Capital Requirements of Swap Dealers and Major Swap Participants

Federal RegisterSep 15, 2020

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 23, and 140

RIN 3038-AD54

Capital Requirements of Swap Dealers and Major Swap Participants

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Final rule.

SUMMARY:

The Commodity Futures Trading Commission (“Commission” or “CFTC”) is adopting new regulations imposing minimum capital requirements and financial reporting requirements on swap dealers (“SDs”) and major swap participants (“MSPs”) that are not subject to a prudential regulator. The Commission is also amending existing capital requirements for futures commission merchants (“FCMs”) to provide specific capital deductions for market risk and credit risk for swaps and security-based swaps entered into by an FCM. The Commission is further adopting amendments to its regulations to permit certain entities dually-registered with the Securities and Exchange Commission (“SEC”) to file an SEC Financial and Operational Combined Uniform Single Report in lieu of CFTC financial reports, to require certain Commission registrants to file notices of certain defined events, and to require notices of bulk transfers to be filed with the Commission electronically and within a defined period of time.

DATES:

Effective date:

November 16, 2020.

Compliance date:

October 6, 2021

FOR FURTHER INFORMATION CONTACT:

Joshua Sterling, Director, 202-418-6056,

jsterling@cftc.gov;

Thomas Smith, Deputy Director, 202-418-5495,

tsmith@cftc.gov;

Joshua Beale, Associate Director, 202-418-5446,

jbeale@cftc.gov;

Jennifer Bauer, Special Counsel, 202-418-5472,

jbauer@cftc.gov;

Rafael Martinez, Senior Financial Risk Analyst, 202-418-5462,

rmartinez@cftc.gov,

Division of Swap Dealer and Intermediary Oversight; Paul Schlichting, Assistant General Counsel, Office of the General Counsel, 202-418-5884,

pschlichting@cftc.gov;

Lihong McPhail, Research Economist and Head of Academic Outreach, 202-418-5722,

lmcphail@cftc.gov,

Office of the Chief Economist; Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581; or Mark Bretscher, Special Counsel, 312-596-0598,

mbretscher@cftc.gov;

Division of Swap Dealer and Intermediary Oversight, Commodity Futures Trading Commission, 525 West Monroe Street, Suite 1100, Chicago, IL 60661.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction

A. Background and Statutory Authority

B. Proposed Rulemakings and Reopening of the Comment Period

C. Consultation With U.S. Securities and Exchange Commission and Prudential Regulators

II. Final Regulations and Amendments to Existing Regulations

A. Capital Framework for FCMs, Covered SDs, and Covered MSPs

B. Capital Requirements for Stand-Alone FCMs and FCM-SDs

1. Introduction to General Capital Requirements for Stand-Alone FCMs and FCM-SDs

2. Minimum Capital Requirement for Stand-Alone FCMs and FCM-SDs

a. Minimum Fixed-Dollar Amount of Net Capital

b. Minimum Capital Requirement Based on 8% Risk Margin Amount

3. Stand-Alone FCM and FCM-SD Calculation of Net Capital and Adjusted Net Capital

a. Stand-Alone FCM and FCM-SD Standardized Market Risk Capital Charges

b. FCM and FCM-SD Standardized Counterparty Credit Risk Capital Charges

c. Model-Based Market Risk and Counterparty Credit Risk Capital Charges

(i) FCMs That Are SEC-Registered ANC Firms

(ii) Market Risk and Credit Risk Capital Models for FCM-SDs That Are Not SEC-Registered BDs

C. Capital Requirements for Swap Dealers and Major Swap Participants

1. Introduction to Covered SD and Covered MSP Capital Requirements

2. Capital Requirement for Covered SDs Electing the Net Liquid Assets Capital Approach

a. Computation of Minimum Capital Requirement

b. Computation of Net Capital To Meet Minimum Capital Requirement

(i) Swap Dealers Not Approved To Use Internal Capital Models

(ii) Swap Dealers Approved To Use Internal Capital Models

3. Capital Requirement for Covered SDs Electing the Bank-Based Capital Approach

a. Computation of Minimum Capital Requirement

4. Capital Requirement for Covered SDs Electing the Tangible Net Worth Capital Approach

5. Capital Requirements for Covered MSP

6. Requirements for Market Risk and Credit Risk Models

a. VaR Models

b. Stressed VaR Models

c. Specific Risk Models

d. Incremental Risk Models

e. Comprehensive Risk Models

f. Credit Risk Models

7. Model Approval Process for Covered SDs and FCM-SDs

8. Liquidity Requirements for Covered SDs and FCM-SDs

9. Equity Withdrawal Restrictions for Covered SDs and Covered MSPs

10. Leverage Ratio Requirements for Covered SDs

D. Swap Dealer and Major Swap Participant Financial Recordkeeping, Reporting and Notification Requirements

1. Routine Financial Reporting and Recordkeeping Requirements

2. Swap Dealer and Major Swap Participant Notice Requirements

3. Swap Dealers and Major Swap Participants Subject to the Capital Rules of a Prudential Regulator

4. Public Disclosures

5. Electronic Filing Requirements for Financial Reports and Regulatory Notices

6. Swap Dealer and Major Swap Participant Reporting of Position Information

7. Reporting Requirements for Swap Dealers and Major Swap Participants Approved To Use Internal Capital Models

8. Weekly Position and Margin Reporting

E. Comparability Determinations for Eligible Covered SDs and Covered MSPs

F. Additional Amendments to Existing Regulations

1. Financial Reporting Requirements for FCMs or IBs That Are Also Registered SBSDs

2. Amendments to the FCM and IB Notice Provisions in Regulation 1.12

3. FCM and IB Unsecured Receivables From Swap Transactions

4. Amendments to FCM and IB Notice and Disclosure Requirements for Bulk Transfers

5. Conforming Amendments to Delegated Authority Provisions in Regulation 140.91

G. Effective Date and Compliance Date

III. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

1. Background

2. New Information Collection Requirements and Related Burden Estimates

i. FOCUS Report

ii. Notice of Failure To Maintain Minimum Financial Requirements

iii. Requests for Extensions of Time To File Financial Statements

iv. Capital Requirements Elections

v. Application for Use of Models

vi. Equity Withdrawal Requirements

vii. Financial Recordkeeping, Reporting and Notification Requirements for SDs and MSPs

viii. Capital Comparability Determinations

IV. Cost Benefit Considerations

A. Background

B. Regulatory Capital

C. General Summary of Rulemaking

D. Baseline

E. Overview of Approaches

1. Bank-Based Capital Approach

2. Net Liquid Assets Approach

3. Alternative Net Capital (“ANC”)

4. Tangible Net Worth

5. Substituted Compliance

F. Entities

1. Bank Subsidiaries

2. SD/BD (Without Models)

3. SD/BD/OTC Derivatives Dealers (Without Models)

4. FCM-SD (Without Models)

5. ANC Firms (SD/BD and/or FCMs That Use Models)

6. Stand-Alone SD (With and Without Models)

7. Non-Financial SD (With and Without Models)

8. MSP

9. Substituted Compliance

G. Liquidity Requirements

H. Equity Withdrawal Restrictions

I. Reporting and Recordkeeping Requirements

J. Section 15(a) Factors

1. Protection of Market Participants and the Public

2. Efficiency, Competitiveness, and Financial Integrity of Swaps Markets

3. Price Discovery

4. Sound Risk Management Practices

5. Other Public Interest Considerations

K. Attachment A to Cost Benefit Considerations

I. Introduction

A. Background and Statutory Authority

The Commission is adopting capital and financial reporting requirements for SDs and MSPs, and is amending existing capital rules for FCMs to provide explicit capital requirements for proprietary positions in swaps and security-based swaps that are not cleared by a clearing organization. The adoption of the capital requirements for SDs and MSPs completes the Congressional mandate directing the Commission to adopt rules imposing both capital requirements on SDs and MSPs that are not subject to a prudential regulator, and imposing initial and variation margin on uncleared swaps entered into by SDs and MSPs that are not subject to a prudential regulator.

The term “prudential regulator” is defined for purposes of the section 4s(e) capital and margin requirements to mean the Board of Governors of the Federal Reserve System (“Federal Reserve Board”); 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.

See

section 1a(39) of CEA (7 U.S.C. 1

et. seq.

Title VII of the Dodd-Frank Act established a new regulatory framework for swap and security-based swap transactions.

The legislation was enacted, among other reasons, to reduce risk, increase transparency, and promote market integrity within the financial system, including by: (i) Providing for the registration and comprehensive regulation of SDs, security-based swap dealers (“SBSDs”), MSPs and major security-based swap participants (“MSBSPs”); (ii) imposing clearing and trade execution requirements on swaps and security-based swaps, subject to certain exceptions; (iii) creating rigorous recordkeeping and real-time reporting regimes; and (iv) enhancing the rulemaking and enforcement authorities of the Commissions with respect to, among others, all registered entities and intermediaries subject to the Commission's oversight. The Dodd-Frank Act further established a jurisdictional boundary by authorizing the Commission to regulate “swaps,” and granting the SEC authority to regulate “security-based swaps.”

Sections 721 and 761 of the Dodd-Frank Act also added definitions of the terms “swap dealer,” “security-based swap dealer,” “major swap participant,” and “major security-based swap participant” to the CEA and Exchange Act.

See

Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the Dodd-Frank Act may be accessed at

http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.

The term “swap” is defined in section 1a(47) of the CEA (7 U.S.C. 1a(47)) and Commission regulation § 1.3 (17 CFR 1.3). The term “security-based swap” is defined in section 3(a)(68) of the Exchange Act (15 U.S.C. 78c(a)(68)). Commission regulations referred to in this release are found at 17 CFR chapter I (2019), and are accessible on the Commission's website at

https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm.

See

CEA sections 1a(33) and (49) (7 U.S.C. 1a(33) and (49)) for the definition of the terms “major swap participant” and “swap dealer,” respectively;

See

Exchange Act section 3(a)(67) and (71) (15 U.S.C. 3(a)(67) and (71)) for the definition of the terms “major security-based swap participant” and “security-based swap dealer,” respectively.

An additional provision of the new swap regulatory framework, section 731 of the Dodd-Frank Act, amended the CEA

by adding section 4s, which requires an entity meeting the definition of an SD or an MSP to register with the Commission.

Section 4s authorizes the Commission to adopt rules requiring such SDs and MSPs to maintain daily trading records of their swaps and all related records (including related cash or forward transactions) and recorded communications.

Section 4s further requires each SD or MSP to conform with the business conduct standards prescribed by the Commission that relate to: (i) Fraud, manipulation, and other abusive practices involving swaps; (ii) diligent supervision of the business of the SD or MSP; (iii) adherence to applicable position limits; and (iv) such other matters as the Commission determines appropriate.

7 U.S.C. 1

et seq.

7 U.S.C. 6s(a).

7 U.S.C. 6s(g).

7 U.S.C. 6s(h).

Section 4s(e) also addresses minimum capital requirements for SDs and MSPs, and imposes initial and variation margin obligations on swaps entered into by SDs and MSPs that are not cleared by a registered derivatives clearing organization.

Section 4s(e) applies a bifurcated approach with respect to capital and margin by requiring each SD and MSP subject to regulation by a prudential regulator to meet the minimum capital and margin requirements adopted by the applicable prudential regulator, and requiring each SD and MSP not subject to regulation by a prudential regulator to meet the minimum capital and margin requirements adopted by the Commission.

Therefore, the Commission's authority to impose capital and margin requirements extends to SDs and MSPs that are non-banking entities that are not subject to a prudential regulator, including non-banking subsidiaries of bank holding companies regulated by the Federal Reserve Board. SDs and MSPs subject to the Commission's capital and margin requirements are referred to in this document as “covered SDs” and “covered MSPs,” respectively. SDs and MSPs subject to the margin and capital requirements of a prudential regulator are referred to in this document as “bank SDs” and “bank MSPs,” respectively.

7 U.S.C. 6s(e).

7 U.S.C. 6s(e)(1).

The Commission previously adopted rules imposing margin requirements for uncleared swap transactions entered into by covered SDs and covered MSPs as required by section 4s(e).

The prudential regulators also adopted rules imposing margin requirements for uncleared swap and security-based swap transactions entered into by bank SDs or bank MSPs.

The prudential regulators further adopted capital requirements applicable to bank SDs

and bank MSPs that incorporate swap and security-based swap transactions into the capital framework.

The Commission adopted final rules on December 18, 2015 imposing initial and variation margin requirements on covered SDs and covered MSPs for swap transactions that are not cleared by a registered derivatives clearing organization (“DCO”).

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

81 FR 636 (Jan. 6, 2016). The margin rules, which became effective on April 1, 2016, are codified in part 23 of the Commission's regulations (17 CFR 23.150-23.159, 23.161). In May 2016, the Commission amended the margin rules to add Commission regulation § 23.160, providing rules on the cross-border application of the margin rules.

See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants—Cross-Border Application of the Margin Requirements,

81 FR 34818 (May 31, 2016).

The prudential regulators published final margin requirements in November 2015.

See Margin and Capital Requirements for Covered Swap Entities,

80 FR 74840 (Nov. 30, 2015).

The prudential regulators have adopted capital rules addressing capital requirements for swap and security-based swap transactions. In this regard, the Federal Reserve Board and OCC have adopted revised capital rules to incorporate Basel III capital adequacy requirements.

See, Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule,

78 FR 62018 (Oct. 11, 2013).

Furthermore, section 764 of the Dodd-Frank Act added section 15F to the Exchange Act to address capital and margin requirements associated with security-based swaps. Section 15F(e)(1)(B) directs the SEC to adopt capital and margin requirements for SBSDs and MSBSPs that do not have a prudential regulator (“nonbank SBSDs” and “nonbank MSBSPs”). The SEC adopted final capital rules for nonbank SBSDs and nonbank MSBSPs, as well as final margin rules for security-based swaps entered into by nonbank SBSDs and nonbank MSBSPs, in June 2019.

Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital and Segregation Requirements for Broker-Dealers,

Exchange Act Release No. 86175 (Jun. 21, 2019), 84 FR 43872 (Aug. 22, 2019) (“

2019 SEC Final Capital Rule”

). The compliance date for these rules is October 6, 2021.

In addition to the new capital authority over covered SDs and covered MSPs, the Commission also has separate statutory authority to adopt rules imposing minimum capital requirements on FCMs.

The Commission expects that certain FCMs will engage in a level of swap dealing activity that will require their registration as SDs with the Commission. Such FCMs that are dually-registered as SDs (“FCM-SDs”) will be subject to the Commission's long-standing FCM capital rules. In addition, other FCMs may engage in a level of swap dealing activity that is less than what is required to register as an SD; FCMs may engage in swaps and security-based swaps as part of their business to, for example, hedge financial and commercial risks (“stand-alone FCMs”). Although the general capital treatment of unsecured market gains as non-current assets and the capital charges for inventory and fixed price commitments have been applied as applicable to the market and credit risk of swap positions for FCMs, to now explicitly address both the market and credit risk of these positions for FCM-SDs and stand-alone FCMs, the Commission is adopting rules to specifically incorporate uncleared swaps and security-based swaps into the existing FCM capital framework by defining specific market risk charges and credit risk charges for such transactions. The Commission's FCM regulations are consistent with its authority under section 4f(b) of the CEA, which authorizes the Commission to impose minimum financial requirements, including capital requirements, on FCMs. This authority extends to establishing capital requirements with respect to all of an FCM's activities, including activities involving swaps and security-based swaps.

Under the Commission's final rules, an FCM-SD and a stand-alone FCM are subject to the FCM capital requirements set forth in regulation 1.17.

Section 4f(b) of the CEA (7 U.S.C. 6f(b)) authorizes the Commission to establish minimum financial requirements for FCMs. The Commission previously adopted minimum capital requirements for FCMs, which are set forth in Commission regulation § 1.17 (17 CFR 1.17).

Section 4s(e)(3)(B) (7 U.S.C. 6s(e)(3)(B)) of the CEA provides that the nothing in section 4s shall limit, or be construed to limit, the authority of the Commission to set financial responsibility rules for an FCM.

