may use must also be applied on a case-by-case basis, like the proposed rule's “control” test, the analysis has already been performed for companies that prepare their financial statements in accordance with relevant standards. For companies that do not prepare these statements, the Commission believes that industry participants are more familiar with the relevant accounting

standards and tests, and they will be less burdensome to apply.

The Commission is deleting the definition of the term “subsidiary.” This term is no longer used in this set of rules.

Additionally, the accounting consolidation analysis typically results in a positive outcome (consolidation) at a higher level of an affiliation relationship than the 25 percent voting interest standard of the legal control test. This is responsive to commenters' concerns that the proposed definitions were over-inclusive.

Because there are circumstances where an entity holds a majority ownership interest and would not consolidate, the Prudential Regulators have reserved the right to include any other entity as an affiliate or subsidiary based on a conclusion that either company provides significant support to, or is materially subject to the risks or losses of, the other company. This provision is meant to leave discretion to the Prudential Regulators in order to avoid evasion. The Commission has determined not to include this provision at this time.

The Commission believes that the modifications to the definition of affiliate will address many of the concerns raised by commenters, including with respect to investment and pension funds. Investment funds generally are not consolidated with the asset manager other than during the seeding period or other periods in which the manager holds an outsized portion of the fund's interests although this may depend on the facts and circumstances. The Commission believes that during these periods, when an entity may own up to 100 percent of the ownership interest of an investment fund, the investment fund should be treated as an affiliate.

This approach to investment funds is similar to that in the 2013 international framework. The Commission acknowledges that some accounting standards, such as the GAAP and IFRS variable interest standards, sometimes require consolidation between a sponsor or manager and a special purpose entity created for asset management, securitization, or similar purposes, under circumstances in which the manager does not hold interests comparable to a majority equity or voting control share. On balance, the Commission believes it is appropriate to treat these consolidated entities as affiliates of their sponsors or managers. They are structured with legal separation to address the concerns of passive investors, but the manager retains such levels of influence and exposure as to indicate its status is beyond that of another minority or passive investor.

In the case of pension funds that are associated with a non-financial end user, the Commission believes that consolidation of the pension fund with its parent would be the exception to the rule under applicable accounting standards. Even if consolidation is applicable for some pension funds, the parent would, as a general matter, be exempt from the rule under TRIPRA and would not be included in the threshold amount calculations.

(vi) Treasury Affiliates Acting as Principal

The Commission has issued no-action letters providing relief with respect to certain Treasury affiliates acting as principal from the clearing requirement provided that certain conditions are met.

Some commenters urged the Commission to provide similar treatment here.

The Commission has determined that similar treatment is appropriate. The Commission has included in the definition of financial end user a provision stating that the term shall not include an eligible treasury affiliate that the Commission has exempted by rule. The Commission will act to implement this approach by rule in a separate procedure.

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

See

W&C (initial and variation margin should not apply to an eligible treasury affiliate as defined in Commission No-Action Letter No. 13-22).

The Prudential Regulators final rules do not include this provision. The Prudential Regulators have stated, however, that if the CFTC acted to exclude these entities by rule, the entities would be excluded from the Prudential Regulators' rule.

80 FR 74840 at 74856.

c. Non-Financial End Users

(i) Proposal

Non-financial end users under the proposal included any entity that was not an SD, an MSP, or a financial end user. The proposal did not require CSEs to exchange margin with non-financial end users. The Commission believes that such entities, which generally are using swaps to hedge commercial risk, pose less risk to CSEs than financial entities.

To ensure the safety and soundness of CSEs, the proposal required a CSE (i) to enter into certain documentation with all counterparties to provide clarity about the parties' respective rights and obligations and (ii) to calculate hypothetical initial and variation margin amounts each day for positions held by non-financial entities that have material swaps exposure to the covered counterparty.

100

That is, the CSE would be required to calculate what the margin amounts would be if the counterparty were another SD or MSP and compare them to any actual margin requirements for the positions.

101

These calculations would serve as risk management tools to assist the CSE in measuring its exposure and to assist the Commission in conducting oversight of the CSE.

100

Proposed Regulations 23.154(a)(6) and 23.155(a)(3).

101

This is consistent with the requirement set forth in section 4s(h)(3)(B)(iii)(II) of the CEA that SDs and MSPs must disclose to counterparties who are not SDs or MSPs a daily mark for uncleared swaps.

(ii) Comments

Many commenters supported the Commission's decision not to impose margin requirements on non-financial end users.

102

One commenter raised concerns about certain uncleared matched commodity swaps that economically offset each other and that are used to hedge municipal prepayment transactions for the supply of long-term natural gas or electricity (municipal prepayment transactions as described earlier).

103

However, two commenters expressed concerns with this decision.

104

These concerns ranged from fears that large market players (such as the type of entities that once included Enron, among others) would be able to participate in the markets on an unmargined basis to disappointment that the Commission did not at least include a requirement for a specific internal exposure limit for commercial counterparties.

102

See

ABA; ETA; CDEU (asking the Commission to make explicit in the rule text the exclusion for non-financial end users from the margin requirements); COPE.

103

This commenter contended that each side of this matched pair of swaps could be subject to different margin treatment that could make these transactions prohibitively expensive. In particular, according to this commenter, the first or “front-end” swap in this matched pair would be between a non-financial end user (typically a government gas supply agency) and a swap entity, while the second swap or “back-end” swap generally would be between a swap entity and a prepaid gas supplier that is a swap entity or other financial entity.

104

See

Public Citizen (opposed the exemption, citing that non-financial end users are not exempt by statute); AFR (suggesting that the Commission should separate clearing and margin exemptions while expressing concerns regarding the scope of this exemption). AFR further argued that margin should be required where the volume of swaps could present risks to the financial system or to affiliated entities deemed to be systemically important.

Many commenters opposed the documentation requirement in the proposal, citing administrative burdens on the parties and noting that non-

financial end users currently use other forms of documentation.

105

Other commenters asked the Commission for clarification with respect to aspects of the documentation requirement.

106

105

See

ISDA; Joint Associations; CDEU; Freddie; COPE; ABA; ETA; BP; Shell TRM.

106

See

Sifma (seeking assurance that (i) a CSE would not violate its obligations to maintain sufficient margin if it releases margin to a counterparty at the conclusion of a dispute resolution mechanism consistent with the U.S. implementation of Basel and the Commission is not requiring the parties to lock in dispositive valuation methods; and (ii) if a non-bank swap entity and a non-financial end user have not agreed to exchange margin, the parties will not need to modify their trading documentation to address matters specified in the proposal such as valuation methodologies and data sources); JBA (seeks clarification on the level of documentation required to “allow the counterparty and regulators to calculate a reasonable approximation of the margin requirement independently); FHLB (arguing that documentation requirement with respect to dispute resolution are inadequate).

