Order Granting Conditional Substituted Compliance in Connection With Certain Capital and Financial Reporting Requirements Applicable to Nonbank Swap Dealers Subject to Regulation by the Financial Services Agency of Japan

Federal RegisterJul 18, 2024

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Chapter I

Order Granting Conditional Substituted Compliance in Connection With Certain Capital and Financial Reporting Requirements Applicable to Nonbank Swap Dealers Subject to Regulation by the Financial Services Agency of Japan

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Order.

SUMMARY:

On August 8, 2022, the Commodity Futures Trading Commission issued a notice and request for comment on an application submitted by the Financial Services Agency of Japan requesting that the Commission determine that registered nonbank swap dealers organized and domiciled in Japan may comply with certain capital and financial reporting requirements under the Commodity Exchange Act and Commission regulations by being subject to, and complying with, corresponding capital and financial reporting requirements of Japan. The Commission also solicited public comment on a proposed comparability determination and related order providing for the conditional availability of substituted compliance in connection with the application.

The Commission is adopting the proposed order with certain modifications and clarifications to address comments. The final order provides that a nonbank swap dealer organized and domiciled in Japan may satisfy the capital requirements under the Commodity Exchange Act and applicable Commission regulations and the financial reporting rules under the Commodity Exchange Act and applicable Commission regulations by complying with certain specified Japanese laws and regulations and conditions set forth in the order.

DATES:

This determination was made by the Commission on June 24, 2024.

FOR FURTHER INFORMATION CONTACT:

Amanda L. Olear, Director, 202-418-5283,

aolear@cftc.gov;

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

tsmith@cftc.gov;

Rafael Martinez, Associate Director, 202-418-5462,

rmartinez@cftc.gov;

Warren Gorlick, Associate Director, 202-418-5195,

wgorlick@cftc.gov;

Liliya Bozhanova, Special Counsel, 202-418-6232,

lbozhanova@cftc.gov;

Joo Hong, Risk Analyst, 202-418-6221,

jhong@cftc.gov;

Justin McPhee, Risk Analyst, 202-418-6223;

jmchpee@cftc.gov,

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

SUPPLEMENTARY INFORMATION:

The Commodity Futures Trading Commission (“Commission” or “CFTC”) is issuing an order providing that registered nonbank swap dealers organized and domiciled in Japan (“Japanese nonbank SDs”) may satisfy certain capital and financial reporting requirements under the Commodity Exchange Act (“CEA”)

and Commission regulations

by being subject to, and complying with, comparable capital and financial reporting requirements under relevant Japanese laws and regulations, subject to certain conditions set forth in the order below. The order is based on the proposed comparability determination and related proposed order published by the Commission on August 8, 2022,

as modified in certain aspects to address comments and to clarify its terms.

7 U.S.C. 1

et seq.

The CEA may be accessed through the Commission's website,

www.cftc.gov.

17 CFR Chapter I. Commission regulations may be accessed through the Commission's website,

www.cftc.gov.

Notice of Proposed Order and Request for Comment on an Application for Capital Comparability Determination from the Financial Services Agency of Japan,

87 FR 48092 (Aug. 8, 2022) (“2022 Proposal”).

I. Introduction

A. Regulatory Background—CFTC Capital, Margin, and Financial Reporting Requirements for Swap Dealers and Major Swap Participants

Section 4s(e) of the CEA

directs the Commission and “prudential regulators”

to impose capital requirements on swap dealers (“SDs”) and major swap participants (“MSPs”) registered with the Commission.

Section 4s(e) also directs the Commission and prudential regulators to adopt regulations imposing initial and variation margin requirements on swaps entered into by SDs and MSPs that are not cleared by a registered derivatives clearing organization (“uncleared swaps”).

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

The term “prudential regulators” is defined in the CEA to mean the Board of Governors of the Federal Reserve System (“Federal Reserve Board”); the Office of the Comptroller of the Currency; the Federal Deposit Insurance Corporation; the Farm Credit Administration; and the Federal Housing Finance Agency. 7 U.S.C. 1a(39).

Subject to certain exceptions, the term “swap dealer” is generally defined as any person that: (i) holds itself out as a dealer in swaps; (ii) makes a market in swaps; (iii) regularly enters into swaps with counterparties as an ordinary course of business for its own account; or (iv) engages in any activity causing the person to be commonly known in the trade as a dealer or market maker in swaps. 7 U.S.C. 1a(49).

The term “major swap participant” is generally defined as any person who is not an SD, and: (i) subject to certain exclusions, maintains a substantial position in swaps for any of the major swap categories as determined by the Commission; (ii) whose outstanding swaps create substantial counterparty exposure that could have serious adverse effects on the financial stability of the U.S. banking system or financial markets; or (iii) is a financial entity that: (a) is highly leveraged relative to the amount of capital it holds and that is not subject to capital requirements established by an appropriate Federal banking agency; and (b) maintains a substantial position in outstanding swaps in any major swap category as determined by the Commission. 7 U.S.C. 1a(33).