The Commission also is adopting financial reporting and recordkeeping requirements for SDs and MSPs. Section 4s(f)(2) of the CEA directs the Commission to adopt rules governing financial condition reporting and recordkeeping for SDs and MSPs, and section 4s(f)(1)(A) requires each registered SD and MSP to make such reports as are required by Commission rule or regulation regarding the SD's or MSP's financial condition.

The Commission also is adopting record retention and inspection requirements consistent with the provisions of section 4s(f)(1)(B).

See

7 U.S.C. 6s(f)(1) and (2).

The Commission previously finalized certain record retention requirements for SDs and MSPs regarding their swap activities.

See, Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; Futures Commission Merchant and Introducing Broker Conflicts of Interest Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants,

76 FR 20128 (Apr. 3, 2012).

The final reporting requirements require covered SDs and covered MSPs to file periodic unaudited financial statements and an annual audited financial report with the Commission and with the registered futures association (“RFA”) of which they are a member.

The final regulations further require covered SDs and covered MSPs to file certain regulatory notices with the Commission and with the RFA of which they are a member. The notices are comparable to the existing FCM notices, and are intended to alert the Commission and RFA to scenarios that may indicate potential financial or operational issues, including instances of undercapitalization and failure to maintain current books and records. Covered SDs and covered MSPs are also required to file notice if certain triggering events regarding the failure to post or collect initial or variation margin with swap counterparties occur.

Section 3 of the CEA states that a purpose of the CEA is to establish a system of effective self-regulation under the oversight of the Commission. Consistent with the self-regulatory concept established under section 3, section 17 of the CEA provides a process whereby an association of persons may register with the Commission as an RFA. Currently, the National Futures Association (“NFA”) is the only RFA under section 17 of the CEA.

The Commission also is adopting a program for non-U.S. domiciled covered SDs or covered MSPs to petition the Commission for a program of substituted compliance. Non-U.S. domiciled covered SDs or covered MSPs may seek a determination from the Commission that they operate in a jurisdiction that has comparable capital adequacy and financial reporting objectives and goals as set forth by the Commission in the final regulations. Non-U.S. domiciled covered SDs or MSPs that operate in a jurisdiction that the Commission has determined meets the capital adequacy and financial reporting objectives of the CEA and the Commission's regulations may meet some or all of their capital and financial reporting requirements by complying with their home country jurisdiction requirements.

The Commission is also adopting several amendments to existing regulations as part of the proposed capital and financial recordkeeping and reporting requirements. The Commission is amending regulation 1.12 to require an FCM or an introducing broker (“IB”) that is subject to the capital rules of both the Commission and the SEC to file a notice with the Commission if the FCM or IB fails to meet the SEC's minimum capital requirement. The Commission is also adopting amendments to regulation 1.12 to require an FCM or an IB that is also registered with the SEC as an SBSD or an MSBSP to file a notice if the SBSD's or MSBSP's net capital falls below the “early warning level” established in the rules of the SEC.

The Commission is also adopting amendments to the bulk

transfer provisions of regulation 1.65 by expanding from 5 to 10 days the advance notice that an FCM or an IB must provide to the Commission prior to the transfer. The Commission is further revising the bulk transfer rules to provide that the notice of the bulk transfer must be filed with the Commission electronically, and delegating the authority to accept delivery of such notice in a period shorter than 10 days to the Director of the Division of Swap Dealer and Intermediary Oversight, provided that the notice must be provided as soon as practicable and in no event later than the day of the transfer.

The SEC requires each SBSD for which there is no prudential regulator to provide notice within 24 hours if the SBSD's net capital or tentative net capital (as applicable) falls below 120% of the SBSD's minimum net capital or tentative net capital requirement. An MSBSP is required to provide notice within 24 hours if its tangible net worth falls below $20 million.

See

17 CFR 240.18-8(b).

The Commission also proposed specific quantitative liquidity requirements for certain SDs. As discussed in section II.C.8. below, the Commission has determined to defer consideration of the proposed liquidity requirements at this time. Accordingly, the Commission is not adopting the proposed liquidity requirements in this final rulemaking. SDs will continue to be subject to the existing risk management program requirements, including the liquidity requirements, set forth in regulation 23.600.

The Commission intends to monitor the impact of the capital and financial reporting requirements being adopted today using data received from covered SDs and covered MSPs once they are subject to these capital and financial reporting requirements. Information that the Commission will receive and observe includes data regarding the level of capital that the covered SDs and covered MSPs are required to maintain, the level of capital actually maintained, the liquidity that the firms maintain, the leverage the firms employ, and the scale and types of swaps and other transactions that they are engaged in. The Commission also will continue to consult with the prudential regulators and the SEC to assess the capital adequacy of SDs, MSPs, SBSDs, and MSBSPs. The Commission will monitor the data resulting from the adoption of today's rules and general market events and consider modifications to the capital and financial reporting requirements in light of this information. The Commission also will monitor the information that it receives to assess the adequacy of the liquidity of SDs and, if appropriate, will consider proposing additional liquidity requirements as necessary.

B. Proposed Rulemakings and Reopening of the Comment Period

The Commission initially proposed capital and financial reporting requirements for covered SDs and covered MSPs in 2011.

The Commission received comments from a broad spectrum of market participants, industry representatives, and other interested parties. The commenters addressed numerous topics including the permissible use of models for computing market risk and credit risk capital charges and the need for harmonization of the Commission's capital and financial reporting requirements for covered SDs with the capital and financial reporting rules of the prudential regulators for bank SDs and with the rules of the SEC for nonbank SBSDs. Commenters particularly emphasized a need for the harmonization of regulatory requirements for covered SDs that also are registered with the SEC as SBSDs.

See Capital Requirements of Swap Dealers and Major Swap Participants,

76 FR 27802 (May 12, 2011) (the “

2011 Capital Proposal

”).

Shortly after the Commission issued the

2011 Capital Proposal,

the Basel Committee on Banking Supervision (“BCBS”) and the International Organization of Securities Commissions, in consultation with the Committee on Payment and Settlement Systems and the Committee on Global Financial Systems, formed a working group (the “WGMR”) to develop internationally harmonized standards for margin requirements for uncleared swaps. Representatives of more than 20 regulatory authorities participated in the WGMR including the Commission, the SEC, Federal Reserve Board, OCC, FDIC, and the Federal Reserve Bank of New York. The Commission elected to defer consideration of the SD and MSP capital and financial reporting rules until the WGMR had completed its work and the Commission had adopted margin requirements for uncleared swap transactions. As noted above, the Commission subsequently adopted final margin requirements for uncleared swaps in December 2015, and the compliance period for the final rules is being phased-in through 2021.

See

81 FR 636 (Jan. 6, 2016) and Commission regulation § 23.161 (17 CFR 23.161)). The Commission also has proposed to extend the compliance date for the final phase-in period to September 1, 2022.

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

85 FR 41463 (July 10, 2020).

In 2016, in consideration of the substantial amount of time that had passed since the

2011 Capital Proposal,

the Commission re-proposed the capital and financial reporting rules for SDs and MSPs to provide commenters with an opportunity to provide further comment in recognition of the significant developments in the swaps marketplace since the

2011 Capital Proposal.

These marketplace developments included more than 100 entities provisionally registering with the Commission as SDs, the Commission adopting final margin rules for uncleared swaps, the prudential regulators adopting final capital and margin rules for swap and security-based swap transactions, and the SEC proposing capital, margin, segregation and financial reporting requirements for SBSDs and MSBSPs.

Capital Requirements of Swap Dealers and Major Swap Participants,

81 FR 91252 (Dec. 16, 2016) (the “

2016 Capital Proposal

” or the “Proposal”). The comment letters for the

2016 Capital Proposal

are available at:

https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1769

(the public comment file). Commenters included financial services associations, agricultural associations, energy associations, insurance associations, banks, brokerage firms, investment managers, insurance companies, pension funds, commercial end users, law firms, public interest organizations, and other members of the public.

The Commission again received comments from a broad spectrum of market participants and other interested parties. The commenters raised several issues with regards to the

2016 Capital Proposal,

including the appropriateness of basing a capital requirement on initial margin requirements, the appropriateness of a liquidity requirement for covered SDs, the use of models to compute market risk and credit risk capital charges, and the need for harmonization of the Commission's rules with the rules of the prudential regulators and the SEC. Commenters also requested that the Commission provide an additional opportunity for public comment on the

2016 Capital Proposal

once the SEC finalized its capital, margin, and financial reporting requirements for SBSDs and MSBSPs. The commenters noted the particular necessity for an opportunity to provide further comment on the

2016 Capital Proposal

as the Commission's Proposal would permit a covered SD to compute its capital as if it were a SBSD subject to the SEC's SBSD capital requirements. The commenters noted that the SEC had received many substantial comments on its proposed nonbank SBSD and nonbank MSBSP capital requirements. The commenters further stated that they would need to review the SEC's final capital, margin and financial reporting rules, including the SEC's response to the many comments on its proposal, in order to provide full comments on the

2016 Capital Proposal.

The Commission ultimately reopened the comment period for the

2016 Capital Proposal.

The

2019 Capital Reopening

was published after the SEC had adopted final capital, margin, segregation, and financial reporting requirements for SBSD and MSBSPs. Accordingly, the

2019 Capital Reopening

provided interested parties with an additional opportunity to provide comments on the

2016 Capital Proposal

after the SEC finalized its capital and financial reporting rules.

See Capital Requirements of Swap Dealers and Major Swap Participants,

84 FR 69664 (Dec. 16,

2019) (the “

2019 Capital Reopening

”). The comment letters for the

2019 Capital Reopening

are available at:

https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1769

One commenter stated that the Commission could not finalize the

2016 Capital Proposal

due to the lack of cost benefit analysis related to additional questions contained in the

2019 Capital Reopening

and was unable to fully assess the potential modifications to the proposed rules without re-proposal.

The commenter further argued that the

2019 Capital Reopening

contained only questions and requests for comment with no specific rule text or accompanying explanation, including evaluation of costs and benefits as the commenter believed required. As a result of this, the commenter posited any final rulemaking following the

2019 Capital Reopening

failed to provide adequate notice of identifiable regulatory outcomes to commenters and therefore, would not satisfy APA considerations for notice and comment rulemaking.

The Commission disagrees. The

2019 Capital Reopening

provided an additional opportunity for commenters to address aspects of the

2016 Capital Proposal

in light of the SEC's final capital rule for SBSDs and MSBSPs, which was itself incorporated by reference into the

2016 Capital Proposal.

See

Letter From Dennis M. Kelleher, President and CEO, Better Markets Inc. (March 3, 2020) (Better Markets 3/3/2020 Letter).

Id.

at page 7.

In 2016, the Commission re-proposed the SD Capital rules for a second time.

In that release, the Commission specifically noted that it had considered the comments from the 2011 proposal in developing the

2016 Capital Proposal.

The

2016 Capital Proposal

again proposed complementary financial reporting rules and recognized the expected use of models. Further, the Commission stated at the time that it had also considered capital rules adopted by the prudential regulators and capital rules proposed by the SEC for security-based swap dealers and major security-based swap participants.

As such, the Commission specifically said that it had to a great extent drawn upon the SEC capital rules in developing the proposed capital requirements.

The

2019 Capital Reopening

did not change the 2016 proposed framework, which has largely remained intact since the original proposal in 2011—such as, what method an entity could use to calculate its required capital and the various capital minimums dependent upon the characteristics of the registered entity, while seeking to maintain comparability to the other capital regimes of the Prudential Regulators and the SEC, as statutorily required. The

2019 Capital Reopening

sought to specifically respond to commenters who had asked for an additional opportunity to comment on the

2016 Capital Proposal

following the finalization of capital rules for SBSDs by the SEC. It gave commenters the opportunity to provide their views on whether certain items should be included or how the process should account for them.

Each of the areas addressed in the

2019 Capital Reopening

signaled potential modifications that the Commission was considering in light of comments received, including modifications adopted by the SEC.

Modifications in the final rule, including a discussion and specific inclusion of various approaches, are therefore the logical outgrowth of the

2016 Capital Proposal.

81 FR 91252 (Dec. 16, 2016).

Id.

at 91254.

Id.

In this regard, Section 4s(e)(3)(D) of the CEA provides that the CFTC, SEC, and prudential regulators shall, to the maximum extent practicable, establish and maintain comparable minimum capital requirements for SDs and MSPs.

Id.

See

84 FR 69665.

Id.

In addition, the

2016 Capital Proposal

included a comprehensive cost benefit consideration section, addressing the Section 15(a) factors in detail. The cost-benefit analysis discussed an elective approach utilizing similar tailored minimums depending on the characteristics of the registered entity—a net liquid asset approach incorporating the traditional FCM and SEC registered broker or dealer (“BD”) capital framework, a bank-based approach incorporating again the risk-weighted assets framework from banking rules, and again a tangible net worth approach for certain eligible firms. The

2016 Capital Proposal

again proposed complementary financial reporting rules and recognized the expected use of models. The public was asked to comment on all aspects of the proposal, and several comments were received in response. A more fulsome discussion is in the Cost-Benefit Consideration section of this document; however, as noted above, the potential modifications described in the

2019 Capital Reopening,

including a discussion and specific inclusion of potential rule language, were logical outgrowths of the

2016 Capital Proposal.

C. Consultation With U.S. Securities and Exchange Commission and Prudential Regulators

The Dodd-Frank Act amended the CEA and the Exchange Act to require the Commission, SEC, and prudential regulators to coordinate and develop comparable capital requirements for SDs and SBSDs, and for MSPs and MSBSPs. Section 4s(e)(3)(D) of the CEA (7 U.S.C. 6s(e)(3)(D), in conjunction with section 15F(e)(3)(D) of the Exchange Act (15 U.S.C. 78o-10(e)(3)(D)), provides that, to the maximum extent practicable, the Commission, SEC and the prudential regulators shall establish and maintain comparable minimum capital requirements for SDs and SBSDs, and for MSPs and MSBSPs. Further, section 4s(e)(3)(D) and section 15F(e)(3)(D) provide that staff of the CFTC, SEC, and prudential regulators shall meet periodically, but no less frequently than annually, to consult on minimum capital requirements. Consistent with this Congressional mandate, the respective staffs of the Commission, SEC, and the prudential regulators have regularly shared drafts of proposed and final rulemakings with staffs of the other agencies for review and comment before taking final action with respect to the proposed or final rulemakings. Consistent with this approach, the Commission provided the SEC and prudential regulators with drafts of the final rules for review and comment, and the final rulemaking reflects comments received from the SEC and prudential regulators.

II. Final Regulations and Amendments to Existing Regulations

A. Capital Framework for FCMs, Covered SDs, and Covered MSPs

FCMs are subject to existing capital requirements set forth in regulation 1.17. The Commission is amending regulation 1.17 to establish capital requirements explicitly for swap and security-based swap transactions entered into by FCMs. The Commission is also amending regulation 1.17 to require an FCM-SD to comply with the amended FCM capital requirements. A discussion of the amendments to

regulation 1.17 for FCMs and FCM-SDs is contained in section II.B. of this release.

The Commission is also adopting final capital rules for covered SDs that are not FCM-SDs, and is adopting final capital rules for covered MSPs. The Commission is adopting a flexible approach that allows covered SDs to elect one of three alternative capital frameworks for establishing their minimum capital requirements and for computing their regulatory capital. The three alternative approaches draw to a great extent on the existing CFTC capital requirements for FCMs contained in regulation 1.17, as well as the SEC's capital requirements for BDs and nonbank SBSDs, and the prudential regulators' capital requirements for bank SDs. Specifically, the Commission's final capital rules, depending on the characteristics of a covered SD, permit such SD to elect: (i) A capital requirement consistent with the SEC's final capital requirements for SBSDs, as well as the existing CFTC capital rules for FCMs and the existing SEC capital rules for BDs (the “Net Liquid Assets Capital Approach”); (ii) a capital requirement consistent with the prudential regulators' capital requirements for bank SDs, and that is based on existing Federal Reserve Board capital requirements for bank holding companies (the “Bank-Based Capital Approach”); or (iii) a capital requirement based on the covered SD's tangible net worth, provided that the covered SD or its parent entity is predominantly engaged in non-financial activities as defined in the rule (the “Tangible Net Worth Capital Approach”). Each of the approaches is discussed in section II. below.