The majority of commenters opposed the hypothetical margin calculation requirement for non-financial end users.

107

Commenters generally noted the extra burdens this requirement may place on CSEs and the non-financial end user, who must monitor their swaps exposures to determine if they exceed the material swaps exposure threshold. Only one commenter expressed support for this requirement.

108

107

See

ISDA; Sifma; Joint Associations; JBA; FSR; ETA; NGCA/NCSA; CDEU; COPE; BP; Shell TRM; CEWG.

108

See

AFR.

(iii) Discussion

In response to the comments, the Commission has removed the hypothetical margin calculation and documentation requirements concerning non-financial end users. Although the Commission continues to believe that its documentation and hypothetical margin calculation requirements would promote the financial soundness of CSEs, the Commission recognizes the additional administrative burdens that its proposed requirements could impose on CSEs and on non-financial end users. The Commission has other requirements that should address the monitoring of risk exposures for these entities.

109

See e.g.,

§ 23.600 of the CFTC's regulations.

Moreover, under the interim final rule discussed below, certain transactions with certain financial counterparties are exempt from the Commission's margin requirements. Section 23.150 of the final rule implements the exemptions enacted in Title III of TRIPRA, which excludes these swaps from the statutory directive issued to the Commission by section 4s of the CEA to impose margin requirements for all uncleared swaps.

The Commission is implementing the transaction based (as opposed to counterparty based) TRIPRA exemptions in § 23.150(b) of the final rule. With respect to municipal prepayment transactions, the Commission notes that CSEs that are parties to these and other types of matched or offsetting swap transactions would need to evaluate each swap to determine whether the requirements of the final rule apply. Under the final rule, it is possible that one swap may be exempt from the requirements of the rule while an offsetting swap is subject to the final rule's requirements as these requirements are set on a risk basis as required under the statute.

A commenter also contended that the rule would cause counterparties to matched commodity swaps to face increased costs to the extent that the rules apply a capital charge to a CSE in connection with these matched swaps. The Commission notes that capital requirements of CSEs are outside the scope of this rulemaking and therefore is not addressing the capital implications of Municipal Prepayment Transactions at this time.

D. Nature and Timing of Margin Requirements

1. Initial Margin

a. Proposal

Subject to thresholds discussed below, the proposal required each CSE to collect initial margin from, and to post initial margin with, each covered counterparty on or before the business day after execution

110

for every swap with that counterparty.

111

The proposal required the CSEs to continue to post and to collect initial margin until the swap is terminated or expires.

112

110

Commission Regulation 23.200(e) defines execution to mean, “an agreement by the counterparties (whether orally, in writing, electronically, or otherwise) to the terms of the swap transaction that legally binds the counterparties to such terms under applicable law.” 17 CFR 23.200(e).

111

Proposed §§ 23.152(a) and 23.153(d).

112

Proposed § 23.152(b).

Recognizing the greater risk that SDs, MSPs, and financial end users pose to the financial system, the Commission proposed to require SDs and MSPs to collect initial margin from, and to post initial margin with, one another. SDs and MSPs also would be required to collect initial margin from, and post initial margin to, financial end user counterparties that have exceeded the material swaps exposure threshold. SDs and MSPs would be required to collect variation margin from, and post variation margin to, each other and all financial end user counterparties.

The proposal contains a provision stating that a CSE would not be deemed to have violated its obligation to collect initial or variation margin if it took certain steps to collect margin from its counterparty in the event the counterparty failed to post.

113

Specifically, if a counterparty failed to pay the required initial margin to the CSE, the CSE would be required to make the necessary efforts to attempt to collect the initial margin, including the timely initiation and continued pursuit of formal dispute resolution mechanisms,

114

or otherwise demonstrate upon request to the satisfaction of the Commission that it has made appropriate efforts to collect the required initial margin or commenced termination of the swap.

113

Proposed § 23.152(c).

114

See

§ 23.504(b)(4) of the CFTC's regulations.

b. Comments

Commenters generally expressed support for two-way initial and variation margin.

115

One commenter suggested that CSEs should not be required to post margin but only to collect margin.

116

Another commenter further supported allowing more time to raise the required initial margin if an increase is mandated as a result of model recalibration.

117

115

See

Barnard; ICI; MFA; Public Citizen; AFR; CME; GPC.

116

See

JBA.

117

See

CCMR.

All commenters that addressed the Commission's proposed timing requirement for initial margin collection opposed it.

118

The basis for these objections included the fact that the settlement and delivery periods for many types of eligible margin securities are longer than the time allowed for margin collection under the proposed rule; the potential inability of financial end users to arrange for collateral transfers under the proposed rule's timeframes; and the difficulties encountered where the parties are in distant time zones.

119

118

See

JFMC; Joint Associations; JBA; Sifma; Sifma-AMG; ISDA; ETA; Shell TRM; BP; GPC; and NGSA/NGCA.

119

See

ISDA; Sifma; JFMC; and JBA.

Other concerns included the fact that valuations are typically determined after market close and that the proposed rule did not include time for portfolio reconciliation and dispute resolution. A commenter suggested that, since financial end users would be required to exchange margin with a CSE in amounts determined by the CSE's models, the final rule should allow for a dispute resolution process acceptable to both the CSE and its counterparty. Commenters proposed a number of alternatives, including moving to a T+2

basis;

120

requiring prompt margin calls no later than a T+1 or T+2 basis with margin transfer occurring one or two days thereafter or according to the standard settlement cycle for the type of collateral; requiring margin collection and settlement weekly; or simply requiring margin collection on a prompt or reasonable basis.

120

See

ISDA.

One commenter asked for clarification that the Commission would not require the calculation and collection of margin more than once a day.

121

See

MFA.

c. Discussion

(i) Two-Way Margin

Consistent with the proposal, the final rule requires a CSE to collect initial margin when it engages in an uncleared swap with another swap entity. Because all swap entities will be subject to a Prudential Regulator or Commission margin rule that requires them to collect initial margin on their uncleared swaps, the final rule will result in a collect-and-post system for all uncleared swaps between swap entities.

When a CSE engages in an uncleared swap with a financial end user with material swaps exposure,

122

the final rule will require the CSE to collect

and

post initial margin with respect to the uncleared swap. Under the final rule, a CSE transacting with a financial end user with material swaps exposure must (i) calculate its initial margin collection amount using an approved internal model or the standardized look-up table, (ii) collect an amount of initial margin that is at least as large as the initial margin collection amount less any permitted initial margin threshold amount (which is discussed in more detail below), and (iii) post at least as much initial margin to the financial end user with material swaps exposure as the CSE would be required to collect if it were in the place of the financial end user with material swaps exposure.