Section 4s(e) applies a bifurcated approach with respect to the above Congressional directives, requiring each SD and MSP that is subject to the regulation of a prudential regulator (“bank SD” and “bank MSP,” respectively) to meet the minimum capital requirements and uncleared swaps margin requirements adopted by the applicable prudential regulator, and requiring each SD and MSP that is not subject to the regulation of a prudential regulator (“nonbank SD” and “nonbank MSP,” respectively) to meet the minimum capital requirements and uncleared swaps margin requirements adopted by the Commission.

Therefore, the Commission's authority to impose capital requirements and margin requirements for uncleared swap transactions extends to nonbank SDs and nonbank MSPs, including nonbanking subsidiaries of bank holding companies regulated by the Federal Reserve Board.

7 U.S.C. 6s(e)(2).

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

The prudential regulators implemented Section 4s(e) in 2015 by amending existing capital requirements applicable to bank SDs and bank MSPs to incorporate swap transactions into their respective bank capital frameworks, and by adopting rules imposing initial and variation margin requirements on bank SDs and bank MSPs that engage in uncleared swap transactions.

The Commission adopted final rules imposing initial and variation margin obligations on nonbank SDs and nonbank MSPs for uncleared swap transactions on January 6, 2016.

The Commission also approved final capital requirements for nonbank SDs and nonbank MSPs on July 24, 2020, which were published in the

Federal Register

on September 15, 2020 with a

compliance date of October 6, 2021 (“CFTC Capital Rules”).

Margin and Capital Requirements for Covered Swap Entities,

80 FR 74840 (Nov. 30, 2015).

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

81 FR 636 (Jan. 6, 2016).

Capital Requirements of Swap Dealers and Major Swap Participants,

85 FR 57462 (Sept. 15, 2020). On April 30, 2024, the Commission amended the capital and financial reporting requirements to revise certain financial reporting obligations, among other changes.

See Capital and Financial Reporting Requirements for Swap Dealers and Major Swap Participants,

89 FR 45569 (May 23, 2024). The amendments have limited impact on nonbank SDs covered by this order.

Section 4s(f) of the CEA addresses SD and MSP financial reporting requirements.

Section 4s(f) authorizes the Commission to adopt rules imposing financial condition reporting obligations on all SDs and MSPs (

i.e.,

nonbank SDs, nonbank MSPs, bank SDs, and bank MSPs). Specifically, Section 4s(f)(1)(A) provides, in relevant part, that each registered SD and MSP must make financial condition reports as required by regulations adopted by the Commission.

The Commission's financial reporting obligations were adopted with the Commission's nonbank SD and nonbank MSP capital requirements, and also had a compliance date of October 6, 2021 (“CFTC Financial Reporting Rules”).

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

7 U.S.C. 6s(f)(1)(A).

85 FR 57462.

B. Commission Capital Comparability Determinations for Non-U.S. Nonbank Swap Dealers and Non-U.S. Nonbank Major Swap Participants

Commission Regulation 23.106 establishes a substituted compliance framework whereby the Commission may determine that compliance by a non-U.S. domiciled nonbank SD or non-U.S. domiciled nonbank MSP with its home country's capital and financial reporting requirements will satisfy all or parts of the CFTC Capital Rules and all or parts of the CFTC Financial Reporting Rules (such a determination referred to as a “Comparability Determination”).

The Commission's capital adequacy and financial reporting requirements are designed to address and manage risks that arise from a firm's operation as an SD or MSP. Given their functions, both sets of requirements and rules must be applied on an entity-level basis (meaning that the rules apply on a firm-wide basis, irrespective of the type of transactions involved) to effectively address risk to the firm as a whole. The availability of such substituted compliance is conditioned upon the Commission issuing a Comparability Determination finding that the relevant foreign jurisdiction's capital adequacy and financial reporting requirements for non-U.S. nonbank SDs and/or non-U.S. nonbank MSPs are comparable to the corresponding CFTC Capital Rules and CFTC Financial Reporting Rules. The Commission would issue a Comparability Determination in the form of an order (“Comparability Order”).

17 CFR 23.106. Commission Regulation 23.106(a)(1) provides that a request for a Comparability Determination may be submitted by a non-U.S. nonbank SD or non-US nonbank MSP, a trade association or other similar group on behalf of its SD or MSP members, or a foreign regulatory authority that has direct supervisory authority over one or more non-US nonbank SDs or non-U.S. nonbank MSPs. However, Commission regulations also provide that any non-U.S. nonbank SD or non-U.S. nonbank MSP that is dually-registered with the Commission as a futures commission merchant (“FCM”) is subject to the capital requirements of Commission Regulation 1.17 (17 CFR 1.17) and may not petition the Commission for a Comparability Determination. 17 CFR 23.101(a)(5) and (b)(4), respectively.