With respect to covered MSPs, the Commission is adopting a minimum regulatory capital requirement based upon the tangible net worth of the MSP. While there currently are no provisionally-registered MSPs or entities pending registration as MSPs, the Commission is adopting final capital requirements in the event that entities seek registration in the future. A capital requirement based upon the tangible net worth of the MSP is consistent with the approach adopted by the SEC for nonbank MSBSPs, as discussed in section II.C.5. of this release.

Broadly speaking, in developing the proposed capital requirements, the Commission strived to advance the statutory goal of helping to protect the safety and soundness of covered SDs and covered MSPs, while also taking into account the diverse nature of the entities registered as SDs, and the existing capital regimes that apply to covered SDs and/or their financial group. In this regard, as of June 30, 2020, there were 108 provisionally registered SDs. Fifty-two of the provisionally registered SDs are bank SDs, subject to a prudential regulator. The remaining 56 SDs are covered SDs, subject to the Commission's capital rules. While each of the 56 covered SDs is registered with the Commission as a result of their swap dealing activities, the SDs represent a broad range of business activities and a diverse population of swap counterparties. Several of the covered SDs are primarily engaged in commodity-focused swap transactions with commercial counterparties, while other covered SDs are focused primarily with financial related swaps, including interest rate, foreign currency, and credit default swaps, and have a broad range of swaps counterparties that includes both commercial and financial counterparties.

The 56 covered SDs subject to the Commission's capital requirements are associated with 21 corporate families, with several families having more than 1 provisionally-registered covered SD. Many of these corporate families are part of U.S. bank or foreign bank holding companies that offer global financial services and are subject to prudential capital regulation, including BCBS-based capital requirements that may extend to some of the provisionally-registered covered SDs. The alternative capital approaches adopted by the Commission are intended to mitigate potential competitive disadvantages and unnecessary costs that might otherwise arise if the Commission were to impose a single capital approach in light of the existing different operating and corporate structures of the covered SDs. The Commission further believes that the flexibility of the capital approaches will potentially benefit market participants by providing a tailored capital regime that encourages SDs that are not part of global financial firms to continue to provide liquidity in the swaps market, particularly to smaller financial or commercial end users that do not have relationships with the large financial SDs.

As mentioned above, FCM-SDs are subject to the FCM capital requirements set forth in regulation 1.17. Covered SDs that are not FCM-SDs and covered MSPs that are not FCM-MSPs are subject to the final capital requirements set forth in regulation 23.101. Regulation 23.101 details the minimum capital requirements for each of the three capital approaches for covered SDs and the eligibility criteria (as applicable), and further defines the capital computations for each approach, including various market risk and credit risk capital charges. Regulation 23.101 also defines the minimum capital requirements for covered MSPs and defines the capital computation for covered MSPs. Each of these capital approaches is discussed below.

B. Capital Requirements for Stand-Alone FCMs and FCM-SDs

1. Introduction to General Capital Requirements for Stand-Alone FCMs and FCM-SDs

The capital requirements for FCMs are set forth in regulation 1.17 and require each FCM to maintain a minimum level of “liquid assets” in excess of the firm's liabilities to provide resources for the FCM to meet its financial obligations as a market intermediary in the regulated futures and cleared swaps markets. As a market intermediary, an FCM provides services to its customers and the marketplace, including, in the event of a customer default, guaranteeing the financial performance of each customer to clearing organizations that clear the customers' futures and cleared swap transactions. To ensure that an FCM is capable of meeting its financial obligations, regulation 1.17 requires an FCM to hold at all times more than one dollar of highly liquid assets for each dollar of liabilities (

e.g.,

money owed to customers, counterparties and creditors), excluding certain subordinated debt.

The FCM capital requirements also are intended to ensure that an FCM maintains a sufficient level of liquid assets in excess of its liabilities in order to effectively and efficiently wind-down its operations by transferring customer positions and funds to other FCMs in the event that the FCM voluntarily or involuntarily ceases operations.

Commission regulation § 1.17(h) (17 CFR 1.17(h)) permits an FCM to exclude certain qualifying subordinated debt from its liabilities in computing its net capital. In order to qualify, the person lending cash to the FCM must subordinate its claim against the FCM to all other creditors of the FCM in addition to agreeing to other conditions, including potential restrictions associated with scheduled repayments of the debt.

The FCM capital requirement contains two components. The first component is a minimum level of “adjusted net capital” that an FCM is required to maintain at any given time. The minimum adjusted net capital requirement is generally the greater of the following: (i) A fixed-dollar amount; (ii) an amount computed based upon the clearing organization margin imposed on customer and noncustomer futures, foreign futures, and cleared swap

positions carried by the FCM; (iii) the amount of net capital required by the SEC for FCMs that are dually-registered as BDs (“FCM/BDs”); or, (iv) the amount of adjusted net capital required by an RFA of which the FCM is a member.

See

Commission regulation § 1.17(a)(1)(i) (17 CFR 1.17(a)(1)(i)).

The second component of the FCM capital requirement is the amount of adjusted net capital that an FCM actually maintains based upon the assets and liabilities of the firm. In determining its adjusted net capital, an FCM is first required to compute its net worth under generally accepted accounting principles (“GAAP”) as adopted in the United States, and then is required to apply certain rule-based adjustments to reduce its net worth to the extent it contains illiquid assets such as fixed assets and unsecured receivables. The resulting calculation reflects the FCM's “net capital.” The FCM is then required to apply certain rule-based capital charges or haircuts to reflect market risk associated with its liquid assets. The resulting calculation reflects the FCM's “adjusted net capital.” The calculation of adjusted net capital in this manner is intended, as noted above, to ensure that the FCM holds at least one dollar of highly liquid assets to meet each dollar of liabilities, excluding certain qualifying subordinated liabilities.

The Commission proposed several amendments to regulation 1.17 in recognition that the current capital requirements do not explicitly reflect FCMs transacting in uncleared swap or security-based swap transactions, or engaging in swap dealing activities. The Commission also proposed to require FCM-SDs to comply with the FCM capital requirements.

The Commission proposed to require FCM-SDs to comply with regulation 1.17 due to the Commission's experience regulating FCMs and its belief that the FCM capital requirements, with its emphasis on liquidity, are well-designed to ensure that an FCM will be able to continue to perform its critical functions in the futures and cleared swaps marketplace. As noted above, FCMs are market intermediaries that provide customers with access to the futures and cleared swaps markets. As market intermediaries, FCMs play a central role in the daily settlement process at derivatives clearing organizations by paying or collecting their customers' initial and variation margin obligations. FCMs also guarantee their customers' financial performance to each DCO, and contribute to DCO guarantee funds. FCMs also provide numerous services for their customers, including providing confirmations of each transaction and periodic account statements. Based on its experience with FCMs, the Commission believes that the FCM capital rule, which is a liquidity-based capital rule, is appropriate for FCM-SDs.

Section 4s(e)(3)(B)(i) of the CEA (7 U.S.C. 6s(e)(3)(B)(i)) states that nothing in section 4s(e) imposing capital and margin requirement on SDs and MSPs limits, or shall be construed to limit, the authority of the Commission to set financial responsibility rules for FCMs pursuant to section 4f(a).

2. Minimum Capital Requirement for FCMs and FCM-SDs

a. Minimum Fixed-Dollar Amount of Net Capital

Regulation 1.17(a)(1)(i) requires an FCM to maintain a minimum amount of adjusted net capital that is equal to or greater than the highest of: (i) $1 million; (ii) for an FCM that engages in off-exchange foreign currency transactions with retail forex customers,

$20 million, plus 5% percent of the FCM's liabilities to the retail forex customers that exceed $10 million; (iii) 8% percent of the sum of the risk margin of futures, options on futures, foreign futures, and swap positions cleared by a clearing organization and carried by the FCM in customer and noncustomer accounts; (iv) the amount of adjusted net capital required by the RFA of which the FCM is a member; and (v) for an FCM that is also registered with the SEC as a BD, the amount of net capital required by the rules of the SEC.

Commission regulation § 5.1(k) (17 CFR 5.1(k)) defines the term “retail forex customer” as a person, other than an eligible contract participant as defined in section 1a(18) of the CEA, acting on its own behalf in any account agreement, contract or transaction described in section 2(c)(2)(B) or 2(c)(2)(C) of the CEA (7 U.S.C. 2(c)(2)(B) or 2(c)(2)(C)).

See

Commission regulation § 1.17(a)(1)(i) (17 CFR 1.17(a)(1)(i)).

The term “risk margin” is defined in regulation 1.17(b)(8) as the level of maintenance margin or performance bond required for the customer or noncustomer positions by the applicable exchanges or clearing organizations, and, where margin or performance bond is required only for accounts at the clearing organization, for purposes of the FCM's risk-based capital calculations applying the same margin or performance bond requirements to customer and noncustomer positions in accounts carried by the FCM, subject to the following: (i) Risk margin does not include the equity component of short or long option positions maintained in an account; (ii) the maintenance margin or performance bond requirement associated with a long option position may be excluded from risk margin to the extent that the value of such long option position does not reduce the total risk maintenance or performance bond requirement of the account that holds the long option position; (iii) the risk margin for an account carried by an FCM which is not a member of the exchange or the clearing organization that requires collection of such margin should be calculated as if the FCM were such a member; and (iv) if an FCM does not possess sufficient information to determine what portion of an account's total margin requirement represents risk margin, all of the margin required by the exchange or the clearing organization that requires collection of such margin for that account, shall be treated as risk margin.

Commission regulation § 1.17(b)(8) (17 CFR 1.17(b)(8)).

The Commission proposed amending regulation 1.17(a)(1)(i)(A) to increase the minimum fixed-dollar amount of adjusted net capital from $1 million to $20 million for FCM-SDs. The Commission did not propose to amend the required minimum fixed-dollar amount of adjusted net capital for stand-alone FCMs that may engage in swap activities at a level that does not require registration as an SD, as the Commission believed that the existing minimum fixed-dollar amount of required adjusted net capital was properly calibrated for such firms.

The Commission believes that the proposed higher minimum dollar amount of adjusted net capital for FCM-SDs is appropriate given the enhanced risk that an FCM-SD assumes in engaging in swap dealing activities, while also continuing to carry futures and cleared swaps customers.

As noted above, FCMs act primarily as market intermediaries for futures and cleared swaps customers and typically do not use their balance sheet to facilitate customer transactions. Absent a customer default, an FCM does not take on market risk of its customers' positions in performing this market intermediary function. FCMs that are FCM-SDs, however, are engaging in swap dealing activities. As dealers, FCM-SDs use their balance sheet to facilitate customer transactions as they are counterparties on swap positions in addition to performing market intermediary functions for their customers. Dealing activities present additional risks to FCM-SDs. As dealers, an FCM-SD is potentially exposed to market risks on uncleared

swap positions, and is exposed to counterparty credit risk from swap counterparties. FCM-SDs also may be required to post initial margin and pay variation margin to swap counterparties on a daily basis for their proprietary uncleared swap positions. The proposed increase in the fixed-dollar amount of the minimum adjusted net capital was intended to address the potential increase in risks posed to FCM-SDs from dealing activities, including the impact that dealing may have on the liquidity of FCM-SDs. The proposed increase in the minimum capital requirement also was intended to otherwise help ensure the safety and soundness of the FCM-SD, as the insolvency of an FCM-SD could have potential adverse consequences to the efficient operation of the market, particularly as the insolvency impacts the futures and cleared swaps customers of the FCM-SD. The Commission further noted that the proposed $20 million minimum adjusted net capital requirement was consistent with the $20 million minimum dollar amount of adjusted net capital imposed by Congress and the Commission on retail foreign exchange dealers (“RFEDs”) or FCMs that enter into off-exchange foreign currency transactions with retail persons under section 2(c)(2)(C) of the CEA and regulation 5.7(a).

2016 Capital Proposal,

81 FR 91252.

The Commission also proposed amending regulation 1.17(a)(1)(ii) to require an FCM-SD that receives approval from the Commission or from an RFA of which it is a member to use internal market risk or credit risk models to compute capital charges in lieu of the standardized capital charges or deductions to maintain net capital equal to or in excess of $100 million, and adjusted net capital equal to or in excess of $20 million. The requirement to maintain a minimum $100 million fixed-dollar amount of net capital was intended to address the issue that while models are more risk sensitive and generally result in substantially lower market risk and credit risk capital charges than standardized charges, models may not capture all risks, including extreme market losses (

i.e.,

tail risk) or liquidity concerns. The requirement for an FCM-SD that is approved to use capital models to maintain a minimum of $100 million of net capital and $20 million of adjusted net capital is consistent with the SEC's final capital rule for SBSDs that are not registered BDs (“stand-alone SBSDs”) and that are approved to use internal models to compute market risk and credit risk capital charges. These entities are required to maintain fixed-dollar tentative net capital of $100 million and fixed-dollar net capital of $20 million.

See

SEC rule 18a-1(a)(2) (17 CFR 240.18a-1(a)(2)).

The Commission did not receive comment on the proposed $20 million fixed-dollar amount of adjusted net capital required of FCM-SDs. The Commission received a comment stating that the proposed $100 million net capital requirement for FCM-SDs that have approval to use internal models to compute market risk or credit risk capital charges in lieu of the standardized capital charges would create an unnecessary barrier to entry.

See

Letter from Joanna Mallers, FIA Principal Traders Group (May 24, 2017) (FIA-PTG 5/24/2017 Letter).

The Commission has considered the proposed amendments of the minimum fixed-dollar amount of net capital and adjusted net capital that FCM-SDs would be required to maintain and is adopting the amendments as proposed.

As noted above, FCMs play a central role as market intermediaries for futures and cleared swaps transactions, including guaranteeing each customer's financial performance to clearing organizations or carrying FCMs. An adequate level of capital is necessary to ensure that FCMs meet their financial obligations, which in turn promotes customer protection and helps ensure the cleared futures and cleared swaps markets operate efficiently. The increase in adjusted net capital for FCM-SDs to $20 million is also necessary to address the additional risk that is inherent in an SD's dealing activities. As a dealer, an FCM-SD uses its balance sheet to facilitate customer swap transactions, is a counterparty in swap transactions, and is obligated to post and collect initial margin and settle variation margin with swap counterparties. Furthermore, the final requirement for an FCM-SD to maintain a minimum of $20 million of adjusted net capital is consistent with the Commission's required minimum adjusted net capital of $20 million for RFEDs, and is consistent with the SEC's final minimum capital requirements for SBSDs.

The

2019 SEC Final Capital Rule

requires BDs that use internal models to compute market risk and credit risk capital charges in lieu of standardized capital charges to maintain $5 billion of net capital and $1 billion of adjusted net capital. FCM/SDs that also are registered with the SEC as BDs are required to comply with the SEC's capital requirements in meeting the Commission's minimum capital requirement.

With respect to the comment that a $100 million minimum net capital requirement for FCM-SD's seeking approval to use capital models may act as a barrier to entry, the Commission notes that the regulation was designed to account for the fact that model-based market risk and credit risk capital charges, while more risk sensitive than standardized capital charges, tend to be substantially lower than standardized charges. The $100 million of net capital is intended to address potential model errors and tail risk and other factors that may not be fully or accurately captured in the models. The Commission further notes that currently the only FCM-SDs provisionally registered are four BD/FCMs that are subject to substantially higher minimum capital requirements under SEC and CFTC rules as discussed in section II.B.3.c.(i). below. Accordingly, no provisionally-registered FCM-SD will be subject to the $100 million minimum net capital requirement based on the current list of provisionally registered SDs.

b. Minimum Capital Requirement Based on 8% Risk Margin Amount

Another component of the minimum capital requirements in regulation 1.17 provides that each FCM must maintain adjusted net capital equal to or greater than 8% of the risk margin amount associated with the futures, foreign futures, and cleared swaps positions carried by the FCM in customer and noncustomer accounts.