122

The calculation of “material swaps exposure” is addressed in more detail in the discussion of the definitions above.

The Commission is not adopting a “collect only” approach for financial end user counterparties recommended by a number of financial industry commenters. The posting requirement under the final rule is one way in which the Commission seeks to reduce overall risk to the financial system, by providing initial margin to non-dealer swap market counterparties that are interconnected participants in the financial markets (

i.e.,

financial end users that have material swap exposure).

123

Commenters representing public interest groups and asset managers supported this aspect of the Commission's approach, stating that it not only would better protect financial end users from concerns about failure of a CSE, but also would act as a discipline on CSEs by requiring them to post margin reflecting the risk of their swaps business.

123

Some of these commenters contrasted the Commission's 2014 proposed approach with those of European and Japanese regulators. In the United States, many financial end users operate outside of the jurisdiction of the Commission to impose margin requirements. Thus, unlike the proposed Japanese and European requirements, which would cover a broader array of financial entities, a collect-only regime in the United States would be applicable only to CSEs and thus could leave a large number of financial entities with significant unmargined potential future exposures to their swap dealers.

The final rule permits a CSE to select from two methods (the standardized look-up table or the internal margin model) for calculating its initial margin requirements as described in more detail in the paragraphs that follow. In all cases, the initial margin amount required under the final rule is a minimum requirement; CSEs are not precluded from collecting additional initial margin (whether by contract or subsequent agreement with the counterparty) in such forms and amounts as the CSE believes is appropriate.

The provisions of the final rule requiring a CSE to collect initial margin amounts calculated under the standardized approach or an internal model apply only with respect to counterparties that are financial end users with material swaps exposure or swap entities.

124

The same is true with respect to the final rule's requirements for eligible collateral and custody of initial margin collected by a CSE.

(ii) Timing

The final rule establishes the timing under which a CSE must comply with the initial margin requirements set out in §§ 23.154 and 155. Under § 23.152 of the final rule, a CSE, on each business day, must comply with the initial margin requirements for a period beginning on or before the business day following the day of execution of the swap and ending on the date the uncleared swap is terminated or expires. “Business day” is defined in § 23.151 to mean any day other than a Saturday, Sunday, or legal holiday.

125

A “business day” under the final rule is not limited by or tied to typical business hours. A swap dealer seeking to post or collect margin may make the transfer during a “business day” but at a time which is before or after typical business hours.

In practice, each CSE typically will have a portfolio of swaps with a specific counterparty, and the CSE will collect and post initial margin for that portfolio with that counterparty on a rolling basis. The final rule requires the CSE to collect and post initial margin each business day for its portfolio of swaps with that counterparty, based on the initial margin amount calculated for that portfolio by the CSE on the previous business day.

126

Of course, if the initial margin amounts have not changed, or the change to the posting or collecting amount (combined with changes in the variation margin amount, as applicable) is less than the minimum transfer amount specified in § 23.151, no posting or collection will be required.

As the CSE and its counterparty enter into new swaps, adding them to the portfolio, these new swaps need to be incorporated into the CSE's calculation of initial margin amounts to be posted and collected on this daily cycle. When a CSE and its counterparty are located in the same or adjacent time zones, this is a straightforward process. However, when the CSE is located in a distant time zone from the counterparty, or the two parties observe different sets of legal holidays, this can be less straightforward.

The Commission added new provisions to the final rule to accommodate practical considerations that arise in these circumstances.

127

The final rule requires the CSE to post and collect initial margin on or before the end of the business day after the “day of execution,” as defined in § 23.151 of the rule. The “day of execution” is determined with reference to the point in time at which the parties enter into the uncleared swap.

127

The approach is patterned on principles incorporated in the Commission's rulemaking on clearing execution, with differences the Commission believes are appropriate in consideration of the bilateral nature of uncleared swap margin and the non-standardized terms of uncleared swaps.

See

Clearing Requirement Determination Under Section 2(h) of the CEA, 77 FR 74,284 (Dec. 13, 2012),

available at:

http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2012-29211a.pdf

When the location of the CSE is in a different time zone than the location of the counterparty, the “day of execution” definition provides three special accommodations for the difference. These accommodations are made in recognition of the fact that each of the two parties to the swap will, as a practical necessity, observe its own “business day” in transmitting instructions to the third-party custodian.

First, if at the time the parties enter into the swap, it is a different calendar day at the location of each party, the day of execution is deemed to be the later of the two calendar days. For example, if a CSE located in New York enters into

a swap at 3:30 p.m. on Monday with a counterparty located in Japan, in the Japanese counterparty's location, it is 4:30 a.m. on Tuesday, and the day of execution (for both parties) will be deemed to be Tuesday.

Second, if an uncleared swap is entered into between 4:00 p.m. and midnight in the location of a party, then such uncleared swap shall be deemed to have been entered into on the immediately succeeding day that is a business day for both parties, and both parties shall determine the day of execution with reference to that business day. For example, if a CSE located in New York enters into a swap at noon on Friday with a counterparty located in the U.K., and in the U.K. counterparty's location, it is 5:00 p.m. on Friday, then the U.K. counterparty will be deemed to enter into the swap the following Monday. Or, if a CSE located in New York enters into a swap at noon on Friday with a counterparty located in Japan, and in the Japanese counterparty's location, it is 1:00 a.m. on Saturday, then the Japanese counterparty will be deemed to enter into the swap the following Monday. In both examples, the day of execution (for both parties) will be Monday.

Third, if the day of execution determined under the foregoing rules is not a business day for both parties, the day of execution shall be deemed to be the immediately succeeding day that is a business day for both parties. For example, this addresses the outcome arising from an uncleared swap entered into by a CSE in New York at noon on Friday with a counterparty in Japan, where it would be 1:00 a.m. on Saturday. Under the first provision, the later calendar day would be deemed the day of execution, which would be Saturday. Accordingly, this third provision would operate to move the deemed day of execution to the next business day for both parties,

i.e.

Monday. As a further example under the same circumstances, except that the Monday was a legal holiday in New York, the day of execution would then be deemed to be Tuesday for both parties.