Furthermore, substituted compliance is not available to non-U.S. bank SDs and non-U.S. bank MSPs with respect to their respective financial reporting requirements under Commission Regulation 23.105(p). Commission Regulation 23.105(p), however, permits non-U.S. bank SDs and non-U.S. bank MSPs that do not submit financial reports to a U.S. prudential regulator to file with the Commission a statement of financial condition, certain regulatory capital information, and Schedule 1 of Appendix C to Subpart E of Part 23 of the Commission's regulations prepared and presented in accordance with the accounting standards permitted by the non-U.S. bank SD's or non-U.S. bank MSP's home country regulatory authorities. 17 CFR 23.105(p)(2).

17 CFR 23.106(a)(3).

The Commission's approach for conducting a Comparability Determination with respect to the CFTC Capital Rules and the CFTC Financial Reporting Rules is a principles-based, holistic approach that focuses on assessing whether the applicable foreign jurisdiction's capital and financial reporting requirements have comparable objectives with, and achieve comparable outcomes to, corresponding CFTC requirements.

The Commission's assessment is not a line-by-line evaluation or comparison of a foreign jurisdiction's regulatory requirements with the Commission's requirements.

In performing the analysis, the Commission recognizes that jurisdictions may adopt differing approaches to achieving regulatory objectives and outcomes, and the Commission will focus on whether the foreign jurisdiction's capital and financial reporting requirements are based on regulatory objectives, and produce regulatory outcomes, that are comparable to the Commission's in purpose and effect, and not whether they are comparable in every aspect or contain identical elements.

17 CFR 23.106(a)(3)(ii).

See also

85 FR 57462 at 57521.

See

85 FR 57462 at 57521.

A person requesting a Comparability Determination is required to submit an application to the Commission containing: (i) a description of the objectives of the relevant foreign jurisdiction's capital adequacy and financial reporting requirements applicable to entities that are subject to the CFTC Capital Rules and the CFTC Financial Reporting Rules; (ii) a description (including specific legal and regulatory provisions) of how the relevant foreign jurisdiction's capital adequacy and financial reporting requirements address the elements of the CFTC Capital Rules and CFTC Financial Reporting Rules, including, at a minimum, the methodologies for establishing and calculating capital adequacy requirements and whether such methodologies comport with international standards; and (iii) a description of the ability of the relevant foreign regulatory authority to supervise and enforce compliance with the relevant foreign jurisdiction's capital adequacy and financial reporting requirements. The applicant must also submit, upon request, such other information and documentation as the Commission deems necessary to evaluate the comparability of the capital adequacy and financial reporting requirements of the foreign jurisdiction.

17 CFR 23.106(a)(2).

The Commission will consider an application for a Comparability Determination to be a representation by the applicant that the laws and regulations of the foreign jurisdiction that are submitted in support of the application are finalized and in force, that the description of such laws and regulations is accurate and complete, and that, unless otherwise noted, the scope of such laws and regulations encompasses the relevant non-U.S. nonbank SDs and/or non-U.S. nonbank MSPs domiciled in the foreign jurisdiction.

Each non-U.S. nonbank SD or non-U.S. nonbank MSP that seeks to rely on a Comparability Order is responsible for determining whether it is subject to the foreign laws and regulations found comparable in the Comparability Order. A non-U.S. nonbank SD or non-U.S. nonbank MSP

that is not legally required to comply with a foreign jurisdiction's laws and/or regulations determined to be comparable in a Comparability Order may not voluntarily comply with such laws and/or regulations in lieu of compliance with the CFTC Capital Rules or the CFTC Financial Reporting Rules.

The Commission provides the applicant with an opportunity to review for accuracy and completeness the Commission's description of relevant home country laws and regulations on which a proposed Comparability Determination and a proposed Comparability Order are based. The Commission relies on this review, and any corrections or feedback received, as part of the comparability assessment. A Comparability Determination and Comparability Order based on an inaccurate description of foreign laws and regulations may not be valid.

The Commission may consider all relevant factors in making a Comparability Determination, including: (i) the scope and objectives of the relevant foreign jurisdiction's capital and financial reporting requirements; (ii) whether the relevant foreign jurisdiction's capital and financial reporting requirements achieve comparable outcomes to the Commission's corresponding capital requirements and financial reporting requirements; (iii) the ability of the relevant foreign regulatory authority or authorities to supervise and enforce compliance with the relevant foreign jurisdiction's capital adequacy and financial reporting requirements; and (iv) any other facts or circumstances the Commission deems relevant, including whether the Commission and foreign regulatory authority or authorities have a memorandum of understanding or similar arrangement that would facilitate supervisory cooperation.