As discussed in section II.B.2.a. above, the term “risk margin” for an account generally means the level of maintenance margin or performance bond required for customer and noncustomer positions by the applicable exchanges or clearing organizations.

Clearing organizations generally set initial margin requirements for futures, foreign futures, and cleared swap positons at a level to cover one-day market moves with a 99% level of confidence.

A noncustomer account is an account that an FCM carries for persons that generally are officers or employees of the FCM (

i.e.,

the persons are not customers of the FCM and the account is not the proprietary account of the FCM).

See

Commission regulation § 1.17(b)(4) (17 CFR 1.17(b)(4)).

See

Commission regulation § 1.17(b)(8) (17 CFR 1.17(b)(8)).

See,

for example, Commission regulation § 39.13(g) (17 CFR 39.13(g)) which provides that a derivatives clearing organization must set margin for futures and swaps on agricultural commodities, energy commodities, and metals using a one-tailed 99% confidence interval with a minimum one-day liquidation period, and must set margin for all other swaps using a one-tailed 99% confidence interval with a minimum five-day liquidation period.

In computing the 8% risk margin amount, an FCM is required to compute risk margin on the positions of each customer on a customer-by-customer basis, and multiply the resulting aggregate risk margin amount by 8%. The 8% risk margin amount is a risk

sensitive calculation in that an FCM's minimum capital requirement is tied to the level of exchange or clearing organization margin associated with each customer's and noncustomer's account. Accordingly, an FCM's minimum capital requirement increases or decreases as the aggregate of its customer and noncustomer risk margin increases or decreases. The 8% risk margin amount is also a volume-based metric as it requires an FCM to compute the risk margin amount on each individual customer and noncustomer account, with no offsets between accounts to reflect offsetting positions or to reflect margin collected on the accounts. As a volume-based metric, an FCM's minimum capital requirement increases or decreases based upon the aggregate amount of risk margin required of each customer and noncustomer account carried by the FCM.

The Commission proposed amending the minimum capital requirement in regulation 1.17(a)(1)(i)(B) by expanding the types of positions that an FCM-SD must include in the 8% risk margin amount calculation. The Commission did not propose to expand the types of positions that must be included in the risk margin amount calculation for stand-alone FCMs. An FCM that is not an FCM-SD must continue to calculate the 8% risk margin amount based upon the customer and noncustomer futures, foreign futures, and cleared swap positions carried by the FCM.

A commenter noted an ambiguity in the

2016 Capital Proposal

in that the Commission stated in the preamble that the proposed increases in the minimum capital requirements would be applicable only to FCM-SDs and not to stand-alone FCMs, but that the proposed rule text in Commission regulation § 1.17 did not clearly draw that distinction.

See

Letter from Walt Lukken, Futures Industry Association, March 3, 2020 (FIA 3/3/2020 Letter). The Commission confirms that the proposed increases in the minimum capital requirements were only applicable to FCM-SDs, and has modified the final rule text to clarify this point.

Regulation 1.17(a)(1)(i)(B) currently requires an FCM, as noted above, to include the risk margin associated with the futures, foreign futures, and cleared swap positions carried in customer and noncustomer accounts in the 8% risk margin amount calculation. The

2016 Capital Proposal

expanded the list of products that an FCM-SD must include in the 8% risk margin amount calculation to further include the cleared security-based swap positions carried for customers and noncustomers, as well as the FCM-SD's proprietary cleared swaps and proprietary cleared security-based swap positions. The positions in the risk margin amount calculation was proposed to be further extended to include the FCM-SD's uncleared swap and uncleared security-based swap positions.

The Proposal required an FCM-SD to include all swaps and security-based swaps in the risk margin amount calculation, including swaps that are excluded from the Commission's margin rules for uncleared swaps and any security-based swaps that the SEC excluded from its margin rules. Specifically, the proposal provided that an FCM-SD must include in its computation of the risk margin amount each outstanding uncleared swap, including swaps exempt from the scope of the Commission's uncleared swaps margin rules by regulation 23.150 (“TRIPRA Exemption),

legacy swaps, foreign exchange swaps as the term is defined in regulation 23.151, or netting set of swaps or foreign exchange swaps, for each counterparty, as if the counterparty were an unaffiliated SD. The Proposal further required an FCM-SD to include the initial margin for all uncleared swaps that would otherwise fall below the $50 million initial margin threshold amount or the $500,000 minimum transfer amount, as defined in regulation 23.151, for purposes of computing the uncleared swap margin amount.

Title III of the Terrorism Risk Insurance Program Reauthorization Act of 2015 amended sections 731 and 764 of the Dodd-Frank Act to provide that the Commission's margin requirements shall not apply to a swap in which a counterparty: (i) Qualifies for an exception under section 2(h)(7)(A) of the CEA; (ii) qualifies for an exemption issued under section 4(c)(1) of the CEA for cooperative entities as defined in such exemption; and (iii) satisfies the criteria in section in section 2(h)(7)(D) of the CEA.

See

Public Law 114-1, 129 Stat. 3.

2016 Capital Proposal,

81 FR 91252 at 91258.

The Commission received comments on various aspects of the proposed 8% risk margin amount calculation for FCM-SDs. Commenters to the

2016 Capital Proposal

and the

2019 Capital Reopening

objected to including cleared and uncleared security-based swaps in the 8% risk margin amount calculation for FCM-SDs.

Commenters stated that the Commission should not include security-based swaps in the 8% risk margin amount calculation as security-based swaps are products regulated by the SEC, and that including SEC-regulated products in the Commission's minimum capital requirement is inconsistent with long-standing CFTC and SEC capital requirements for FCMs and BDs.

See

FIA 3/3/2020 Letter; Letter from Briget Polichene, Institute of International Bankers, Scott O'Malia, International Swaps and Derivatives Association, and Kenneth Bentsen, Jr., Securities Industry and Financial Markets Association (March 3, 2020) (IIB/ISDA/SIFMA 3/3/2020 Letter).

See

IIB/ISDA/SIFMA 3/3/2020 Letter.

A commenter noted that a dually-registered FCM/BD is generally required to maintain adjusted net capital equal to the greater of (i) 8% of the margin required for futures, foreign futures, and cleared swaps carried by the FCM for customers and noncustomers, or (ii) 2% of the debit items calculated in respect of the BD's customer securities positions.

The commenter further stated that the approach of setting separate, as opposed to aggregate, requirements for Commission and SEC regulated products allows the agency that Congress selected to regulate a given product to determine the appropriate balance between robust capital cushions and robust market liquidity.

Id.

The commenter further noted that the

2019 SEC Final Capital Rule

continued this historical approach as the SEC elected to include in its minimum capital requirement the initial margin associated only with customer and noncustomer cleared security-based swaps and the SBSD's uncleared security-based swaps.

The SEC's final rule did not incorporate initial margin associated with customer cleared swap positions or uncleared swap positions, or otherwise include positions that are not subject to the SEC's jurisdiction.

Id.

One commenter stated that FX forwards and swaps should be excluded from the 8% risk margin amount calculation as Congress gave the United States Treasury Department the authority over these products.

See

Letter from Joanna Mallers, FIA Principal Traders Group (March 3, 2020) (FIA-PTG 3/3/2020 Letter).

The Commission has considered the proposal and the comments received, and is adopting a minimum capital requirement based upon a percentage of the risk margin amount. The Commission is modifying the final rule, however, to exclude cleared security-based swap and uncleared security-based swap positions from the risk margin amount calculation. The Commission acknowledges that in setting minimum capital requirements for FCMs, including FCMs that are dually-registered as FCM/BDs, it has historically considered only the futures related activities of an FCM. In this regard, the Commission's initial minimum capital requirement was based upon a percentage of futures customer and noncustomer funds held by an FCM, and was subsequently

amended to be based upon a percentage of the risk margin associated with futures and cleared swaps customer and noncustomer positions carried by an FCM.

The Commission has not historically required an FCM/BD to maintain a level of minimum capital necessary to meet the aggregate of the CFTC's minimum requirement and the SEC's minimum requirement, which is based on the FCM/BD's securities activities.

See Minimum Financial and Related Reporting Requirements for Futures Commission Merchants and Introducing Brokers,

69 FR 49784 (Aug. 12, 2004).

The Commission believes that the overall adequacy of the minimum capital requirement at an FCM-SD should be based upon the activities of the FCM-SD in CFTC-regulated markets. This allows the Commission to monitor the adequacy of the minimum capital requirements based upon its expertise and experience with Commission-regulated products and markets. In addition, an FCM-SD that is also registered as a BD would continue to be subject to the minimum capital requirements established by the SEC for BDs in addition to the minimum capital requirements established by the Commission for FCM-SDs. The Commission's current capital rule requires an FCM/BD to maintain a minimum level of capital that is greater than the higher of the CFTC minimum requirement for FCMs or the SEC minimum requirement for BDs.

Therefore, an FCM-SD that is registered as a BD will have to maintain minimum capital in an amount based upon the greater of the CFTC or SEC minimum requirement. This would help ensure the safety and soundness of the FCM-SD by providing readily available financial resources to address operational, legal, compliance, or other risks, and, if necessary, by providing financial resources to assist with the orderly liquidation of the FCM-SD in the event of its insolvency.

See

Commission regulation § 1.17(a)(1)(i)(D) (17 CFR 1.17(a)(1)(i)(D)).

Commenters also stated that the Commission's proposed inclusion of the proprietary futures and proprietary cleared swap positions in an FCM-SD's 8% risk margin amount calculation would duplicate existing capital charges required under regulation 1.17.

The commenters noted that regulation 1.17(c)(5)(x) currently requires an FCM to take a capital charge in an amount equal to 100% or 150% of the margin required by a clearing organization for proprietary futures and cleared swap positions

in computing its adjusted net capital.

Another commenter stated that including margin associated with proprietary cleared swaps in the 8% risk margin amount was not necessary as proprietary cleared positions present minimal credit risk to an FCM-SD as the only credit exposure is to a clearing organization or broker.

The proprietary futures and cleared swaps capital charge also would apply to FCM-SDs under the Commission's Proposal, as FCM-SDs are required to comply with regulation 1.17. One commenter also stated that the SEC in its final rules requires a BD or SBSD to take a standardized capital charge for cleared security-based swaps equal to 100% of the margin required by a clearing agency, and does not impose a 150% charge for positions held by non-clearing BDs or SBSDs.

The commenter stated that if the Commission adopts this capital charge, it should do so in a manner that is consistent with the SEC's final rule.

See

FIA 3/3/2020 Letter.

Commission regulation § 1.17(c)(5)(x) (17 CFR 1.17(c)(5)(x)) currently requires an FCM that is a clearing member of a clearing organization to take a capital charge equal to 100% of the margin required by the clearing organization for the cleared positions. FCMs that are not clearing members are required to take a capital charge equal to 150% of the maintenance margin required by the applicable clearing organization for the cleared positions.

See

Letter from Stephen Berger, Citadel Securities (May 15, 2017) (Citadel 5/15/2017 Letter); Letter from Mary Kay Scucci, Securities Industry and Financial Markets Association (May 15, 2017) (SIFMA 5/15/2017 Letter); Letter from Walter Lukken, Futures Industry Association (May 15, 2017) (FIA 5/15/2017 Letter); FIA-PTG 5/24/2017 Letter; FIA 3/3/2020 Letter; FIA-PTG 3/3/2020 Letter.

See

IIB/ISDA/SIFMA 3/3/2020 Letter.

See

IIB/ISDA/SIFMA 3/3/2020 Letter.

See also,

SEC rule 15c3-1(c)(2)(vi)(O) (17 CFR 240.15c3-1(c)(2)(vi)(O)) which provides that capital charge for a proprietary cleared security-based swaps is the margin amount of the clearing agency or, if the security-based swap references an equity security, the broker or dealer may take a deduction using the method specified in rule 15c3-1a (17 CFR 240.15c3-1a).

The Commission has reconsidered the Proposal and the comments received and is modifying final regulation 1.17(a)(1)(i)(B) to not include proprietary futures, foreign futures, and proprietary cleared swaps from the risk margin amount calculation. The Commission believes that the requirement for an FCM-SD to take a capital charge equal to 100% or 150% of the required initial margin or required maintenance margin, as applicable, on its proprietary cleared positions adequately accounts for the risk associated with those positions, as it reflects the potential market risk presented by the positions as determined by a clearing organization or broker and further recognizes that the initial margin posted with the clearing organization or broker is no longer available for use in the FCM-SD's business and, thus, warrants at least a 100% capital charge. The market risk capital charge imposed on proprietary futures and cleared swaps for FCM-SDs approved to use capital models for market risk would be model-based and not the margin imposed by a clearing organization. Since a market risk charge would reduce the FCM-SD's capital, the Commission believes that it is appropriate to exclude the proprietary cleared positions from the 8% risk margin amount calculation.

The Commission believes that under such circumstances it is not necessary to impose an additional capital requirement in the form of an increase in the minimum capital requirement equal to 8% of the margin associated with the FCM-SD's proprietary cleared futures, foreign futures, and swaps positions. In this regard, the Commission notes that an FCM-SD's credit exposure is limited on cleared positions to either a clearing organization or to an FCM that carries the FCM-SD's account (or in the case of foreign futures, a foreign broker that carries the FCM-SD's account). The credit exposure on such cleared positions is limited as clearing organizations and FCMs/foreign brokers are regulated entities that are generally subject to financial requirements, including capital, margining, and financial reporting requirements. Clearing organizations and FCMs/foreign brokers are also subject to regulations regarding the holding of customer funds to ensure that such funds are used solely for the benefit of the customer and not for the benefit of other customers or of the clearing organization or FCM/foreign broker.

Furthermore, as noted above, an FCM-SD will be required to maintain a level of net capital that is sufficient to cover the market risk charges associated with the proprietary cleared futures, foreign futures, and cleared swap positions.

See, e.g.,

Commission regulations §§ 1.20, 1.22, and 39.15 (17 CFR 1.20, 1.22 and 39.15).

The Commission is also modifying the final regulation to set the risk margin amount multiplier for uncleared swaps at 2% of the “uncleared swap margin” amount required on such positions. The term “uncleared swap margin” is defined in regulation 1.17(b)(11) to mean the amount of initial margin that the FCM-SD would compute on each uncleared swap position pursuant to the calculation requirements of regulation 23.154. The FCM-SD must include all uncleared swap positions in the

calculation of the uncleared swap margin amount, including uncleared swaps that are exempt from the scope of the Commission's margin regulations for uncleared swaps pursuant to regulation 23.150, exempt foreign exchange swaps or foreign exchange forwards, or netting set of swaps or foreign exchange swaps, for each counterparty, as if the counterparty was an unaffiliated swap dealer. Furthermore, in computing the uncleared swap margin amount, an FCM-SD may not reduce the uncleared swap margin amount to reflect the

initial margin threshold amount

or the

minimum transfer amount

as such terms are defined in regulation 23.151.

The Commission is modifying the definition of the term “uncleared swap margin” in final paragraph (b)(11) of Commission regulation 1.17 (17 CFR 1.17(b)(11)) to align the wording of the regulation to be consistent with the definition of the term “uncleared swap margin” in regulation 23.100 for SDs that are not also registered FCMs.

The Commission is modifying the risk margin amount multiplier in recognition that the Commission's margin requirements generally impose a higher margin requirement on uncleared swap positions relative to cleared swaps and futures positions. Minimum initial margin requirements for cleared futures and swap transactions are generally set by clearing organizations. In this regard, the FCM minimum capital requirement of 8% of the risk margin amount on futures and cleared swaps is based upon margin calculations using clearing organization models that require a 99% one-tailed confidence interval over a minimum liquidation period of one day for futures, agricultural swaps, energy swaps, and metal swaps, and a minimum liquidation period of five days for all other swaps, including financial swaps such as interest rate swaps.

In contrast, initial margin for uncleared swaps is required to be calculated at a 99% one-tailed confidence interval over minimum liquidation period of 10 business days (or the maturity of the swap if shorter).