Section 23.152 consistently requires the CSE to begin posting and collecting initial margin reflecting that swap no later than the end of the business day following that day of execution and thereafter collect and post on a daily basis. The Commission believes the final rule should provide adequate time for the CSE to include the new swap in the regular initial margin cycle, under which the CSE calculates the initial margin posting and collection requirements each business day for a portfolio of swaps with a counterparty, and under which the independent custodian(s) for both parties must hold segregated eligible margin collateral in those amounts by the end of the next business day, pursuant to the respective instruction of the parties. The CSE is required to continue including the swap in its determination of the initial margin posting and collection requirements for that portfolio until the date the swap expires or is terminated.

The Commission has made limited adjustments to the final rule to accommodate operational concerns created by differences in time zones and legal holidays between the counterparties, but otherwise has retained the proposed approach. The Commission recognizes that the final rule requires initial margin to be posted and collected so quickly that CSE and their counterparties may be required to take precautionary steps. These could include (i) pre-positioning eligible margin collateral at the custodian, (ii) using readily-transferrable forms of eligible collateral, such as cash, or (iii) initially supplying readily-transferrable forms of eligible collateral and subsequently arranging to substitute other eligible margin collateral after the initial margin collateral has been delivered to the custodian and the minimum margin requirements have been satisfied.

The Commission also recognizes that the final rule will require portfolio reconciliation and dispute resolution to be performed after initial margin has been collected, as adjustments to the original margin call, rather than before. While the Commission recognizes the incremental regulatory burden created by the final rule's timing requirement, the Commission believes the additional delay that would be introduced by the commenters' alternatives would reduce the overall effectiveness of the margin requirements, as any further timing delay will result in an increased margin period of risk, which is not accounted for in calculating the initial margin amount.

128

For example, if the Commission provided T+3 as the required timing for the posting of margin, the initial margin model's margin period of risk of 10 days, would only end up being 7 days, as the initial margin amount would not be available for another 3 days after its calculation (

i.e.,

10 days (margin period of risk)—3 days (T+3 posting requirement) = 7 days).

Under § 23.152 of the final rule, a CSE shall not be deemed to have violated its obligation to collect or post initial or variation margin from or to a counterparty if: (1) The counterparty has refused or otherwise failed to provide or accept the required margin to or from the CSE; and (2) the CSE has (i) made the necessary efforts to collect or to post the required margin, or has otherwise demonstrated upon request to the satisfaction of the Commission that it has made appropriate efforts to collect the required margin, or (ii) commenced termination of the uncleared swap with the counterparty promptly following the applicable cure period and notification requirements.

Under the final rule, disputes that may arise between a CSE and its counterparty should be handled pursuant to the terms of the relevant contract or agreement and in the normal course of business. A CSE would not be deemed to have violated its obligation to collect or post initial or variation margin from or to a counterparty if the counterparty is acting in accordance with agreed-upon practices to settle a disputed trade.

2. Netting Arrangements

a. Proposal

The proposal would permit netting of initial margin across swaps and variation margin across swaps, but would not permit the netting of initial and variation margin.

129

Any netting would have to be done pursuant to an eligible master netting agreement (“ENMA”).

130

The agreement would create a single legal obligation for all individual transactions covered by the agreement upon an event of default. It would specify the rights and obligations of the parties under various circumstances.

131

129

Proposed §§ 23.152(c) and 23.153(c).

130

Proposed § 23.151, definition of “eligible master netting agreement.”

131

Id.

The proposed rule provided that if uncleared swaps entered into prior to the applicable compliance date were included in the EMNA, those swaps would be subject to the margin requirements.

132

Under the proposal, a CSE would need to establish a new EMNA to cover swaps entered into after the compliance date in order to exclude pre-compliance date swaps.

132

The netting provisions in the proposal were in § 23.153(c).

b. Comments

A number of commenters argued that, in order to allow close-out netting and contain costs, the final rule should not require new master agreements to separate pre- and post-compliance date swaps, and that parties should be permitted to use credit support annexes that are part of the EMNA instead of new master agreements to distinguish

pre-and post-compliance date swaps.

133

One party also asked the Commission for confirmation that the requirement to separately margin pre- and post-effective date swaps applies only to initial and not variation margin.

134

Another party argued that ISDA should publish and standardize a credit support annex that would conform to the requirements of the margin regulations and parties should be allowed to use such credit support annex alongside other existing credit support annexes among the parties.

135

133

See

TIAA-CREF; CPFM; ICI; Sifma; ISDA; Sifma-AMG; ABA; JBA; CS; AIMA; MFA; FSR; Freddie; ACLI; and FHLB. One commenter also requested clarification that the use of an EMNA does not prevent use of a master-master netting agreement. The final rule requires that any uncleared swaps that are netted for purposes of calculating the margin requirements under the final rule are subject to an EMNA that meets the definition in § 23.151 of the final rule regardless of whether or not there is a master-master agreement.

134

See

ICI.

135

See

Freddie.

c. Discussion

The final rule permits a CSE to calculate initial margin (using an initial margin model) or variation margin on an aggregate net basis across uncleared swap transactions that are executed under an EMNA.

136

Although the proposal provided that the margin requirements would not apply to uncleared swaps entered into before the rule's compliance dates, as a general rule, the proposal provided that if an EMNA covered uncleared swaps that were entered into before the applicable compliance date, those uncleared swaps would be subject to the requirements of the rule and must be included in the aggregate netting portfolio for purposes of calculating the required margin.

136

Initial margin and variation margin amounts may not be netted against each other under the final rule. In addition, initial margin netting is only for the purposes of calculating the collection amount or post amount under an approved initial margin model, which may not be netted against each other.

As discussed by several commenters, the Commission recognizes that CSEs and their counterparties may wish to separate netting portfolios under a single EMNA. Accordingly, the final rule provides that an EMNA may identify one or more separate netting portfolios that independently meet the requirement for close-out netting

137

and to which, under the terms of the EMNA, the collection and posting of margin applies on an aggregate net basis separate from and exclusive of any other uncleared swaps covered by the agreement. (These separate netting portfolios are commonly covered by separate credit support annexes to the EMNA.)

137

See

§ 23.151 (paragraph 1 of the EMNA definition).

This rule facilitates the ability of the parties to document two separate netting sets, one for uncleared swaps that are subject to the final rule and one for swaps that are not subject to the margin requirements. A netting portfolio that contains only uncleared swaps entered into before the applicable compliance date is not subject to the requirements of the final rule. The rule does not prohibit the parties from including one or more pre-compliance-date swaps in the netting portfolio of uncleared swaps subject to the margin rule, but they will thereby become subject to the final rule's margin requirement, as part of the netting portfolio. Similarly, any netting portfolio that contains any uncleared swap entered into after the applicable compliance date will subject the entire netting portfolio to the requirements of the final rule.