17 CFR 23.106(a)(3) and 85 FR 57462 at 57520-57522.

In performing the comparability assessment for foreign nonbank SDs, the Commission's review will include the extent to which the foreign jurisdiction's requirements address: (i) the process of establishing minimum capital requirements for nonbank SDs and how such process addresses risk, including market risk and credit risk of the nonbank SD's on-balance sheet and off-balance sheet exposures; (ii) the types of equity and debt instruments that qualify as regulatory capital in meeting minimum requirements; (iii) the financial reports and other financial information submitted by a nonbank SD to its relevant regulatory authority and whether such information provides the regulatory authority with the means necessary to effectively monitor the financial condition of the nonbank SD; and (iv) the regulatory notices and other communications between a nonbank SD and its foreign regulatory authority that address potential adverse financial or operational issues that may impact the firm. With respect to the ability of the relevant foreign regulatory authority to supervise and enforce compliance with the foreign jurisdiction's capital adequacy and financial reporting requirements, the Commission's review will include an assessment of the foreign jurisdiction's surveillance program for monitoring nonbank SDs' compliance with such capital adequacy and financial reporting requirements, and the disciplinary process imposed on firms that fail to comply with such requirements.

The Commission would conduct a similar analysis, adjusted as appropriate to account for regulatory distinctions, in performing a comparability assessment for foreign nonbank MSPs. Commission Regulation 23.101(b) requires a nonbank MSP to maintain positive tangible net worth. There are no MSPs currently registered with the Commission. 17 CFR 23.101(b).

Commission Regulation 23.106 further provides that the Commission may impose any terms or conditions that it deems appropriate in issuing a Comparability Determination.

Any specific terms or conditions with respect to capital adequacy or financial reporting requirements will be set forth in the Commission's Comparability Order. As a general condition to all Comparability Orders, the Commission will require notification from the applicants of any material changes to information submitted by the applicants in support of a comparability finding, including, but not limited to, changes in the foreign jurisdiction's relevant laws and regulations, as well as changes to the relevant supervisory or regulatory regime.

17 CFR 23.106(a)(5).

To rely on a Comparability Order, a nonbank SD or nonbank MSP domiciled in the foreign jurisdiction and subject to supervision by the relevant regulatory authority (or authorities) in the foreign jurisdiction must file a notice with the Commission of its intent to comply with the applicable capital adequacy and financial reporting requirements of the foreign jurisdiction set forth in the Comparability Order in lieu of all or parts of the CFTC Capital Rules and/or CFTC Financial Reporting Rules.

Notices must be filed electronically with the Commission's Market Participants Division (“MPD”).

The filing of a notice by a non-U.S. nonbank SD or non-U.S. nonbank MSP provides MPD staff with the opportunity to engage with the firm and to obtain representations that it is subject to, and complies with, the laws and regulations cited in the Comparability Order and that it will comply with any listed conditions. MPD will issue a letter under delegated authority from the Commission confirming that the non-U.S. nonbank SD or non-U.S. nonbank MSP may comply with the foreign laws and regulations cited in the Comparability Order in lieu of complying with the CFTC Capital Rules and CFTC Financial Reporting Rules upon MPD's confirmation through discussions with the non-U.S. nonbank SD or non-U.S. nonbank MSP that the firm is subject to, and complies with, such foreign laws and regulations, is subject to the jurisdiction of the applicable foreign regulatory authority (or authorities), and can meet the conditions in the Comparability Order.

17 CFR 23.106(a)(4)(i).

Notices must be filed in electronic form to the following email address:

MPDFinancialRequirements@cftc.gov.

17 CFR 23.106(a)(4)(ii) and 17 CFR 140.91(a)(11).

Each non-U.S. nonbank SD and each non-U.S. nonbank MSP that receives confirmation from the Commission that it may comply with a foreign jurisdiction's capital adequacy and financial reporting requirements will be deemed by the Commission to be in compliance with the corresponding CFTC Capital Rules and/or CFTC Financial Reporting Rules.

A non-U.S. nonbank SD or non-U.S. nonbank MSP that receives confirmation of substituted compliance remains subject, however, to the Commission's examination and enforcement authority.

Accordingly, if a nonbank SD or nonbank MSP fails to comply with the foreign jurisdiction's capital adequacy and/or financial reporting requirements, the Commission may initiate an action for a violation of the corresponding CFTC Capital Rules and/or CFTC Financial Reporting Rules.

In addition, a finding of a violation by a foreign jurisdiction's regulatory authority is not a prerequisite for the exercise of such examination and enforcement authority by the Commission.

17 CFR 23.106(a)(4)(ii). Confirmation will be issued by MPD under authority delegated by the Commission. Commission Regulation 140.91(a)(11). 17 CFR 140.91(a)(11).

17 CFR 23.106(a)(4)(ii).

Id.