The greater margin period of risk for uncleared swaps generally requires a higher level of initial margin, which would increase the FCM-SD's minimum capital requirement for uncleared swaps relative to cleared transactions. The modification of the final rule to set the risk margin amount multiplier at 2% for uncleared swap positions is appropriate given the generally higher initial margin requirements imposed on such positions under the Commission's regulations relative to cleared positions. In addition, as noted above, FCM-SD's will also be required to take market risk charges for each of its proprietary positions, including uncleared swaps, in computing its adjusted net capital.

See

Commission regulation § 39.13(g) (17 CFR 39.13(g)).

See

Commission regulation § 23.154(b)(2) (17 CFR 23.154(b)(2)).

As noted by a commenter, the 8% risk margin amount was proposed in 2003, and subsequently adopted in 2004, based upon an analysis and comparison of the then existing FCM capital regime that was based on a percentage of the customer funds held by an FCM, with a minimum capital requirement based upon risk margin associated with the customer positions carried by the FCM.

Staff also had the benefit of observing data of the actual performance of the two capital regimes for an extended period of time as each FCM was required to calculate its minimum capital requirement based on customer funds and its capital requirement based on a percentage of its risk margin amount for approximately two years as part of a pilot program.

See Minimum Financial and Related Reporting Requirements for Futures Commission Merchants and Introducing Brokers,

68 FR 40835 (July 9, 2003) and 69 FR 49784 (Aug. 12, 2004).

See also, CFTC Division of Trading and Markets, Review of Standard Portfolio Analysis of Risk Margining System Implemented by the Chicago Mercantile Exchange, Board of Trade Clearing Corporation, and the Chicago Board of Trade (Apr. 2001) (“T&M 2001 Report”). See

IIB/ISDA/SIFMA 3/3/2020 Letter.

See T&M 2001 Report.

The Commission does not have the benefit of similar comprehensive data regarding the multiplier for the uncleared swaps risk margin amount at this time. However, the Commission's decision to modify the final rule by removing cleared and uncleared security-based swaps, as well as proprietary futures, foreign futures, and cleared swaps positions from the risk margin amount calculation, and to set the multiplier at 2% should mitigate many of the commenters' concerns that the proposed 8% risk margin amount calculation was over inclusive of the types of positions included in the calculation and was set at a percentage that was too high.

The modification to remove proprietary futures, foreign futures, cleared swap, and cleared and uncleared security-based swap positions from the risk margin amount calculation also mitigates concerns raised by commenters that the capital rule “double counts” positions by requiring an FCM-SD to include such positions in its minimum capital requirement while also requiring the FCM-SD to take market risk and credit risk charges in computing its adjusted net capital. The modifications to the final rule also more closely aligns the Commission's minimum capital requirement for FCM-SDs with the approach adopted by the SEC for setting minimum capital requirements for BDs that are SBSDs and stand-alone SBSDs.

The Commission will review within five years of the effective date of this rule, the impact that the 2% risk margin amount has on the level of minimum capital required of FCM-SDs after the compliance date of the rules. The Commission will use the financial statements and other information that it will receive from FCM-SDs under existing FCM financial reporting requirements to assess whether the minimum capital requirements for FCM-SDs are adequately calibrated to ensure their safety and soundness. The information that the Commission will receive will allow it to determine if it would be appropriate to propose amending the minimum capital requirement by, among other things, increasing or decreasing the risk margin amount multiplier.

3. Stand-Alone FCM and FCM-SD Calculation of Net Capital and Adjusted Net Capital

As previously noted, the second component of the FCM and FCM-SD capital requirement is the computation of the firm's adjusted net capital based upon the assets and liabilities of the firm. Regulation 1.17(c)(5) defines the term “adjusted net capital” as an FCM's “current assets” (

i.e.,

current, liquid assets excluding, however, most unsecured receivables), less all of the FCM's liabilities (except certain qualifying subordinated debt). An FCM is further required to impose certain prescribed capital deductions (“capital charges” or “haircuts”) from the current market value of the FCM's proprietary positions (

e.g.,

futures, securities, debt instruments, money market instruments, and commodities) in computing its adjusted net capital to reflect potential market risk associated with the firm's proprietary positions, as well as to provide a capital cushion against other potential risks, including liquidity, legal, and operational risk.

Regulation 1.17(c)(5) establishes specific standardized capital charges for market risk for an FCM's proprietary positions in physical inventory, forward contracts, fixed price commitments, and securities. Regulation 1.17(c)(5), however, did not explicitly address market risk capital charges for uncleared swap or security-based swap positions. While FCMs have not historically engaged in a significant level of swaps or security-based swap transactions, the Commission has required FCMs to use the standardized market risk capital charges specified in regulation

1.17(c)(5)(ii), or the standardized market risk capital charges established by SEC rule 15c3-1 (17 CFR 240.15c3-1) (“SEC rule 15c3-1”) for dually-registered FCM-BDs, to compute market risk capital charges for uncleared swap and security-based swap positions.

For example, existing Commission regulation § 1.17(c)(5)(ii)(C) (17 CFR 1.17(c)(5)(ii)(C)) imposes a market risk capital charge on inventory positions held by an FCM equal to 20% of the market value of the inventory, and § 1.17(c)(5)(ii)(G) (17 CFR 1.17(c)(5)(ii)(G)) imposes the same market risk capital charge of 20% on the value of fixed price commitments and forward contracts. FCMs holding agricultural swaps or energy swaps have been required to take a market risk capital charge equal to 20% of the notional value of the swap under the application of either of these two provisions.

The Commission proposed amendments to regulation 1.17(c)(5) to more explicitly provide for specific standardized market risk capital charges for an FCM's or FCM-SD's proprietary positions in uncleared swaps and security-based swaps.

The Proposal further provided that an FCM or FCM-SD that obtained approval to use internal market risk capital models could use such models in lieu of the standardized market risk charges. In order to use capital models, an FCM-BD must have obtained SEC approval to use capital models. These dually-registered FCM-BDs are referred to as “Alternative Net Capital Firms” (“ANC Firms”), and are subject to enhanced minimum capital requirements as discussed below. An FCM which is not a BD, but also is registered as an SBSD would also be subject to the approval of both the Commission and the SEC to use models, but with lesser applicable fixed dollar net capital and adjusted net capital thresholds. The proposed standardized market risk charges and model-based charges are also discussed below.

2016 Capital Proposal,

81 FR 91252 at 91266-67.

a. Stand-Alone FCM and FCM-SD Standardized Market Risk Capital Charges

FCMs currently are required to take standardized market risk charges for proprietary positions in computing their adjusted net capital under regulation 1.17. The current standardized market risk charges are aligned with the SEC's market risk capital charges for BDs, and reflect the two agencies' long-standing efforts of maintaining a uniform capital rule for FCMs and BDs as most FCMs are dually-registered as BDs. In this regard, regulation 1.17 requires FCMs that hold positions in securities and securities-related products, such as U.S. Government securities, equity securities and options, municipal securities, commercial paper, and certificates of deposit, to take market risk capital charges on such positions in the manner and amount specified by SEC rule 15c3-1 and rule 15c3-1a (17 CFR 240.15c3-1a) (“SEC rule 15c3-1a”). FCMs that hold positions in commodities, including foreign currency and physical commodities, are required to take market risk capital charges set forth in Commission regulation 1.17(c)(5). For example, regulation 1.17(c)(5) requires an FCM to take a capital charge equal to 0% to 20% of the market value of inventory depending on whether the FCM's inventory position is adequately offset (or “covered”) by proprietary futures positions.

The standardized Commission and SEC market risk capital charges are generally computed based upon the market value of the position multiplied by a percentage factor set forth in the rule or regulation.

See

Commission regulation § 1.17(j) (17 CFR 1.17(j)) for the definition of the term “cover.”

Regulation 1.17 and SEC rules, however, did not provide explicit market risk capital charges for swaps or security-based swaps. To the extent an FCM engages in uncleared swap or security-based swap transactions, the FCM is required to take a market risk capital charge based upon the standardized capital charges contained in SEC rules 15c3-1, 15c3-1a, or Commission regulation 1.17(c)(5) that are applicable to proprietary positions in securities, inventory, foreign currency, fixed price commitments, or forward contracts. For example, an energy swap is treated as a fixed price commitment under regulation 1.17(c)(5), and an FCM is required to take a market risk capital charge equal to 20 percent of the notional value of the swap.

The purpose of the market risk capital charge is to require an FCM, in computing its adjusted net capital, to reserve a minimum level of capital to cover potential future losses in the value of the swap.

For example, swaps with a reference asset of a physical commodity are subject to a capital charge equal to 20% of the notional value of the contract (

See

Commission regulation § 1.17(c)(5)(ii)(G) (17 CFR 1.17(c)(5)(ii)(G)).

The

2016 Capital Proposal

proposed amending the standardized market risk capital charges to explicitly reflect uncleared swap and security-based swap positions. The Commission proposed to amend regulation 1.17(c)(5)(iii) to provide a schedule of standardized market risk capital charges for positions in uncleared credit default swaps, interest rate swaps, foreign exchange swaps, commodity swaps, and all other uncleared swaps.

The Commission also proposed that an FCM or an FCM-SD must take the applicable standardized capital charge in SEC rule 15c3-1, as such rule was proposed to be amended, for proprietary positions in uncleared security-based swaps, including uncleared security-based credit default swaps and equity swaps.

See 2016 Capital Proposal,

81 FR 91252 at 91266-67.

The SEC proposed amending rules 15c3-1 and 15c3-1b to establish standardized capital charges for security-based swaps and swaps that would apply to stand-alone BDs and BDs that are also registered SBSDs.

See Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital Requirements for Broker-Dealers,

77 FR 70214 (Nov. 23, 2012) (“

SEC 2012 Proposed Capital Rule

”).

Credit default swaps are generally defined by the reference asset or entity, the notional amount, the duration of the contract, and credit events. The Commission proposed standardized market risk capital charges for credit default swaps using maturity grids. The “maturity grid” was based on a “maturity grid” approach that was proposed and subsequently adopted by the SEC for credit default swaps and security-credit default swaps.

Market risk capital charges for uncleared credit default swaps were proposed to be based on two variables under the

2016 Capital Proposal:

(i) The length of time to maturity of the credit default swap; and (ii) the amount of the current offered basis point spread on the uncleared credit default swap. The standardized market risk charge for an unhedged short position in a credit default swap was the applicable percentage specified in the grid. The deduction for an unhedged long position was 50% of the applicable deduction specified in the grid.

SEC rule 15c3-1(c)(2)(vi)(P)(

) (17 CFR 240.15c3-1(c)(2)(vi)(P)(

)).

See

proposed paragraph (c)(5)(iii)(A) of Commission regulation § 1.17;

2016 Capital Proposal,

81 FR 91252 at 91307.

The

2016 Capital Proposal

also permitted an FCM to net long and short positions where the uncleared credit default swaps reference the same entity or obligation, reference the same credit events that would trigger payment by the seller of the protection, reference the same basket of obligations that would determine the amount of payment by the seller of protection upon the occurrence of a credit event, and are in the same or adjacent maturity and spread categories (as long as the long and short positions each have maturities within three months of the other maturity category). In this case, the FCM was required to take the specified market risk percentage deduction only

on the notional amount of the excess long or short position.

See 2016 Capital Proposal,

81 FR 91252 at 91267.

For uncleared interest rate swaps, the Commission proposed a standardized market risk capital charge approach that required multiplying the notional amount of the swap by a stated percent.

The percentage that applied to the notional amount was determined by referencing the standardized haircuts in SEC rule 15c3-1(c)(2)(vi)(A) for U.S. government securities with comparable maturities to the interest rate swaps maturities, and would range from 0% (for interest rate swaps with a remaining time to maturity of less than 3 months) to 6% (for interest rate swaps with a remaining time to maturity of 25 years or more). The

2016 Capital Proposal

further provided that an FCM may net certain long and short uncleared interest rate swaps to reduce the net notional amount of the interest rate swaps subject to the market risk capital charge. The net amount of the long and short interest rate swaps was determined based upon the existing SEC netting schedule for government securities, which is based upon the time to maturity of the interest rate swaps. For example, long and short interest rate swaps with maturity dates ranging between 3 years to less than 5 years are subject to market risk capital charge equal to 3% on the net long or short interest rate swap position.

Id.

The Proposal further provided that the market risk capital charge for interest rate swaps must not be less than 0.5% of the amount of the long position that was netted against a short position, notwithstanding that the netting provisions contained in SEC rule 15c3-1 does not impose a market risk capital charge on U.S. government securities with less than 3 months to maturity.

The 0.5% floor on the total amount of the long interest rate swaps netted against the short interest rate swaps was designed to account for potential differences between the movement of interest rates on U.S. government securities and interest rates upon which swap payments are based.

The SEC proposed minimum standardized market risk charge of 1% of the net notional value of the interest rate swaps for SBSDs and 0.5% for BDs.

See SEC Proposed Capital Rule,

77 FR 70214 at 70345; Proposed rule 18a-1b(b)(2)(C) for SBSDs and proposed rule 15c3-1b(2)(ii)(C).

The Commission also proposed specific market risk capital charges for foreign currency swaps, commodity swaps, security-based swaps, and all other uncleared swaps. The Proposal requires FCM and FCM-SDs to take a market risk capital charge for foreign currencies swaps that is consistent with the standardized market risk charges for foreign currency positions and foreign currency forwards contained in regulation 1.17(c)(5). Specifically, the Commission proposed market risk charges equal to 6% of the notional value of a foreign currency swap that references euros, British pounds, Canadian dollars, Japanese yen, or Swiss francs. Foreign currency swaps that reference any other currency are subject to a market risk capital charge equal to 20% of the notional value of the respective swap.

With respect to swaps referencing a physical commodity, the Proposal required FCM and FCM-SDs to take a market risk capital charge equal to 20% of the market value of the relevant commodity underlying a commodity swap. Consistent with the foreign currency and interest rate swaps, the proposed commodity swap market risk capital charge was based upon the existing capital charges for physical commodities set forth in regulation 1.17(c)(5). The Proposal further required an FCM or FCM-SD to take the market risk capital charges specified in SEC rules for security-based swaps, which would include equity swaps, and for any swap that has a reference asset that is subject to specific SEC market risk capital charges and is not otherwise subject to a Commission imposed capital charge.

Commenters objected to the proposed standardized market risk capital charges as being too punitive and not tailored to the risk posed by the relevant portfolios of positions.

Specifically, commenters noted that the proposed standardized market risk charges for interest rate swaps are substantially higher than the capital charges based on clearing house maintenance margin requirements for cleared interest rate futures contracts.

One commenter provided a sample matched book portfolio of interest rate swaps demonstrating that an FCM would have substantially higher capital charges under the proposed standardized approach as compared to the model approach or as compared to clearing house maintenance margin requirements.

These commenters indicated that the excessive capital requirements derived from the proposed standardized market risk capital charges would particularly impact small to mid-sized SDs that are not approved or otherwise do not use internal market risk capital models.

See

SIFMA 5/15/2017 Letter; Letter from Michael Sharp, Jefferies Group LLC (May 12, 2017) (Jefferies 5/12/2017 Letter).

SIFMA and Jefferies each estimated that the proposed standardized market risk charges for uncleared interest rate swaps would be substantially higher than the clearing house margin requirements.

See Id.

See

Jefferies 5/12/2017 Letter.

See

proposed Commission regulation § 23.101(a)(1),

2016 Capital Proposal,

81 FR 91252 at 91310-11.

See

SIFMA 5/15/2017 Letter; Letter from Ryan Hayden, ED&F Man Derivative Products, Inc./INTL FCStone Markets, LLC (March 3, 2020) (ED&F Man/INTL FCStone 3/3/2020 Letter); IIB/ISDA/SIFMA 3/3/2020 Letter; FIA 3/3/2020 Letter; Letter from Alexander Lange, ABN AMRO Securities (USA) LLC; Michael Bando, ING Capital Markets LLC; Adam Hopkins, Mizuho Capital Markets LLC; David Moser, Nomura Holding America Inc. (January 29, 2018) (ABN/ING/Mizuho/Nomura 1/29/2018 Letter).