The netting provisions of the final rule also address the implications of status changes for counterparties. As discussed above, the final rule imposes a requirement to exchange initial margin only with respect to financial end users whose swap portfolios exceed the material swap exposure threshold. This means that a CSE may accumulate a portfolio of swaps with a financial end user below the threshold, subject to a variation margin requirement, and later if the financial end user crosses the threshold, only new swaps entered into after the change in the financial end user's status will be subject to both initial and variation margin requirements. To address this possibility, the final rule extends the treatment of separate netting portfolios under a single ENMA beyond pre-compliance-date swaps to include separate netting portfolios for swaps entered into before and after a financial end user's change into a higher risk status.

138

As discussed earlier, the change in status might also occur as a counterparty moves in or out of financial end user status entirely. The final rule extends the separate netting portfolio treatment to all status changes equally.

The netting provisions in the final rule are modified from the proposal in order to provide clarifications to address implementation concerns raised by commenters. The proposed rule provided that if uncleared swaps entered into prior to the applicable compliance date were included in the EMNA, those swaps would be subject to the margin requirements.

139

Under the proposal, a CSE would need to establish a new EMNA to cover swaps entered into after the compliance date in order to exclude pre-compliance date swaps.

139

The netting provisions in the proposal were in § 23.153.

The final rule addresses the commenters' concerns regarding close-out netting and preserves close-out netting by allowing an EMNA to identify one or more separate netting portfolios to which the requirements of the final rule apply on an aggregate net basis. Thus, under the final rule, pre-compliance date swaps in the same EMNA as post-compliance date swaps would be subject to the requirements of the final rule unless they are treated under the EMNA as separately identified netting portfolio.

The Commission believes it would be inconsistent with the purposes and objectives of the rule to permit a CSE to net a counterparty's uncleared swap obligations to the CSE in determining margin collection amounts, unless the CSE can conclude on a well-founded basis that the netting provisions of the agreement can be enforced against the counterparty (as required in accordance with the final rule's definition of the EMNA).

The Commission will address commenters' concerns regarding the lack of availability of netting in foreign jurisdictions in its application of the margin rule on cross-border transaction final rule.

The Commission does not believe that it would be appropriate for margin requirements for uncleared swaps to be offset by netting other products or exposures across markets against other products that may present different concerns about safety and soundness or financial stability, or that are not subject to similar associated margin requirements. Such treatment appears inconsistent with the purposes of the Dodd-Frank Act.

E. Calculation of Initial Margin

1. Overview

a. Proposal

Under the proposed rules, a CSE could calculate initial margin using either a model-based method or a standardized table-based method.

140

The required amount of initial margin would be the amount computed pursuant to either an internal model or the table minus an initial margin threshold amount of $65 million.

141

In the proposal, the initial margin threshold was calculated on a consolidated basis (

i.e.

including all of the entity's affiliates). This amount

could not be less than zero.

142

The initial margin specified under the proposal would be a minimum requirement, and the parties would have been free to require more initial margin. To ease the transaction costs associated with the exchange of margin, the Commission also proposed a minimum transfer amount of $650,000.

143

140

Proposed § 23.154.

141

Proposed § 23.151, definition of “initial margin threshold amount.”

142

Proposed § 23.154(a)(4).

143

Proposed § 23.151.

b. Comments

A few commenters urged that the threshold should be set for individual legal entities within a group instead of at the group level,

144

while at least one commenter expressed support for applying the threshold to the larger consolidated group.

145

One commenter argued that firms should be required to disclose their aggregate uncollateralized exposures from use of the initial margin threshold as well as allocation of the threshold across counterparties, including affiliated counterparties.

146

The same commenter also argued that the full amount of gross initial margin should be exchanged, and asked for increased disclosure requirements regarding uncollateralized exposures (

e.g.,

exposures that fall below the initial margin threshold).

144

CEWG; BP; Shell TRM; ISDA; Sifma AMG.

145

Public Citizen.

146

CME.

Commenters also suggested that the minimum transfer amount should apply separately to initial and variation margin.

147

A commenter also urged the Commission to revisit the amounts periodically to ensure international consistency.

148

Another commenter suggested that entities for which the U.S. Dollar is not the common or transacting currency or whose payment obligations are in another currency should be allowed to use an average exchange rate between the U.S. Dollar and the foreign currency for calculating thresholds.

149

One commenter also suggested that the Commission allow the counterparties to set a minimum transfer amount below $650,000.

150

Another commenter requested confirmation that the rule allows a minimum transfer amount but does not require it.

147

See

ISDA; JBA; Sifma.

148

See

Sifma.

149

See

ICI.

150

See

Shell TRM.

Commenters also asked for separate treatment of various arrangements under which the assets of a single investment fund or pension plan are treated as separate portfolios or accounts, each assigned some portion of the fund's or plan's total assets for purposes of managing them pursuant to different investment strategies or by different investment managers as agent for the fund or plan.

151

Commenters said these “separate accounts” are generally managed under documentation that caps the asset manager's ability to incur liabilities on behalf of the fund or plan at the amount of the assets allocated to the account.

151

One industry group commenter also cited as an example a securitization vehicle that creates separate issuances of asset-backed securities through use of a series trust.

c. Discussion

As an initial matter, the final rules allow CSEs to choose between model-based and table-based initial margin calculations. The Commission expects that some CSEs may choose to adopt a mix of internal models and standardized approaches to calculating initial margin requirements. For example, it may be the case that a CSE engages in some swap transactions on an infrequent basis to meet client demands but the level of activity does not warrant all of the costs associated with building, maintaining, and overseeing a quantitative initial margin model. Further, some CSE clients may value the transparency and simplicity of the standardized approach. In such cases, the Commission expects that it would be acceptable to use the standardized approach to margin such swaps.

Under certain circumstances it may be appropriate to employ both a model based and standardized approach to calculating initial margins. At the same time, the Commission is aware that differences between the standardized approach and internal model based margins across different types of swaps could be used to “cherry pick” the method that results in the lowest margin requirement. Rather, the choice to use one method over the other should be based on fundamental considerations apart from which method produces the most favorable margin results. Similarly, the Commission does not anticipate there should be a need for CSEs to switch between the standardized or model-based margin methods for a particular counterparty, absent a significant change in the nature of the entity's swap activities. The Commission expects CSEs to provide a rationale for changing methodologies if requested. The Commission will monitor for evasion of the swap margin requirements through selective application of the model and standardized approach as a means of lowering the margin requirements.

The final rule does not require a CSE to collect or to post initial margin collateral to the extent that the aggregate un-margined exposure either to or from its counterparty remains below $50 million.