C. Japan Financial Services Agency's Application for a Comparability Determination for Japan-Domiciled Nonbank Swap Dealers

On September 30, 2021, the Financial Services Agency of Japan (“FSA”) submitted an application (“FSA Application”) requesting that the Commission conduct a Comparability Determination and issue a Comparability Order finding that compliance with certain designated capital requirements of Japan (the “Japanese Capital Rules”) and certain designated financial reporting requirements of Japan (the “Japanese Financial Reporting Rules”) by a Japanese nonbank SD registered with

the FSA as a Type I Financial Instruments Business Operator (“FIBO”) satisfies corresponding CFTC Capital Rules and CFTC Financial Reporting Rules applicable to a nonbank SD under Sections 4s(e) and (f) of the CEA and Commission Regulations 23.101 and 23.105.

There are currently three Japanese nonbank SDs registered with the Commission, and the FSA represented in its application that each of the three Japanese nonbank SDs are FSA-registered and regulated FIBOs.

Letter from Yuji Yamashita, Deputy Commissioner for International Affairs, Financial Services Agency of Japan, dated September 30, 2021, pp. 4-5 (fn. 11). The FSA Application is available on the Commission's website at:

https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm.

The three Japanese nonbank SDs currently registered with the Commission are: BofA Securities Japan Co., Ltd.; Goldman Sachs Japan Co., Ltd.; and Morgan Stanley MUFG Securities Co., Ltd. The FSA's application did not request a Comparability Determination with respect to nonbank MSPs as currently there are no MSPs registered with the Commission and, accordingly, no nonbank MSPs domiciled in Japan and registered with the FSA. Accordingly, the Commission's Comparability Determination and Comparability Order do not address nonbank MSPs.

The FSA represented that the capital adequacy and financial reporting requirements for swap activities in Japan are governed by the Japanese legal framework for financial regulation, which is mainly composed of Acts, Cabinet Orders, Ministerial Orders, and FSA Notices.

With regard to the Japanese Capital Rules and the Japanese Financial Reporting Rules, the Financial Instruments and Exchange Act (Act No. 25 of 1948) (“FIEA”) and its related order, Cabinet Office Order on Financial Instruments Business (Cabinet Office Order No. 52 of 2007) (“COO”), set forth the prudential capital and financial reporting requirements applicable to FIBOs, including the Japanese nonbank SDs.

FIEA, COO, and related FSA Notices impose mandatory capital and reporting requirements on FIBOs, including Japanese nonbank SDs. Comprehensive Guidelines for Supervision of Financial Instruments Business Operators, etc. (“Supervisory Guidelines for FIBO”) also supplement the framework.

The technical requirements for FIBOs, including Japanese nonbank SDs, to calculate capital adequacy ratios are specified in the FSA Notice No. 59 of 2007 (“Notice on Capital”) in accordance with Article 177(8) and Article 178(1) of the COO.

FSA Application at p. 4.

Businesses categorized as Type I Financial Instruments Business (Article 28(1) of the FIEA) can only be conducted by Type I FIBOs registered under Article 29 of the FIEA. Type I Financial Instruments Business includes market transactions of derivatives and foreign market derivatives transactions pertaining to certain highly liquid securities and over-the-counter transactions of derivatives.

To implement and reinforce the legal framework, the FSA has developed and published supervisory guidelines. The supervisory guidelines are meant for FSA staff, but are public documents, which are expected to be followed by the applicable financial institutions. Financial institutions are consulted in connection with the establishment of, and any amendments to, the supervisory guidelines. FSA staff conducts supervision and enforcement based on the supervisory guidelines.

D. Proposed Comparability Determination and Proposed Comparability Order for Japan-Domiciled Nonbank Swap Dealers

On August 8, 2022, the Commission published the 2022 Proposal, seeking comment on the FSA Application and the Commission's proposed Comparability Determination and related Comparability Order.

The 2022 Proposal set forth the Commission's preliminary Comparability Determination and proposed Comparability Order providing that, based on its review of the FSA Application and applicable Japanese laws and regulations, the Commission preliminarily found that the Japanese Capital Rules and the Japanese Financial Reporting Rules, subject to the conditions set forth in the proposed Comparability Order, achieve comparable outcomes and are comparable in purpose and effect to the CFTC Capital Rules and CFTC Financial Reporting Rules.

The Commission, however, noted that there were certain differences between the Japanese Capital Rules and CFTC Capital Rules and certain differences between the Japanese Financial Reporting Rules and the CFTC Financial Reporting Rules. As such, the Commission proposed certain conditions to the Comparability Order.

The proposed conditions were designed to promote consistency in regulatory outcomes, to reflect the scope of substituted compliance that would be available notwithstanding the differences, and to ensure that the Commission and National Futures Association (“NFA”) receive information to monitor Japanese nonbank SDs for ongoing compliance with the Comparability Order.

The Commission further stated that, in its preliminary view, the identified differences would not be inconsistent with providing a substituted compliance framework for Japanese nonbank SDs subject to the conditions specified in the proposed Comparability Order.