Commenters also requested that the Commission reconsider the standardized capital charge on currency swaps.

The commenters noted that an FCM or FCM-SD would have to take a market risk capital charge equal to 20% of the notional amount of an uncleared foreign currency non-deliverable forward contract, while the standardized (or grid-based) initial margin requirements on such a contact is 6% of the notional amount.

One commenter recommended that the final rule align the capital charge with the volatility and liquidity conditions of the relevant currency pair.

Another commenter stated that the standardized capital charge is too high for a product that is highly liquid and recommended that the capital charge be aligned with the standardized initial margin requirement of 6% under the uncleared margin rules.

Letter from Stephen John Berger, Citadel Securities, March 3, 2020 (Citadel 3/3/2020 Letter); FIA-PTG 3/3/2020 Letter.

IIB/ISDA/SIFMA 3/3/2020 Letter; Citadel 3/3/2020 Letter.

Citadel 3/3/2020 Letter.

FIA-PTG 3/3/2020 Letter.

Another commenter stated that a covered SD that enters into a swap with uncleared swap contracts containing a flip-clause should require a charge for required margin on such contract plus market risk.

Letter from William Harrington (3/3/2020) (Harrington 3/3/2020 Letter).

The Commission acknowledged in the

2019 Capital Reopening

that the proposed standardized market risk charges would impact FCMs, FCM-SDs, and covered SDs that do not have approval to use internal market risk capital models, which are more likely to be smaller to mid-sized firms that may not be part of a financial group that has the approval of the SEC, a prudential regulator, or a foreign regulator to use internal capital models. The Commission further believed that establishing a more appropriate market risk capital charge for uncleared interest

rates swaps, in particular, given the relatively high market risk capital charge would benefit market participants by encouraging smaller to mid-sized FCMs, FCM-SDs, and covered SDs to remain in the market or to enter the market. Accordingly, the Commission requested further comment on the proposed standardized market risk charge for uncleared interest rate swaps. The Commission also noted that the SEC's final capital rule for BDs and SBSDs imposed a minimum capital requirement for uncleared interest rate swaps equal to

1/8

of one percent (0.125%) and only applicable to the matched long position that is netted against a short position in the case of a uncleared interest rate swap with a maturity of three months or more.

See 2019 SEC Final Capital Rule,

rule 18a-1b(b)(2)(ii)(A)(

) (17 CFR 240.18a-1b(b)(2)(ii)(A)(

) for SBSDs and rule 15c3-1b(b)(2)(ii)(A)(

) (17 CFR 240.15c3-1b(b)(2)(ii)(A)(

)) for BDs.

The Commission has considered the comments and is adopting the proposed standardized market risk charges for uncleared swaps and uncleared security-based swaps as proposed, with several modifications that are discussed below. The standardized market risk capital charges being adopted are generally based on existing Commission and SEC standardized market risk charges for positions in foreign currencies, commodities, U.S. treasuries, equities and other instruments, which, in the Commission's long experience, have generally proven to be effective and appropriately calibrated to address potential market risk in the positions. The Commission believes at this time that this approach, in conjunction with other charges discussed herein, appropriately accounts for the wide variety of possible uncleared swap transactions that FCMs, FCM-SDs, and covered SDs may engage in, including bespoke swap transactions involving flip-clauses or other unique features. Overtime, the Commission may consider adjusting these charges as a result of experience with their impacts on required capital in these firms and as market developments may warrant.

In response to several commenters, the Commission recognizes that standardized market risk charges are not as risk sensitive as market risk models, and generally result in higher market risk capital charges than internal models. The Commission notes, however, the lower capital charges for firm's approved to use market risk model is one of the reasons that model approved firms are subject to the higher minimum capital requirements. As noted in section II.B.2.a. above, FCM-SDs that are approved to use internal market risk models are required to maintain net capital of at least $100 million and adjusted net capital of $20 million, while FCM-SDs that are not approved to use internal market risk models are required to maintain $20 million of adjusted net capital, but are not subject to the $100 million dollar net capital requirement. The imposition of $100 million net capital requirement is to provide protection for potential model errors or the failure of the models to address all applicable risks. The Commission believes that it is appropriate to require FCM-SDs that do not use internal models and therefore have a lower capital requirement to be subject to the higher standardized market risk capital charges. The approach is also consistent with the approach adopted by both the Commission and SEC with respect to ANC Firms that have been approved to use internal capital models and, which under the

2019 SEC Final Capital Rule,

are subject to a minimum capital requirement of $5 billion of tentative net capital and $1 billion of net capital.

SEC rule 15c3-1(a)(7) (17 CFR 240.15c3-1(a)(7)).

In addition, the Commission believes that FCM-SDs will seek approval to use model-based market risk charges. There currently are four FCM-SDs provisionally-registered with the Commission. Each of the FCM-SDs is an ANC Firm that is approved to use market risk capital models and, which under the

2019 SEC Final Capital Rule,

is subject to the SEC's minimum capital requirement of $5 billion of tentative net capital and $1 billion of net capital. In order to effectively compete with the existing FCM-SDs and other covered SDs, any new FCM-SD registrant would need to obtain model approval.

The Commission is also modifying the final regulation by reducing the minimum capital charge for a portfolio of interest rate swaps to align with the SEC's final capital requirement for BD's and SBSD's using standardized capital charges. In reviewing the comments, the Commission realizes that the standardized market risk charges for interest rate swaps that it proposed in its

2016 Capital Proposal

was too high relative to the market risk of the positions. The Proposal's imposition of a minimum market risk capital charge of .5% of the notional amount of the matched long interest rate swaps has been shown by commenters to be poorly calibrated to the market risk of the positions. Therefore, under the final regulation, an FCM-SD or FCM is required to take a capital charge of at least

1/8

of one percent (0.125%) of the matched long interest rate swap positions that is netted against a short interest rate swap positions with a maturity of three months or more. The Commission believes that in making this change, the overall effect on the amount of capital held by an FCM or an FCM-SD will not have a substantial adverse impact on the safety and soundness of these entities. The Commission, however, will monitor the standardized capital charges and refine the percentages as it obtains experience with the level of interest rate swaps transactions entered into by stand-alone FCMs and FCM-SDs and magnitude of the market risk charges on such positions.

The Commission is also making a technical modification to the final capital rule for credit default swaps. As noted in the

2019 Capital Reopening,

the

2019 SEC Final Capital Rule

includes the same standardized capital charges for credit default swaps for BDs and SBSDs as proposed by the Commission for FCMs, FCM-SDs, and covered SDs. There is a slight difference between the Commission's Proposal and the SEC's final rule, however, in applying the capital charges based upon the time to maturity. Specifically, the maturity grids differ by one month, and there are some slight changes to the rule text. The Commissions is modifying the time to maturity grids and the wording in the final rule to align with the SEC's final rule to avoid having dually-registered entities being subject to slightly different regulatory requirements with respect to market risk charges for credit default swaps. The Commission believes that this modification will have no material impact on its capital requirements.

The Commission is also modifying the final rule to provide that an FCM or FCM-SD may reduce market risk charges for uncleared swap positions, other than credit default swaps which as proposed provided for netting, to account for comparable offsetting positions.

The Commission noted in the

2019 Capital Reopening

that the SEC adopted a netting proviso applicable to both BDs and SBSDs, permitting a reduction of the resulting market risk capital charge by an amount equal to any reduction recognized for comparable long or short positions in the reference asset or interest rate under

regulation 1.17 or SEC rule 15c3-1.

For example, an FCM or FCM-SD that is required to take market risk charges on equal and opposite legs of a portfolio of foreign currency swaps is permitted to net the market risk charges on the long and short positions to the extent that the positions are comparable.

See

paragraph (c)(5)(iii)(D) of Commission regulation § 1.17, as amended (17 CFR 1.17(c)(5)(iii)(D)).

SEC rule 15c3-1b(b)(2)(ii)(B) (17 CFR 240.15c3-1b(b)(2)(ii)(B)) for BDs and rule 18a-1b(b)(2)(ii)(B) (17 CFR 240.18a-1b(b)(2)(ii)(B)) for SBSDs.

The Commission stated in the

2019 Capital Reopening

that it intended to maintain consistency with the

2019 SEC Final Capital Rule

with respect to the applicability of the standardized market risk charges for uncleared currency and commodity swaps, and requested comment on including the same netting proviso to regulation 1.17(c)(5)(iii).

Commenters to the

2019 Capital Reopening

generally supported the netting provision.

One commenter stated that such an approach would be consistent with common and current risk management practices and would allow non-financial SDs to be more responsive to customer needs.

See 2019 Capital Reopening,

84 FR 69664 at 69672.

See

Citadel 3/3/2020 Letter; IIB/ISDA/SIFMA 3/3/2020 Letter; Letter from Alexander Holtan, Commercial Energy Working Group (March 3, 2020) (CEWG 3/3/2020 Letter); Letter from Sebastian Crapanzano and Soo-Mi Lee, Morgan Stanley (March 3, 2020) (MS 3/3/2020 Letter).

See

Citadel 3/3/2020 Letter page 5.

The Commission believes that it is appropriate that an FCM or an FCM-SD be permitted to net offsetting swap positions in computing the market risk on the portfolio of swap positions in an identical fashion as the SEC has adopted for BDs and SBSDs. Otherwise, the capital rule would require individual capital charges on each swap position without any consideration of the actual risk of the positions. Such an approach would discourage FCMs or FCM-SDs from hedging their exposures and from participating in the swaps market. The ability to net offsetting positions in computing market risk is also a fundamental approach that has been adopted by other regulators including the SEC, prudential regulators, and others. Therefore the Commission is adopting the netting provision as set forth at regulation 1.17(c)(5)(iii)(D).

FCMs currently are required by regulation 1.17(c)(5)(x) to take standardized capital charges on proprietary cleared futures and cleared swap positions. The capital charge is equal to 100% of the margin requirement imposed by the clearing organization on the positions if the FCM is a clearing member of such clearing organization. For FCMs that are not clearing members of the clearing organization that clears the positions, the capital charge is equal to 150% of the applicable maintenance margin requirement of the applicable board of trade or clearing organization, whichever is greater. FCM-SDs also are subject to these capital charges as such firms must comply with the FCM capital requirements set forth in regulation 1.17.

Several commenters requested that the Commission eliminate the requirement for an FCM to take capital charges equal to 150% of the margin for proprietary futures or cleared swap positions. One commenter stated that there is no justification for a higher capital charge as market risk is independent of whether the firm is or is not a clearing firm.

This commenter also noted that the SEC's final capital rules for SBSDs impose a capital requirement for proprietary cleared positions equal to 100% of the required clearing organization margin, and do not require a non-clearing SBSD to take a higher capital charge of 150% of required margin.

Another commenter stated that there is no justification for assessing covered SDs that are non-clearing members the higher 150% charge and imposing such a requirement is placing the SDs at an unnecessary competitive disadvantage. The commenter recommended that all SDs should be able to take a standardized market risk charge equal to the clearing organizations' margin requirement.

See

IIB/ISDA/SIFMA 3/3/2020 Letter.

Id.

See

FIA-PTG 3/3/2020 Letter.

The Commission has considered the Proposal and comments and is not revising regulation 1.17(c)(5)(x). The capital requirement for FCMs to take a capital charge for cleared proprietary positions has been in place for many years. The higher capital charge for non-clearing FCMs takes into consideration that such firms are not subject to heightened capital and other requirements that are imposed by clearing organizations on clearing members. FCM clearing members also are required to post guarantee fund contributions to clearing organizations to support their financial obligations, and are subject to clearing organization assessment authority in the event that a shortfall results from the default of a fellow clearing member. The higher capital charge for non-clearing FCMs and FCM-SDs is intended to ensure that such firms retain an appropriate level of capital and liquid resources to meet their financial obligations, including to their carrying FCMs and ultimately to clearing organizations, and the Commission believes that the 150% capital charge is appropriate to help ensure the safety and soundness of the FCM or FCM-SD.

b. FCM and FCM-SD Standardized Counterparty Credit Risk Capital Charges

FCMs currently are required to take standardized capital charges to reflect counterparty credit risk associated with uncleared swap and security-based swap positions. The Commission's capital rule requires an FCM that holds swap or security-based swap positions to mark the positions to their respective fair market values in their financial records.

Swap and security-based swap positions that have mark-to-market losses result in the FCM recognizing variation margin payables to swap and security-based swap counterparties. Such losses reduce the FCM's capital either by the payment of variation margin or the recognition of a liability. Swap and security-based swap positions that have mark-to-market gains result in the FCM recognizing variation margin receivables from the swap and security-based swap counterparties. The variation margin receivables, however, are subject to a 100% counterparty credit risk capital charge unless the receivables are secured by readily marketable collateral.

Commission regulation § 1.17(c)(1) (17 CFR 1.17(c)(1)).

See

Commission regulation § 1.17(c)(1) and (2) (17 CFR 1.17(c)(1) and (2)), which defines the term “net capital” and requires an FCM to include unrealized gains and losses in the computation of net capital, and further provides that an FCM must generally exclude unsecured receivables (including unsecured receivables from swap and security-based swap counterparties).

The Commission proposed to retain the 100% counterparty credit risk charges for unsecured receivables from swap and security-based swap counterparties in the Proposal, and further proposed extending this treatment to FCM-SDs. The Proposal further imposed the 100% counterparty credit risk treatment applied to all swap and security-based swap counterparties of the FCM or FCM-SD, including commercial end users, that are exempt from the requirement to exchange variation margin.

100

The FCM or FCM-SD also would be required to take a 100% capital charge on unsecured receivables resulting from transactions that are exempt from the margin requirements, including legacy swap and security-based swap transactions and foreign exchange forward and swap

transactions, as well as any receivables from counterparties that are subject to a $500,000 minimum transfer amount.

101

100

See

Commission regulation § 23.150 (17 CFR 23.150).

101

Commission regulation § 23.153 (17 CFR 23.153), provides that a covered SD is not required to collect or post variation margin with a particular swaps counterparty until the combined initial and variation margin required to be exchanged with the counterparty exceeds $500,000.

The Commission proposed the 100% capital charge on unsecured receivables from swap and security-based swap counterparties as it is was consistent with the Commission's general approach of requiring an FCM to exclude unsecured receivables from its adjusted net capital. As noted above, the Commission's capital rule focuses on the liquidity of the FCM and unsecured receivables do not reflect a liquid asset to the FCM that it may use in order to meet its own financial obligations.

The Proposal effectively required an FCM or FCM-SD that did not have approval to use models to compute counterparty credit risk to take a 100% capital charge for unsecured receivables due from swap and security-based swap counterparties. This would include counterparties that are not obligated to exchange variation margin with the FCM or FCM-SD, including commercial end users, affiliates, and counterparties engaging foreign exchange swaps as the term is defined in regulation 23.151.

FCM-SDs are also subject to the Commission's margin rules for uncleared swap transactions and may be directly or indirectly subject to the SEC's margin rules for uncleared security-based swaps. Under the Commission's margin rules, an FCM-SD is generally required to post initial margin for uncleared swap transactions entered into with other SDs or financial end users with a third-party custodian and may post initial margin with the custodian for security-based swaps. Stand-alone FCMs that engage in swaps and security-based swaps also may be obligated or elect to post initial margin for such transactions with a third-party custodian in accordance with the Commission's or the SEC's respective uncleared swap and security-based swap margin rules. Such deposits would generally be treated under the Commission's capital rule as an unsecured receivable from the third-party custodian, and subject to a 100% capital charge.

The Commission proposed to amend regulation 1.17(c)(2)(ii)(G) to permit an FCM or an FCM-SD to include initial margin funds it deposited with third-party custodians for uncleared swaps and uncleared security-based swaps in its capital computation, provided that the margin is held in accordance with the requirements established by the applicable Commission or SEC margin rules.

102

The Commission proposed to permit FCMs and FCM-SDs to include initial margin posted with third-party custodians as capital in recognition that the Commission's capital rules require an FCM-SD or stand-alone FCM to post initial margin for their uncleared swap transactions with third-party custodians to ensure that the FCM-SD or FCM meets its financial obligations to swap counterparties. The Commission also believes that the FCM-SD has minimal credit risk from the third-party custodian as the Commission's margin regulations require that the FCM-SD enter into a custodial agreement with the third-party custodian that prohibits the custodian from rehypothecating, repledging, reusing, or otherwise transferring (including though repurchase agreements) the collateral held by the custodian.