152

In this regard, the final rule is generally consistent with the 2013 international framework and the 2014 proposal. The initial margin threshold amount of $50 million has been adjusted relative to the $65 million threshold in the proposed rule in the manner described below.

152

§ 23.151, definition of “initial margin threshold amount.”

The Commission believes that allowing CSEs to apply initial margin thresholds of up to $50 million is consistent with the rule's risk-based approach, as it will provide relief to counterparties, while ensuring that initial margin is collected from those counterparties with exposure over the threshold, which could pose greater systemic risk to the financial system. The initial margin threshold also should serve to reduce the aggregate amount of initial margin collateral required by the final rule.

Under the final rule, the initial margin threshold applies on a consolidated entity level. It will be calculated across all non-exempted

153

uncleared swaps between a CSE and its affiliates and the counterparty and the counterparty's affiliates.

154

The requirement to apply the threshold on a fully consolidated basis applies to both the counterparty to which the threshold is being extended and the counterparty that is extending the threshold. Applying this threshold on a consolidated entity level precludes the possibility that CSEs and their counterparties could create legal entities and netting sets that have no economic basis and are constructed solely for the purpose of applying additional thresholds to evade margin requirements.

153

To the extent that an uncleared swap transaction is exempt from the margin requirements pursuant to § 23.150(b), consistent with TRIPRA, the interim final rule excludes the exempted swap transaction from the calculation of the initial margin threshold amount.

154

The threshold may be allocated among entities within the consolidated group, at the agreement of the CSE and the counterparties, but the total must remain below $50 million on a combined basis. For an example illustrating allocations, see the 2014 proposal.

Although some commenters suggested the Commission should not implement the threshold across the CSE and counterparties on a consolidated basis, and instead rely on general anti-evasion authority to address efforts to exploit the threshold, the Commission has not done so. The revisions to the affiliate and subsidiary definitions in the final

rule, described above, simplify implementation of the consolidated approach and should help address some of the concerns raised by commenters in this respect.

The Commission notes that the threshold represents a minimum requirement and should not be viewed as preventing parties from contracting with each other to require the collection of initial margin at a lower threshold, using the same method as set forth in the final rule. For such transactions, the Commission expects CSEs to make their own internal credit assessments when making determinations as to the credit and other risks presented by their specific counterparties. Therefore, a CSE dealing with a counterparty it judges to be of high credit quality may determine that a counterparty-specific threshold of up to $50 million is appropriate.

In response to commenters, and to clarify the Commission's intent, the Commission notes that the $50 million threshold is measured as the amount of initial margin for the relevant portfolio of uncleared swaps pursuant to either the internal model or standardized initial margin table used by the CSE.

155

The Commission has not incorporated suggestions by a commenter that the Commission permit the threshold to be calculated in foreign currencies. Conversion to USD can be readily accomplished and provides a measure of relative consistency in application from counterparty to counterparty within and across CSEs.

155

Although one commenter urged the Commission to require CSEs to make granular disclosures about the use of the $65 million threshold to their investors, credit providers, and the central counterparties of which the CSE is a member, the suggestion is beyond the scope of this margin rulemaking. The Commission notes the final rule does not prohibit a CSE from providing this information, should it wish to negotiate that arrangement with an interested party.

In addition, the Commission has not incorporated suggestions by commenters for separate treatment of various arrangements under which the assets of a single investment fund vehicle or pension plan are treated as separate portfolios or accounts, each assigned some portion of the fund's or plan's total assets for purposes of managing them pursuant to different investment strategies or by different investment managers as agent for the fund or plan.

156

One industry group commenter also cited as an example a securitization vehicle that creates separate issuances of asset-backed securities through use of a series trust.

While the Commission recognizes these types of asset management approaches are well-established industry practice, and that separate managers acting for the same fund or plan do not currently take steps to inform the fund or plan of their uncleared swap exposures on behalf of their principal on a frequent basis, the Commission is not persuaded that it would be appropriate to extend each separate account its own initial margin threshold. Based on the comments, it appears the liability cap on each account manager often will be reflected in the fund's or plan's contract with the manager. If one manager breaches its limit, there could be cross-default implications for other managed accounts, and in periods of market stress, the cumulative effect of multiple managers' uncleared swaps could, in turn, strain the fund or plan's resources. Because all the swaps are transacted on behalf of a single legal principal, the Commission does not believe that the subdivision of these separately managed accounts is sufficient to merit the extension of separate thresholds.

157

Nevertheless, the Commission expects that in most cases, two separate investment funds of a single asset manager would not be consolidated under the relevant accounting standards and thus would not be affiliates under this rule.

157

Some commenters expressing this concern made the same point with respect to application of the material swaps exposure threshold, which is also calculated on a legal entity basis. The Commission has the same reservations about subdividing the material swaps exposure test at the managed account level, and these reservations are even somewhat compounded given that the Commission has revised the threshold to $8 billion in reflection of the financial end user's overall market exposure, instead of a CSE-specific exposure.

The final rule provides for a minimum transfer amount for the collection and posting of margin by CSEs. The final rule does not require a CSE 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.

158

This minimum transfer amount is consistent with the 2013 international framework and has been adjusted relative to the amount that appeared in the proposal in the manner described below.

158

See

§ 23.151 of the final rule. The minimum transfer amount only affects the timing of margin collection; it does not change the amount of margin that must be collected once the $500,000 threshold is crossed. For example, if the margin amount due from (or to) the counterparty were to increase from $500,000 to $800,000, the CSE would be required to collect the entire $800,000 (subject to application of any applicable initial margin threshold amount).

The final rule has been modified from the proposal to make clear that the minimum transfer amount applies to the combined amount of initial and variation margin. The Commission believes that the proposal's minimum transfer amount of $500,000 is appropriately sized to generally alleviate the operational burdens associated with making de minimis margin transfers and that the amount applies to both initial and variation margin transfers on a combined basis. The Commission also confirms that the minimum transfer amount is allowed but not required under the final rule, and parties are free to collect and post margin below that amount.

2. Models

As in the proposed rule, the final rule adopts an approach whereby CSEs may calculate initial margin requirements using an approved initial margin model. As in the case of the proposal, the final rule also requires that the initial margin amount be set equal to a model's calculation of the potential future exposure of the uncleared swap consistent with a one-tailed 99 percent confidence level over a 10-day close-out period. More specifically, under the final rule, initial margin models must capture all of the material risks that affect the uncleared swap including material non-linear price characteristics of the swap.