2022 Proposal, 87 FR 48092 (Aug. 8, 2022).

See

2022 Proposal at 48092. Consistent with the process specified in section I.B. above for conducting Comparability Determinations, the Commission provided the FSA with an opportunity to review for factual accuracy and completeness the Commission's description of relevant Japanese laws and regulations on which the proposed Comparability Determination and proposed Comparability Order were based. The Commission has relied on FSA's review, and has incorporated feedback and corrections received from the FSA. As previously noted, a Comparability Determination and Comparability Order based on an inaccurate description of foreign laws and regulations may not be valid.

See

2022 Proposal at 48114.

NFA is a registered futures association under section 17 of the CEA (7 U.S.C. 21). Each SD registered with the Commission is required to be an NFA member. 17 CFR 170.16. NFA, as a registered futures association, is also required by the CEA to adopt rules imposing minimum capital, segregation, and other financial requirements, as applicable, to its members, including SDs, that are at least as stringent as the Commission's minimum capital, segregation, and other financial requirements for such registrants, and to implement a program to audit and enforce such requirements. 7 U.S.C. 21(p). Therefore, the Commission's proposed Comparability Order required Japanese nonbank SDs to file certain financial reports and notices with NFA so that it may perform oversight of such firms as required under section 17 of the CEA. The Commission will refer to NFA in this Comparability Determination when referring to the requirements or obligations of a registered futures association.

2022 Proposal at 48114.

The proposed Comparability Order was limited to the comparison of the Japanese Capital Rules to the CFTC Capital Rules' Bank-Based Capital Approach (“Bank-Based Approach”) for computing regulatory capital for nonbank SDs, which is based on certain capital requirements imposed by the Federal Reserve Board for bank holding companies.

As noted by the Commission in the 2022 Proposal, the FSA had not requested, nor has the Commission performed, a comparison of the Japanese Capital Rules to the Commission's TNW Approach or NLA Approach.

Id.

As described in the 2022 Proposal, the CFTC Capital Rules provide nonbank SDs with three alternative capital approaches: (i) the Tangible Net Worth Capital Approach (“TNW Approach”); (ii) the Net Liquid Assets Capital Approach (“NLA Approach”); and (iii) the Bank-Based Approach.

See

2022 Proposal at 48095-48096, and 17 CFR 23.101. The Bank-Based Approach is consistent with the Basel Committee on Banking Supervision's (“BCBS”) international framework for bank capital requirements (“BCBS framework” or “Basel standards”). The BCBS is the primary global standard-setter for the prudential regulation of banks and provides a forum for cooperation on banking supervisory matters. Institutions represented on the BCBS include the Federal Reserve Board, the European Central Bank, Deutsche Bundesbank, Bank of England, Bank of France, Bank of Japan, Banco de Mexico, and Bank of Canada. The BCBS framework is available at

https://www.bis.org/basel_framework/index.htm.

See

2022 Proposal at 48114.

E. General Comments on the FSA Application and the Commission's Proposed Finding of Comparability Between the CFTC Capital Rules and CFTC Financial Reporting Rules and the Japanese Capital Rules and Japanese Financial Reporting Rules

The public comment period on the FSA Application, the proposed Comparability Determination, and the proposed Comparability Order ended on October 7, 2022. The Commission received six comment letters from the following interested parties: Better Markets, Inc. (“Better Markets”); the FSA; the International Bankers Association of Japan (“IBAJ”); a joint letter from the Institute of International Bankers (“IIB”), the International Swaps and Derivatives Association (“ISDA”), and the Securities Industry and Financial Markets Association (“SIFMA”); and two letters from William J. Harrington.

Letter From Stephen Hall, Legal Director and Securities Specialist, Better Markets (Oct. 7, 2022) (“Better Markets Letter”); Letter from Yuji Yamashita, Deputy Commissioner for International Affairs, FSA (Oct. 7, 2022) (“FSA Letter”); Letter From Philippe Avril, Chair, IBAJ (Oct. 6, 2022) (“IBAJ Letter”); Letter From Stephanie Webster, General Counsel, IIB; Steven Kennedy, Global Head of Public Policy, ISDA; Kyle L. Brandon, Managing Director, Head of Derivatives Policy, SIFMA (collectively, “Associations”) (Oct. 7, 2022) (“Associations Letter”); Letters from William J. Harrington (“Harrington”) (Oct. 7 and Oct. 20, 2022) (“Harrington 10/7/2022 Letter” and “Harrington 10/20/2022 Letter”) The comment letters for the 2022 Proposal are available at:

https://comments.cftc.gov/PublicComments/CommentList.aspx?id=7301.

Two commenters expressed support for the proposed Comparability Determination and proposed Comparability Order, agreeing with the Commission's overall analysis and determination of comparability of the CFTC Capital Rules and CFTC Financial Reporting Rules and the Japanese Capital Rules and Japanese Financial Reporting Rules.

In addition, the FSA submitted a comment letter in support of the Commission's proposal, and recommending several technical amendments to the proposed Comparability Determination and Comparability Order that were corrective or typographical in nature.

Associations Letter at p. 1; IBAJ Letter at p. 1.