103

The custodial agreement also must be a legal, valid, binding, and enforceable agreement under the laws of all relevant jurisdictions including in the event of a bankruptcy, insolvency, or similar proceeding.

104

102

See 2016 Capital Proposal,

81 FR 91252 at 91306-07, proposed paragraph (c)(2)(ii)(G) of Commission regulation § 1.17.

103

See

Commission regulation § 23.157 (17 CFR 23.157).

104

Id.

The Commission is adopting the amendment to regulation 1.17(c)(2)(ii)(G) to permit FCMs and FCM-SDs to recognize margin posted with a third-party custodian for swap and security-based swap transactions as a current asset in computing their adjusted net capital. In order to qualify as a current asset, the initial margin must be deposited by the FCM or FCM-SD with a third-party custodian in accordance with the requirements specified in the Commission's uncleared swap margin rules set forth in regulations 23.150 through 23.161, or the SEC's uncleared security-based swap margin rules. The Commission is modifying the final regulation to clarify that initial margin posted by an FCM or FCM-SD with third-party custodians for uncleared swaps or uncleared security-based swaps entered into with bank SDs subject to the margin rules of a prudential regulator and entered into with foreign registered SDs that operate in a jurisdiction that has received a margin Comparability Determination by the Commission under regulation 23.160 also may be recognized as a current asset in computing adjusted net capital.

The Commission also proposed to require an FCM-SD to take a capital charge to reflect undermargined uncleared swap positions with a counterparty.

105

A capital charge for undermargined positions protects the FCM-SD by ensuring that it maintains capital to cover potential future credit exposure to swap counterparties, which is consistent with the statutory objective of ensuring the safety and soundness of the FCM-SD. The proposed undermargined capital charge further provided that an FCM-SD could reduce the amount of the capital charge by any amount owed by the FCM-SD to the counterparty resulting from uncleared swap transactions. The undermargined capital charge for uncleared swap positions is consistent with existing Commission undermargined capital charges for customer and noncustomer futures, foreign futures, and cleared swap accounts carried by an FCM.

106

The Commission did not receive comments on the proposed capital charges, and is adopting the undermargined capital charges with modifications as discussed below.

105

Proposed paragraph (c)(5)(xv) of Commission regulation § 1.17 did not specifically impose undermargined capital charges for security-based swaps.

See 2016 Capital Proposal,

81 FR 91252 at 91308. Such charges, however, are applicable to an FCM-SD under Commission regulation § 1.17(b)(1) (17 CFR 1.17(b)(1)), which provides that an FCM (including an FCM-SD) that has an asset or liability defined in the capital rules of the SEC shall treat such assets or liabilities for capital purposes in accordance with the rules of the SEC, provided that the Commission did not define a specific capital treatment in regulation 1.17.

106

See

Commission regulation § 1.17(c)(5)(viii) and (ix) for undermargined capital charges for customer and noncustomer futures, foreign futures, and cleared swap accounts.

The Commission is modifying final paragraph (c)(5)(xv) of regulation 1.17 by adopting two separate paragraphs. Final regulation 1.17(c)(5)(xv) requires an FCM-SD to take a capital charge in an amount necessary for a swap counterparty or security-based swap counterparty to meet its respective Commission margin requirement for uncleared swap positions and the SEC margin requirement for uncleared security-based swap transactions to the SD. The final regulation would apply only to uncleared swaps and uncleared security-based swaps that are subject to the Commission's or SECs' margin requirements under applicable regulations. The final regulation further provides that the FCM-SD may reduce the amount of the undermargined charge to reflect calls for margin issued by the FCM-SD to the counterparty that are outstanding within the respective time frames established in the margin rules of the Commission and SEC, as applicable, to collect margin from a counterparty. This provision replaces

the proposed language in regulation 1.17(c)(5)(xv) that would have permitted a covered SD to reduce the undermargined capital charge by any amount owed by the counterparty to the SD. The modified provision more accurately reflects the process of an SD calling for outstanding margin and is consistent with the undermargined capital charges for an FCM carrying customer and noncustomer accounts and the undermargined capital charge adopted by the SEC for SBSDs.

Final regulation 1.17(c)(5)(xvi) requires an FCM-SD to take a capital charge for uncleared swaps and uncleared security-based swaps that are exempt or excluded from the Commission's or SEC's margin requirements, such as commercial end users and transactions entered into prior to the compliance date of the margin regulations (

i.e.,

legacy swaps). In this regard, swaps entered into prior to the Phase 6 uncleared margin compliance date or with excluded counterparties for which no margin has been collected are treated no differently than other uncollateralized exposures under the Commission's rules. Such treatment for capital purposes of these counterparty exposures is consistent with the capital rules of both the SEC and prudential regulators as applied to their respective registrants.

107

The final regulation further provides that the FCM-SD may reduce the amount of the undermargined capital charge by any funds deposited by the counterparty to margin its swaps or security-based swap positions. These deposits would include funds deposited by the counterparty and held by third-party custodians or held by the FCM directly.

107

See, e.g.,

SEC rule 18a-1(c)(1)(viii) (17 CFR 240.18a-1(c)(1)(viii)).

The Commission also modified the final rule text to clarify that the undermargined swap capital charges in regulation 1.17(c)(5)(xv) and (xvi) are applicable only to FCM-SDs and not FCMs, as FCM-SDs are subject to the Commission's margin requirements for uncleared swap transactions. Stand-alone FCMs, however, are not directly subject to the Commission's uncleared swap margin requirements as they are not SDs. Final regulations 1.17(c)(5)(xv) and (xvi) also have been modified to align the regulatory text more closely with the comparable SEC rule text requiring SBSDs to take capital charges for undermargined uncleared security-based swap and uncleared swaps positions from counterparties.

108

As noted above, the final regulation is designed to help ensure the safety and soundness of the FCM-SD by requiring the firm to reserve capital in the event a counterparty defaults on its swaps and security-based positions that are undermargined.

108

See

SEC rule 18a-1(c)(viii) (17 CFR 240.18a-1(c)(1)(viii)).

The Commission also requested comment on whether FCM-SD's or covered SD's should be permitted to recognize alternative forms of collateral (

e.g.,

letters of credit and liens) provided by commercial end-users that are exempt from clearing and from the uncleared margin requirements in computing the FCM-SD's or SD's counterparty credit risk charges for uncleared swap transactions.

109

Several commenters supported such alternative or non-financial collateral. One commenter stated that alternative forms of collateral, such as parent guarantees, letters of credit, or liens on assets are frequently used by SDs as credit risk mitigants when non-financial end-users do not post cash collateral on uncleared derivatives.

110

The commenter stated that allowing FCM-SDs to recognize alternative forms of collateral in computing credit risk charges is consistent with Congressional intent that FCM-SD capital requirements should not be punitive to end-users. This commenter further stated that permitting FCM-SDs to recognize non-cash collateral as a credit risk mitigant is consistent with the prudential regulators' final rule on the standardized approach to counterparty credit risk (“SA-CCR”), which provides that banks may take into account non-cash collateral in computing credit risk charges for OTC derivatives. Another commenter stated that non-cash collateral allows for the value of the commercial market participant's assets making it an effective method for satisfying credit requirements without unnecessarily setting aside capital from a productive use.

111

One commenter also stated that the Commission could require FCM-SD's to appropriately haircut non-cash collateral to address the general illiquid nature of non-cash collateral.

112

109

See 2019 Capital Reopening,

at 69681.

110

See

CEWG 3/3/2020 Letter; NCGA/NGSA 3/3/2020 Letter; Shell 3/3/2020 Letter.

111

See

NCGA/NGSA 3/3/2020 Letter.

112

See

Shell 3/3/2020 Letter.

The Commission has considered the comments and is not modifying the credit risk charges to recognize non-cash collateral. Margin provides an FCM-SD or a covered SD with protection from a potential counterparty default. In a default situation, non-financial collateral may not be immediately available, or the collateral may be available but may take time to liquidate. This may exacerbate potential losses to the FCM-SD or covered SD or expose such firms to additional risk by, for example, leaving them exposed to the market risk of cash market positions that were being hedged by the swap. While the Commission is not modifying the final rules to reflect non-cash collateral, it will continue to monitor and assess FCM-SD's and covered SD's acceptance of non-cash collateral from commercial end-users and consider possible revisions to its rules after it gains further experience with the capital condition of such firms.

c. Model-Based Market Risk and Counterparty Credit Risk Capital Charges

(i) FCMs That Are SEC-Registered ANC Firms

Commission regulation 1.17(c)(6) permits an FCM that is dually-registered with the SEC as a BD to use internal models to compute market risk and credit risk capital charges in lieu of standardized capital charges in computing its adjusted net capital under Commission regulation 1.17 provided that the SEC has approved the FCM/BD's use of such models for computing net capital under SEC rule 15c3-1. The SEC has approved certain FCM/BDs to use internal models to compute market risk capital charges for proprietary positions in securities, debt instruments, futures, security-based swaps and swaps in lieu of standardized capital charges contained in SEC rules 15c3-1 or 15c3-1b. The SEC also has approved the use of internal models to compute credit risk charges associated with exposures from swap and security-based swap counterparties in lieu of the standardized 100% unsecured receivable capital charges. As noted in section II.B.3. above, these FCM/BDs are referred to as ANC Firms. Five FCMs currently are ANC Firms, with four of the firms also provisionally-registered SDs.

Regulation 1.17(c)(6) requires an ANC Firm to file a notice with the Commission in order to use the SEC's approved capital models. The notice must include the SEC's approval order and other information, including: (i) A list of the categories of positions that the ANC Firm holds in its proprietary accounts, and, for each such category, a description of the methods that the ANC Firm will use to calculate its deductions for market risk and credit risk, and also, if calculated separately, deductions for specific risk; (ii) a description of the value at risk (VaR) models to be used for its market risk and credit risk

deductions, and an overview of the integration of the models into the internal risk management control system of the ANC Firm; (iii) a description of how the ANC Firm will calculate current exposure and maximum potential exposure for its deductions for credit risk; (iv) a description of how the futures commission merchant will determine internal credit ratings of counterparties and internal credit risk weights of counterparties, if applicable; and (v) a description of the estimated effect of the alternative market risk and credit risk deductions on the amounts reported by the ANC Firm as net capital and adjusted net capital. Further qualitative and quantitative requirements for such market risk and credit risk models are discussed in section II.C.6. of this release.

ANC Firms also are subject to heightened SEC capital requirements as a condition of using the capital models. The

2019 SEC Final Capital

rule requires an ANC Firm, including an FCM that is dually-registered as an ANC Firm, to maintain tentative net capital of at least $5 billion and net capital of not less than the greatest of $1 billion or the sum of (i) 2% of the risk margin amount associated with customer cleared security-based swaps and uncleared security-based swaps and (ii) the aggregate indebtedness of the ANC Firm or 2% of the aggregate debit items computed in accordance with the Formula for Determination of Reserve Requirements for Brokers and Dealers (Exhibit A to rule 15c3-3).

113

The

2019 SEC Final Capital

rule also requires an ANC Firm to provide the SEC, and CFTC if dually-registered as an FCM, with a written notice if its tentative net capital falls below $6 billion.

114

113

See 2019 SEC Final Capital Rule,

84 FR 43872 at 43874; 17 CFR 240.15c3-1(a)(7). All ANC firms currently use the 2% aggregate debit item financial ratio (the “alternative standard”) under rule 15c3-1(a)(1)(ii).

114

Id.

The Commission proposed to retain the above notice and filing process to permit ANC Firms that register as FCMs or FCM-SDs to use the SEC-approved internal capital models in lieu of the standardized market risk and credit risk capital charges in computing their adjusted net capital under regulation 1.17. Currently, only four of the 56 provisionally-registered covered SDs are FCMs, and each of the FCM-SDs is an ANC Firm with capital model approval from the SEC. Accordingly, such FCM-SDs will be required to maintain tentative net capital of no less than $5 billion and net capital of no less than $1 billion upon the compliance date of the

2019 SEC Final Capital Rule.

115

The Commission is electing to retain regulation 1.17(c)(6) to permit ANC Firms to engage in swap and security-based swap transactions under the existing regulatory structure, including the SEC's revised minimum capital requirements, as it believes that the minimum capital requirements are adequately designed to help ensure the safety and soundness of the FCM-SD.

115

The Commission's term “net capital” is equivalent to the SEC's term “tentative net capital” and the Commission's term “adjusted net capital” is equivalent to the SEC's term “net capital.” The term “tentative net capital” is generally defined as an entity's assets less liabilities (excluding certain qualifying subordinated debt), and “net capital” as tentative net capital less certain capital deductions such as market risk and credit risk deductions.

See

17 CFR 240.18a-1.

(ii) Market Risk and Credit Risk Capital Models for FCM-SDs That Are Not SEC-Registered BDs

The Commission proposed amending regulation 1.17(c)(6) to permit FCM-SDs that are not SEC registered BDs to apply to the Commission, or an RFA of which the FCM-SD is a member, for approval to use internal market risk or credit risk models in lieu of the standardized capital charges. If an FCM or covered SD is also a registered BD, it may only use market risk and credit risk capital models if the SEC has approved such firm to use such models and the firm meets the capital requirements of an ANC Firm. Therefore, the Commission's proposal to extend the use of capital models to FCM-SDs is only applicable to FCM-SDs that are not registered with the SEC as BDs. The purpose of the amendment proposed in regulation 1.17(c)(6) was to provide FCM-SDs that were not dually-registered as BDs with the ability to use internal capital models in lieu of the standardized capital charges and to establish a mechanism for the FCM-SDs to obtain approval for such models. FCM-SDs that may also be registered as SBSDs or OTC Derivatives Dealers but not BDs would also be able to use this provision with respect to the use of models; however, they would separately need to obtain the SEC's approval to use models as registered SBSDs and OTC Derivatives Dealers. While currently the only FCMs that are provisionally-registered as SDs are the four ANC Firms, the Commission believed that other stand-alone FCMs may register as SDs and that the regulations should provide an opportunity for such firms to use capital models to compute market and credit risk.

Proposed regulation 1.17(c)(6)(v) required an FCM-SD to apply in writing, and further required that the market risk and credit risk models contain specified qualitative and quantitative requirements proposed to be established by the Commission in new regulation 23.102 and Appendix A to regulation 23.102.

116

The qualitative and quantitative requirements for the FCM-SD's models are comparable to the existing SEC model requirements for ANC Firms and non-BD SBSDs, and the Commission's proposed model requirements for covered SDs. The qualitative and quantitative requirements for the capital models are discussed in detail in section II.C.6. of this release.

116

Please note that due to changes in

Federal Register

publication requirements, the appendix that had been referred to as Appendix A to section 23.102 in previous documents is being published in this final rule as Appendix A to Subpart E of Part 23.

The Commission also proposed enhanced fixed-dollar minimum capital requirements as a condition for an FCM-SD to obtain capital model approval. Specifically, the Commission proposed that FCM-SDs must maintain net capital of no less than $100 million and adjusted net capital of no less than $20 million in order to use capital models. The $100 million net capital requirement was in recognition that model-based capital charges are generally substantially lower than the Commission's standardized capital charges, and that models may not fully capture all risks at all times.

117

The minimum fixed-dollar capital requirement is also consistent with the Commission's proposed minimum fixed-dollar capital requirement for covered SDs, and is consistent with the SEC's minimum fixed-dollar capital requirement for OTC derivative dealers and non-BD SBSDs.

118

117

See

section II.B.2.a. above for a discussion of the fixed-dollar minimum capital requirements for FCM-SDs.

118

See

sections II.C.2.a. and II.C.3.a. of this release for a discussion of the Commission's minimum capital requirements for covered SDs.