159

See

§ 23.154(b)(2) of the final rule. An exception to this requirement has been made in the specific case of cross-currency swaps. In a cross-currency swap, one party exchanges with another party principal and interest rate payments in one currency for principal and interest rate payments in another currency, and the exchange of principal occurs upon the inception of the swap, with a reversal of the exchange of principal at a later date that is agreed upon at the inception of the swap.

Under the final rule, an initial margin model need not recognize any risks or risk factors associated with the foreign exchange transactions associated with the fixed exchange of principal embedded in a cross-currency swap as defined in § 23.151 of the final rule. The initial margin model must recognize all risks and risk factors associated with all other payments and cash flows that occur during the life of the cross-currency swap. In the context of the standardized margin approach, described further below, the gross initial margin rates have been set equal to those for interest rate swaps. This treatment recognizes that cross-currency swaps are subject to risks arising from fluctuations in interest rates but does not recognize any risks associated with the fixed exchange of principal since principal is typically not exchanged on interest rate swaps.

For example, the initial margin calculation for a swap that is an option on an underlying asset, such as an option on a credit default swap contract, would be required to capture material

non-linearities arising from changes in the price of the underlying asset or changes in its volatility. Moreover, the margin calculations for derivatives in distinct product-based asset classes, such as equity and credit, must be performed separately without regard to derivatives contracts in other asset classes. Each derivative contract must be assigned to a single asset class in accordance with the classifications presented in the final rule (

i.e.,

foreign exchange or interest rate, commodity, credit, and equity). The presence of any common risks or risk factors across asset classes cannot be recognized for initial margin purposes.

The Commission's belief is that these modeling standards should ensure a strong initial margin regime for uncleared swaps that sufficiently limits systemic risk and reduces potential counterparty exposures.

a. Commission Approval

The proposal required CSEs to obtain the written approval of the Commission before using a model to calculate initial margin.

160

The CSE would have to demonstrate that the model satisfied all of the requirements of this section on an ongoing basis.

161

In addition, a CSE would have to notify the Commission in writing before extending the use of a model that has been approved for one or more types of products to any additional product types, making any change to any initial margin model that has been approved that would result in a material change in the CSE's assessment of initial margin requirements, or making any material change to assumptions used in an approved model.

162

The Commission could rescind its approval of a model if the Commission determined that the model no longer complied with this section.

163

160

Proposed § 23.154(b)(1).

See

BCBS/IOSCO Report at 12: “any quantitative model that is used for initial margin purposes must be approved by the relevant supervisory authority.”

161

Id.

162

Proposed § 23.154(b)(1).

163

Id.

(i) Comments

While one commenter disapproved of the use of proprietary initial margin models,

164

several commenters supported the use of either a proprietary

165

or a standardized (developed by the industry) initial margin model.

166

One commenter urged the Commission to recognize a model that has been approved by other regulators, including foreign authorities in jurisdictions with margin requirements consistent with the 2013 international standards.

167

Another commenter suggested that the Commission provide more information regarding the process for model approval.

168

164

See

AFR (supporting instead the adoption of a unified modeling capacity within the regulatory community).

165

See

Barnard; SIFMA; GPC (cautioning that initial margin models must be consistent with commonly accepted market practice and should be open for review by market participants).

166

See

CPFM; Sifma; MetLife; Freddie; AFR.

167

See

IFM.

168

See

JBA (asking the Commission to provide information regarding the data and documents necessary to the process, and also the timeline for the submissions);

see also

Shell TRM (urging the Commission to adopt a process for provisional approval of models).

(ii) Discussion

Under the final regulations, all initial margin models must be approved before being used for margin calculation purposes. In the event that a model is not approved, initial margin calculations would have to be performed according to the standardized initial margin approach that is detailed in Regulation 23.154(c) and discussed below.

Given the number of SDs and the likely complexity of the models, the Commission is concerned that, with its limited resources, it might not be able to review models as thoroughly and expeditiously as it would like. Accordingly, the Commission has determined to amend the final rules to provide that a CSE may use a model approved by a registered futures association (“RFA”) or the Commission. Currently, the National Futures Association (“NFA”) is the only RFA.

As an RFA, NFA is required to establish minimum capital and other financial requirements applicable to its members that are at least as stringent as the capital and financial requirements imposed by the Commission. This requirement to establish financial requirements extends to SD and MSP margin requirements for uncleared swap transactions.

The Commission anticipates that NFA margin rules will recognize the use of models, and that the minimum requirements for such models, including the quantitative and qualitative requirements of the models, are the same as, or more stringent than, the requirements set forth in final § 23.154. Accordingly, final § 23.154 provides that an SD or MSP may use models to compute initial margin requirements if such models have been approved by NFA.

Given that CSEs may engage in highly specialized and complex swap dealing activity, it is expected that specific initial margin models may vary across CSEs. Accordingly, the specific analyses that will be undertaken in the context of any single model review may have to be tailored to the specific swap dealing activity of the CSE. Initial margin models will also undergo periodic reviews to ensure that they remain compliant with the requirements of the rule and are consistent with existing best practices over time.

Given the complexity and diverse nature of uncleared swaps, it is expected that CSEs may choose to make use of vendor-supplied products and services in developing their own initial margin models. The final rule does not place any limitations or restrictions on the use of vendor-supplied model components such as specific data feeds, computing environments, or calculation engines beyond those requirements that must be satisfied by any initial margin model. In particular, the Commission will conduct a holistic review of the entire initial margin model and assess whether the entire model and related inputs and processes meet the requirements of the final rule.

169

The Commission expects that NFA will conduct a similar process for the models it reviews.

To the extent that a CSE uses vendor-supplied inputs in conjunction with its own internal inputs and processes, the model approval decision will apply to the specific initial margin model used by a CSE and not to a generally available vendor-supplied model. To the extent that one or more vendors provide models or model-related inputs (

e.g.,

calculation engines) that, in conjunction with the CSEs' own internal methods and processes, are part of an approved initial margin model, the Commission may also approve those vendor models and model-related inputs for use by other CSEs though that determination will be made on a case-by-case basis depending on the entirety of the processes that are employed in the application of the vendor-supplied inputs and models by a CSE.

In many instances, CSEs whose margin models would be subject to Commission or RFA review would be affiliates of entities whose margin models would be subject to review by one of the Prudential Regulators. In such situations, the Commission or the RFA would coordinate with the Prudential Regulators in order to avoid duplicative efforts and to provide expedited approval of Prudential Regulator approved models.

170

For

example, if a Prudential Regulator had approved a model of an insured depository institution registered as an SD, Commission or RFA review of a comparable model used by its non-bank affiliate would be greatly facilitated. Similarly, the Commission or the RFA would coordinate with the SEC for CSEs that are dually registered and would coordinate with foreign regulators that had approved margin models for foreign CSEs.