FSA Letter. In particular, the FSA recommended that the Commission add Article 47 of the FIEA to the list of relevant provisions comprising the Japanese Capital Rules enumerated in proposed Condition 4. FSA Letter at p. 2. The Commission has revised final Condition 4 to that effect.

Conversely, two commenters disagreed with the CFTC's proposed Comparability Determination and proposed Comparability Order.

Better Markets asserted that the principles-based, holistic approach applied by the Commission, which assesses whether the applicable foreign jurisdiction's capital and financial requirements achieve comparable outcomes to the corresponding Commission requirements, is “insufficiently rigorous, leaving far too much room for inaccurate and unwarranted comparability determinations.”

Better Markets Letter at p. 2; Harrington 10/20/2022 Letter at p. 20.

Better Markets Letter at p. 2.

The Commission does not believe that the principles-based, holistic assessment that it conducted on the comparability of the Japanese Capital Rules and Japanese Financial Reporting Rules with the CFTC Capital Rules and CFTC Financial Reporting Rules was “insufficiently rigorous,” nor does the Commission believe that it left “room for inaccurate and unwarranted comparability determinations.” The principles-based, holistic approach employed in the Comparability Determination was performed in accordance with the substituted compliance assessment framework adopted by the Commission for capital and financial reporting requirements for foreign nonbank SDs and set out in Commission Regulation 23.106. Consistent with this assessment framework, the Commission focused on whether the Japanese Capital Rules and Japanese Financial Reporting Rules are designed with the objective of ensuring overall safety and soundness of the Japanese nonbank SDs in a manner that is comparable with the Commission's overall objective of ensuring the safety and soundness of nonbank SDs.

As stated in the 2022 Proposal, due to the detailed and complex nature of the capital frameworks, differences in how jurisdiction approach and implement the requirements are expected, even among jurisdictions that base their requirements on the principles and standards set forth in the BCBS framework.

Furthermore, as discussed in Section I.B. above, when adopting Commission Regulation 23.106, the Commission stated that “its approach to substituted compliance is a principles-based, holistic approach that focuses on whether the foreign regulations are designed with the objectives of ensuring the overall safety and soundness of the [non-US nonbank SD] in a manner that is comparable with the Commission's overall capital and financial reporting requirements, and is not based on a line-by-line assessment or comparison of a foreign jurisdiction's regulatory requirements with the Commission's requirements.”

See

2022 Proposal at 48098.

85 FR 57462 at 57521.

The approach and standards set forth in Commission Regulation 23.106, with the focus on “comparable outcomes,” are also consistent with the Commission's precedents of undertaking a principles-based, holistic assessment of the comparability of foreign regulatory regimes for purposes of substituted compliance for cross-border swap transactions. The Commission first outlined its approach to substituted compliance with respect to swaps requirements in 2013, when it issued an Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations.

In the Guidance, the Commission stated that “[i]n evaluating whether a particular category of foreign regulatory requirement(s) is comparable and comprehensive to the applicable requirement(s) under the CEA and Commission regulations, the Commission will take into consideration all relevant factors, including but not limited to, the comprehensiveness of those requirement(s), the scope and objectives of the relevant regulatory requirement(s), the comprehensiveness of the foreign regulator's supervisory compliance program, as well as the home jurisdiction's authority to support and enforce its oversight of the registrant.”

The Commission emphasized that in this context, “comparable does not necessarily mean identical.”

Rather, the Commission stated that it would evaluate whether the home jurisdiction's regulatory requirement is comparable to, and as comprehensive as, the corresponding U.S. regulatory requirement(s).

In conducting comparability determinations based on the policy set forth in the Guidance, the Commission noted that the “outcome-based” approach recognizes that “foreign regulatory systems differ and their approaches vary and may differ from how the Commission chose to address an issue, but that the foreign jurisdiction's regulatory requirements nonetheless achieve the regulatory outcome sought to be achieved by a certain provision of the CEA or Commission regulation.”

Interpretative Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations,

78 FR 45292 (July 26, 2013) (“Guidance”).

Guidance at 45343.

Id.

See e.g., Comparability Determination for the European Union: Certain Entity-Level

Requirements,

78 FR 78923 (December 27, 2013) at 78926.

The Commission further elaborated on the required elements of comparability in 2016, when it issued final rules to address the cross-border application of the Commission's margin requirements for uncleared swap transactions. Specifically, the Commission stated that its substituted compliance approach reflects an outcome-based assessment of the comparability of a foreign jurisdiction's margin requirements with the Commission's corresponding requirements.

The Commission further stated that it would evaluate the objectives and outcomes of the foreign margin requirements in light of foreign regulator(s)' supervisory and enforcement authority.

Consistent with its previously stated position, the Commission recognized that jurisdictions may adopt different approaches to achieving the same outcome and, therefore, the assessment would focus on whether the foreign jurisdiction's margin requirements are comparable to the Commission's in purpose and effect, not whether they are comparable in every aspect or contain identical elements.