See

SEC rule 15c3-1(a)(5) (17 CFR 240.15c3-1(a)(5)) for minimum capital requirements for OTC Derivative Dealers that are not SBSDs and rule 18a-1(a)(2) (17 CFR 240.18a-1(a)(2)) for SBSDs that are not BDs, other than OTC Derivatives Dealers.

The proposed $100 minimum fixed-dollar amount of net capital for FCM/SDs, however, is not consistent with the SEC's current approach for ANC Firms or SBSDs/ANC Firms approved to use internal models. As noted above, ANC Firms are subject to minimum fixed-dollar tentative net capital requirement of $5 billion, and a minimum fixed-dollar net capital requirement of $1 billion. The Commission stated in the Proposal that it believed that FCM/SDs that are not BDs do not raise the same types of risks as ANC Firms that would

warrant a $5 billion minimum tentative net capital requirement. The Commission noted that ANC firms represent the largest BDs and are engaged in significant brokerage businesses including providing customer financing for securities transactions, engaging in repurchase transactions and other activities. FCMs generally have limited proprietary futures trading and operate primarily as market intermediaries for customers trading futures and foreign futures transactions. In this capacity, FCMs receive and hold customer funds in segregated accounts that are used to satisfy the customers' financial obligations to clearing organizations. Even in their capacity as SDs, the margin regulations mitigate the risks to and from the FCM as they generally are required to exchange variation margin on swaps on a daily basis with all other SDs and financial end users, and to post and collect initial margin with counterparties that are SDs and financial end users.

The Commission did not receive specific comments on the use of models by FCM-SDs that are not ANC Firms. The Commission has considered the issue and is adopting the proposed amendment to regulation 1.17(c)(6) to provide a model approval process for FCM-SDs that are not BDs substantially as proposed, but with a modification to not adopt the proposed liquidity requirement and also to comport with the final model process requirements for covered SDs.

119

While the four FCM-SDs provisionally-registered with the Commission are ANC Firms and already approved to use models, the Commission believes that other, non-BD FCM-SDs have the potential to enhance market liquidity in certain sections of the swaps market, particularly with smaller counterparties and less frequently traded products. The Commission believes that it is important to provide an opportunity for such firms to potentially enter the market and service counterparties that may not have significant choice in selecting SDs. For example, FCM-SDs may be more willing to make markets in commodity swaps to agricultural firms and smaller commercial end users such as farmers and ranchers that might not otherwise be able to use such markets to manage risks in their businesses or might have to pay higher fees to engage in swaps if the number of SDs was limited. The Commission further believes that given the nature of the business operations of FCM-SDs, the proposed minimum capital requirement of $100 million of adjusted net capital is consistent with the objective of section 4s(e) of the CEA of helping to ensure the safety and soundness of the FCM-SD.

119

Commission regulation § 1.17(c)(6) (17 CFR 1.17(c)(6)) provides that an FCM-SD may apply for model approval with the Commission or with an RFA of which it is a member.

See

section II.C.7. below for a discussion of model approvals, including the Commission's standards and process for reviewing and approving capital models, and the process that the Commission will use in determining whether NFA's approval of an FCM-SD's capital models may serve as an alternative means of complying with the Commission's model approval requirement.

C. Capital Requirements for Swap Dealers and Major Swap Participants

1. Introduction to Covered SD and Covered MSP Capital Requirements

The Commission is adopting final capital requirements for covered SDs and covered MSPs in order to help ensure the safety and soundness of the SDs and MSPs by requiring such firms to maintain a minimum level of financial resources that is based upon the level of margin associated with the uncleared swaps entered into by the firms. The appropriate setting of minimum capital requirements will help ensure that covered SDs and covered MSPs are able to meet their respective financial obligations to swap and security-based swap counterparties, and to creditors generally. The ability of the covered SDs and covered MSPs to meet their financial obligations will provide for a more efficient and effective swaps marketplace for participants by reducing the potential for covered SDs or covered MSPs to default on their obligations to swap and security-based swap counterparties.

There are currently 56 covered SDs subject to the Commission's capital requirements. As noted in section II.A. above, these 56 covered SDs represent a diverse group of corporate entities, ranging from subsidiaries of major global financial and banking institutions to entities that are primarily engaged in physical commodities such as agriculture and energy. The Commission also understands that these 56 covered SDs have a significant level of diversity in swap counterparties, ranging from financial end users to commercial enterprises.

The Commission is providing flexibility to address the diversity of the business models of the covered SDs by permitting each SD that is not also a registered FCM to elect one of two possible capital alternatives.

120

The first alternative is the Net Liquid Assets Capital Approach, which is based on the liquidity-based capital rule for FCMs in regulation 1.17, as well as the liquidity-based capital requirements imposed on BDs and SBSDs by the SEC. The second alternative is the Bank-Based Capital Approach, which is based on the capital requirements established by the Federal Reserve Board for bank holding companies and is generally consistent with the prudential regulators' capital rules applicable to bank SDs. The flexibility provided by the Commission's covered SD capital rules is consistent with the Congressional mandate in the Dodd-Frank Act directing the Commission, SEC, and prudential regulators to adopt, to the maximum extent practicable, comparable minimum capital requirements for SDs and SBSDs.

121

120

SDs that are FCM-SDs are required to comply with the FCM capital requirements contained in Commission regulation § 1.17 (17 CFR 1.17), as amended by this final rulemaking.

See

section II.B. above for a further discussion.

121

See

section 4s(e)(3)(D) of the CEA (7 U.S.C. 6s(e)(3)(D)) and section 15F(e)(3)(D)(ii) of the Exchange Act (15 U.S.C. 78o-10(e)(3)(D)(ii)).

The Commission's final rule further allows certain eligible covered SDs to elect to compute their regulatory capital under the Tangible Net Worth Capital Approach. The Tangible Net Worth Capital Approach requires a covered SD to maintain a tangible net worth, computed in accordance with GAAP, equal to or greater than the highest of: (i) $20 million, plus the market risk and credit risk exposures associated with its swap and related hedge positions that are part of the covered SD's dealing activities; (ii) 8% uncleared swap margin associated with the covered SD's swaps positions; and (iii) the amount of capital required by an RFA of which the covered SD is a member.

To use the Tangible Net Worth Capital Approach, a covered SD must be predominantly engaged in non-financial activities, or be part of a corporate parent entity that is predominantly engaged in non-financial activities. The Commission is adopting the Tangible Net Worth Capital Approach as it would be available only for covered SDs that, either directly or at their corporate parent level, are primarily involved in non-financial, commercial activities. As the Commission has previously noted, financial firms generally present a higher level of systemic risk to the financial system than commercial firms as the profitability and viability of financial firms are more tightly linked to the health of the financial system than commercial firms.

122

See 2016 Capital Proposal,

81 FR 91252 at 91255.

The Commission's final capital requirements for covered MSPs require such firms to maintain a positive

tangible net worth. The final MSP capital requirements are discussed in section II.C.5. below.

2. Capital Requirement for Covered SDs Electing the Net Liquid Assets Capital Approach

a. Computation of Minimum Capital Requirement

The Commission's capital requirements for covered SDs electing the Net Liquid Assets Capital Approach generally incorporate by reference the SEC's capital requirements contained in rule 18a-1 for SBSDs that are not also registered as BDs.

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The capital requirements are set forth in regulation 23.101, and are comprised of two components. The first component of the capital rule requires a covered SD to compute the minimum amount of capital that the SD is required to hold at any given point in time. The second component of the capital rules requires a covered SD to compute, based upon its balance sheet and certain adjustments including market risk and credit risk capital charges to its swaps, security-based swaps, and other proprietary positions, the actual amount of capital that the covered SD maintains. The covered SD's actual capital must be equal to or greater than its minimum capital requirement at all times in order for the covered SD to be in compliance with the rules.

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Rule 18a-1 (17 CFR 240.18a-1) (“rule 18a-1”) also applies to SBSDs that are OTC derivatives dealers, as that term is defined in SEC Rule 3b-12 (17 CFR 240.3b-12).

The

2016 Capital Proposal

required a covered SD electing the Net Liquid Assets Capital Approach to maintain a minimum level of net capital

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equal to or greater than the highest of the following criteria:

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As noted above, covered SDs electing the Net Liquid Assets Capital Approach are subject to the SEC's capital requirements for SBSDs set forth in SEC rule 18a-1, which has been incorporated into the Commission's rules by reference. The Commission and SEC use different terms to express capital requirements. The Commission's term “net capital” is equivalent to the SEC's term “tentative net capital” and the Commission's term “adjusted net capital” is equivalent to the SEC's term “net capital.” The term “tentative net capital” is generally defined as an entity's assets less liabilities (excluding certain qualifying subordinated debt), and “net capital” as tentative net capital less certain capital deductions such as market risk and credit risk deductions.

See

17 CFR 240.18a-1. This document will use the SEC defined terms for purposes of the discussion of the Net Liquid Assets Capital Approach.

(1) $20 million; or

(2) Net capital equal to or greater than 8% of the sum of:

(a) The amount of “uncleared swap margin” (as that term was proposed to be defined in regulation 23.100)

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for each uncleared swap position open on the books of the covered SD, computed on a counterparty-by-counterparty basis pursuant to Commission regulation 23.154 (17 CFR 23.154);

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The term “uncleared swap margin” is defined in Commission regulation § 23.100 to mean the amount of initial margin that a swap dealer would be required to collect from each swap counterparty pursuant to the margin rules for uncleared swap transactions (Commission regulation § 23.154 (17 CFR 23.154)). The term “uncleared swap margin” includes all uncleared swaps that an SD is required to collect margin for under the margin regulations, and also includes all uncleared swaps that are exempt or excluded from the margin requirements including swaps with commercial end users, swaps entered into prior to the respective compliance dates of the Commission's margin requirements set forth in Commission regulation § 23.161 (17 CFR 23.161) (

i.e.,

legacy swaps), and excluded swaps with an affiliated entity.

(b) The amount of initial margin required for each uncleared security-based swap position open on the books of the covered SD, computed on a counterparty-by-counterparty basis pursuant to SEC Rule 18a-3(c)(1)(i)(B) (17 CFR 240.18a-3(c)(1)(i)(B)), without regard for any amounts that may be excluded or exempted under the SEC's rules;

(c) The amount of “risk margin requirement” (as that term is defined in Commission regulation 1.17(b)(8) (17 CFR 1.17(b)(8))) for the covered SD's cleared futures, foreign futures, and swaps positions open on the books of the covered SD; and

(d) The amount of initial margin required by a clearing organization for proprietary cleared security-based swaps positions open on the books of the covered SD; or

(3) The capital required by the RFA of which the covered SD is a member.

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The

2016 Capital Proposal

also required a covered SD that received approval from the Commission, or from an RFA of which the covered SD was a member, to use internal models to compute market risk and credit risk capital charges for its swaps, security-based swaps, and other proprietary positions when computing its capital, as described in section II.C.2.a. of this release, to maintain a minimum level of tentative net capital equal to $100 million.

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See 2016 Capital Proposal,

81 FR 91252 at 91260-61.

Fixed-Dollar Capital Requirement for Net Liquid Assets Capital Approach

The first criterion under the Net Liquid Assets Capital Approach required a covered SD to maintain a minimum of $20 million of net capital and, if the covered SD was approved to use market risk or credit risk models, $100 million of tentative net capital and $20 million of net capital.

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The Commission requested comment in the

2016 Capital Proposal

on the appropriateness of the fixed-dollar capital requirements of $100 million of tentative net capital and $20 million of net capital.

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The Commission received one comment regarding the proposed requirement that covered SDs must maintain a minimum of $20 million of net capital, and a minimum of $100 million of tentative net capital and $20 million of net capital if approved to use market risk or credit risk models.

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The commenter stated that the requirement that SDs using internal models must have $100 million in tentative net capital would create an unnecessary barrier to entry.

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The Commission recognizes the commenter's concern but believes that covered SDs must maintain a minimum of $100 million of tentative net capital if approved to use models in order to provide an appropriate buffer of capital to protect against model errors and to protect against the models not recognizing all types of risk, such as operational risk, compliance risk, legal risk, and liquidity risk. Models will result in substantially lower market risk charges than the standardized market risk charges, which will allow a covered SD to engage in more of the transactions than they otherwise would be able to enter into at the same level of capital. In order to protect against model errors, the Commission believes that it is necessary to have an enhanced minimum capital requirement.

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See 2016 Capital Proposal,

81 FR 91252 at 91261.

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See 2016 Capital Proposal,

81 FR 91252 at 91262.

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See

FIA-PTG 5/24/2017 Letter.

130

Id.

at 3-4.

The Commission has considered the Proposal further and is adopting the requirements as proposed. The Commission believes, given the role that covered SDs play in the financial markets by engaging in swap dealing activities, it is appropriate to require all covered SDs to maintain a minimum level of net capital, stated as an absolute fixed-dollar amount, that does not fluctuate with the level of the firms' dealing activities to help ensure the safety and soundness of the covered SDs. The $20 million minimum net capital requirement also is consistent with the minimum regulatory capital requirements adopted for covered SDs that elect the Bank-Based Capital Approach or the Tangible Net Worth Capital Approach, as discussed in sections II.C.3. and II.C.4., respectively, of this release. Furthermore, the $20

million minimum net capital requirement for covered SDs that elect the Net Liquid Assets Capital Approach is consistent with the minimum capital requirements adopted by the SEC for SBSDs.

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In addition, the requirement for a covered SD to maintain a minimum of $100 million of tentative net capital if approved to use models is consistent with the SEC minimum capital requirement for stand-alone SBSDs approved to use capital models.

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See

SEC rule 18a-1(a)(2) (17 CFR 240.18a-1(a)(1)).

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See

SEC rule 18a-1(a)(2) (17 CFR 240.18a-1(a)(2)).

Risk Margin Amount Calculation Under Net Liquid Assets Capital Approach

The second criterion under the proposed Net Liquid Assets Capital Approach required a covered SD to maintain a minimum level of net capital equal to or greater than 8% of the sum of: (i) The amount of “uncleared swap margin” (as that term was proposed to be defined in regulation 23.100) for each uncleared swap position open on the books of the covered SD, computed on a counterparty-by-counterparty basis pursuant to Commission regulation 23.154; (ii) the amount of initial margin required for each uncleared security-based swap position open on the books of the covered SD, computed on a counterparty-by-counterparty basis pursuant to SEC rule 18a-3(c)(1)(i)(B) without regard to any initial margin exemptions or exclusions that the rules of the SEC may provide to such security-based swap positons; (iii) the amount of “risk margin” (as defined in Commission regulation 1.17(b)(8)) required by a clearing organization for the covered SD's futures, swaps, and foreign futures positions that are open on the books of the covered SD; and (iv) the amount of initial margin required by a clearing organization for security-based swaps that are open on the books of the covered SD.

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The proposed 8% risk margin amount required a covered SD to include all swaps and security-based swaps in its computation of the margin for uncleared swaps and security-based swaps subject to the 8% risk margin amount calculation, including any swaps positions that are not included in the margin requirements under Commission regulations 23.150 through 23.161, and any security-based swaps positions that are exempt or excluded from the SEC's margin requirements in rule 18a-3(c)(1)(i)(B).

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See

paragraph (a)(1)(ii)(A)(

) of proposed Commission regulation § 23.101.

See 2016 Capital Proposal,

81 FR 91252 at 91310.

The proposed 8% risk margin amount was based on the Commission's minimum capital requirements for FCMs, which includes a requirement that each FCM must maintain a level of adjusted net capital that is equal to or greater than 8% of the risk margin amount associated with the futures, foreign futures, and cleared swap positions carried in customer and noncustomer accounts.

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This requirement was intended to ensure that a covered SD electing the Net Liquid Assets Capital Approach maintains a minimum level of capital that is proportionate to all risks associated with the SD's operations and activities. The Commission believed that the proposed 8% risk margin amount was an appropriate approach as the minimum capital requirement was correlated with the “risk” of the SD's futures, foreign futures, swaps, and security-based swaps positions as measured by the margin required on the positions. Specifically, a covered SD's minimum capital requirement would increase or decrease in proportion to the number, size, complexity, and market risk inherent in the SD's derivatives business.

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134

See

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