170

Whether an initial margin model has obtained a Prudential Regulators approval will be given a significant weight in determining whether the model meets the Commission's standards.

The provision permitting a CSE to use a model approved by an RFA is a point of distinction between the Commission's rules and those of the Prudential Regulators. The Prudential Regulators do not have a comparable rule.

b. Applicability to Multiple Swaps

(i) Proposal

The proposal provided that to the extent more than one uncleared swap is executed pursuant to an EMNA

171

between a CSE and a covered counterparty, the CSE would be permitted to calculate initial margin on an aggregate basis with respect to all uncleared swaps governed by such agreement.

172

However, only exposures in certain asset classes could be offset. If the agreement covered uncleared swaps entered into before the applicable compliance date, those swaps would have to be included in the calculation.

173

171

This term is defined in proposed § 23.151.

172

Proposed § 23.154(b)(2).

173

Id.

The proposal defined EMNA as any written, legally enforceable netting agreement that creates a single legal obligation for all individual transactions covered by the agreement upon an event of default (including receivership, insolvency, liquidation, or similar proceeding) provided that certain conditions are met. These conditions include requirements with respect to the CSE's right to terminate the contract and to liquidate collateral and certain standards with respect to legal review of the agreement to ensure that it meets the criteria in the definition.

(ii) Comments

A number of commenters requested that the Commission remove the “suspends or conditions payment” language.

174

These commenters argued that this provision would be inconsistent with the ISDA Master Agreement which allows a non-defaulting counterparty to suspend payment to a defaulting counterparty.

175

174

ACLI; FSR; Freddie; ISDA; MetLife; Sifma AMG; Sifma; and Vanguard.

175

One commenter urged the Commission not to “outsource” the EMNA definition to ISDA, noting that the vast majority of existing master netting agreements are governed by the ISDA Master Agreement. The commenter argued that the ISDA Master Agreement contains provisions that may be contrary to the interests of counterparties other than ISDA's large swap entity members, such as mandatory arbitration covenants.

See

Better Markets. So long as an agreement meets the requirements of the EMNA definition, however, the Commission is not endorsing, requiring. or prohibiting use of a particular master netting agreement in the final rule.

A few commenters urged the Commission to align its definition with that of the Prudential Regulators,

176

while others argued that ISDA master agreements should qualify as ENMAs.

177

One commenter supported the use of netting agreements,

178

while others cautioned that entities operating in jurisdictions where netting is not enforceable may be penalized by having to put up a greater amount of collateral.

179

176

See

Sifma; FHLB.

177

See

ETA; Joint Associations; NGSA/NGCA.

178

See

Barnard.

179

See

JFMC.

See also

ISDA (suggesting netting restrictions on posting variation margin (where restricted by law for example) to non-netting counterparties).

Commenters generally expressed support for the recognition of foreign stays in the proposal's definition of ENMA.

180

A few commenters argued that a limited stay under State insolvency and receivership laws applicable to insurance companies also should be recognized under this provision.

181

Some commenters also argued for permitting appropriate contractual stays.

182

180

AIMA; ICI; SIFMA. However, at least one commenter expressed concern that allowing for foreign jurisdiction and contractual stays could limit important bankruptcy protections for commercial end users and argued that the rule should recognize and clearly state that market participants' rights to avoid stays and other limitations of their close-out rights should be protected. CEWG.

181

See

ACLI; MetLife.

182

See

ISDA; Sifma AMG (a party should be allowed to suspend ongoing performance where an event of default or potential event of default has occurred and is continuing); AFR (upon the default of a party, the non-defaulting party should be allowed to enter into a limited contractual stay and suspend payment obligation to the defaulting party according to the process set forth in the ISDA 2014 Resolution Stay Protocol).

A number of commenters expressed various concerns with the provision of the EMNA that requires a CSE to conduct sufficient legal review to conclude with a well-founded basis (and maintains sufficient written documentation of that legal review) that the agreement meets the requirements with respect to the CSE's right to terminate the contract and liquidate collateral and that in the event of a legal challenge (including one resulting from default or from receivership, insolvency, liquidation, or similar proceeding), the relevant court and administrative authorities would find the agreement to be legal, valid, binding, and enforceable under the law of the relevant jurisdictions.

183

These commenters urged that requiring a legal opinion would be expensive and may not be able to be given without qualification, meaning parties can never be certain that a contract is enforceable.

184

Some of these commenters recommended removing the requirement that the ENMA be enforceable in multiple jurisdictions since it would be legally impractical.

185

183

One commenter, for example, urged “would” should be changed to “should” as “would” is difficult to satisfy in bankruptcy courts making it difficult to state with certainty. CEWG.

184

ACLI; GPC; ICI; JBA; Sifma AMG;

see also

CEWG.

185

See

GPC; Sifma AMG.

(iii) Discussion

The final rule defines an EMNA to be any written, legally enforceable netting agreement that creates a single legal obligation for all individual transactions covered by the agreement upon an event of default (including receivership, insolvency, liquidation, or similar proceeding) provided that certain conditions are met.

186

These conditions include requirements with respect to the CSE's right to terminate the contract and liquidate collateral and certain standards with respect to legal review of the agreement to ensure it meets the criteria in the definition. The legal review must be sufficient so that the CSE may conclude with a well-founded basis that, among other things, the contract would be found legal, binding, and enforceable under the law of the relevant jurisdiction and that the contract meets the other requirements of the definition.

186

This definition of ENMA aligns with the recently adopted definition of a “qualifying master netting agreement” for bank regulatory capital purposes and the Prudential Regulators' margin requirements.

See

Regulatory Capital Rules, Liquidity Coverage Ratio: Interim Final Revisions to the Definition of Qualifying Master Netting Agreement and Related Definitions, 79 FR 78287 (Dec. 30, 2014).

The EMNA definition includes a requirement that the agreement not include a walkaway clause, which is defined as a provision that permits a non-defaulting counterparty to make a lower payment than it otherwise would make under the agreement, or no payment at all, to a defaulter or the estate of a defaulter, even if the defaulter or the estate of the defaulter is a net creditor under the agreement.

The proposed EMNA definition included additional language in the definition of walkaway clause that would expressly preclude an EMNA from including a clause that permits a non-defaulting counterparty to “suspend or condition payment” to a defaulter or the estate of a defaulter, even if the defaulter or the estate of the defaulter is or otherwise would be, a net creditor under the agreement. This additional language is not being included in the final rule's definit

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