The Commission's policy thus reflects an understanding that a line-by-line evaluation of a foreign jurisdiction's regulatory regime is not the optimum approach to assessing the comparability of complex structures whose individual components may differ based on jurisdiction-specific considerations, but which achieve the objective and outcomes set forth in the Commission's framework.

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

81 FR 34817, 34836-34837 (May 31, 2016).

Id.

With respect to the FSA Application, the process leading to the Comparability Determination involved Commission staff obtaining English language translations of relevant Japanese laws, rules, and regulations cited in the FSA Application from the FSA.

Staff verified the assertions and citations contained in the FSA Application regarding the specific Japanese Capital Rules and Japanese Financial Reporting Rules to the relevant English language versions of the Japanese laws, rules, and regulations.

Commission staff received English translations on May 11, 2021.

Staff also reviewed the FSA website to confirm various provisions of Japanese laws and regulations that were relevant to the proposed Comparability Determination and proposed Comparability Order.

Commission staff also evaluated the comparability of the Japanese Capital Rules and Japanese Financial Reporting Rules with the CFTC Capital Rules and CFTC Financial Reporting Rules with respect to the following areas: (i) the process of establishing minimum capital requirements for Japanese nonbank SDs and how such process addresses risk, including market risk and credit risk of the Japanese nonbank SD's on-balance sheet and off-balance sheet exposures; (ii) the types of equity and debt instruments that qualify as regulatory capital in meeting a Japanese nonbank SD's minimum capital requirements; (iii) the financial reports and other financial information submitted by a Japanese nonbank SD to the FSA, and whether such information provides the FSA with the means necessary to effectively monitor the financial condition of the Japanese nonbank SD; and (iv) the regulatory notices and other communications between a Japanese nonbank SD and the FSA that address potential adverse financial or operational issues that may impact the firm.

With respect to the ability of the FSA to supervise and enforce compliance with the Japanese Capital Rules and Japanese Financial Reporting Rules, the Commission's assessment included a review of the FSA's surveillance program for monitoring Japanese nonbank SDs compliance with Japanese Capital Rules and Japanese Financial Reporting Rules, and the disciplinary process imposed on firms that fail to comply with such requirements.

2022 Proposal at 48098-48112.

Id.

at 48112-48113.

Contrary to the position articulated by Better Markets regarding the nature of the comparability assessment, the Commission believes that the principles-based, holistic assessment of the Japanese Capital Rules and Japanese Financial Reporting Rules against the CFTC Capital Rules and CFTC Financial Reporting Rules, as outlined above and discussed in detail in Section II below, was sufficiently rigorous for purposes of determining if the Japanese laws and regulations are comparable in purpose and effect to the CEA and Commission regulations.

Better Markets further asserted that even under a principles-based, holistic approach, the FSA capital and financial reporting requirements for Japanese nonbank SDs do not satisfy the test for an order granting substituted compliance because the FSA's regulatory framework governing capital and financial reporting is not comparable to the corresponding CFTC requirements.

Better Markets cited the Commission's inclusion of conditions in the proposed Comparability Order as demonstrating the Commission's need “to compensate for the acknowledged obvious gaps in the FSA framework.”

Better Markets further stated that the differences between the Japanese and the CFTC capital and financial reporting regimes mandate denial of the FSA Application for a comparability determination.

Better Markets Letter at p. 2.

Id.

The Commission disagrees that the inclusion of conditions in the Comparability Order precludes a finding of comparability with respect to the Japanese Capital Rules and Japanese Financial Reporting Rules. The Commission's comparability assessment process, consistent with the holistic approach, contemplates the potential need for a Comparability Order to contain conditions. Specifically, Commission Regulation 23.106(a)(5) states that the Commission may impose any terms and conditions it deems appropriate in issuing a Comparability Order, including conditions with respect to capital adequacy and financial reporting requirements of non-U.S. nonbank SDs.

17 CFR 23.106(a)(5), which provides that in issuing a Capital Comparability Determination, the Commission may impose

any terms and conditions it deems appropriate,

including certain capital adequacy and financial reporting requirements on swap dealers. . . (Emphasis added). Commission Regulation 23.106(a)(3) establishes the Commission's standard of review for performing a Comparability Determination and provides that the Commission may consider all relevant factors, including whether the relevant foreign jurisdiction's capital adequacy and financial reporting requirements achieve comparable outcomes to the Commission's corresponding capital adequacy and financial reporting requirements for SDs. 17 CFR 23.106(a)(3)(ii).

The process employed in this Comparability Determination is consistent with the Commission's established approach to conducting comparability assessments. Upon a finding of comparability, the Commission's policy generally is that eligible entities may comply with a substituted compliance regime subject to the conditions the Commission places on its finding, and subject to the Commission's retention of its examination authority and its enforcement authority.

In this regard, the Commission has stated that certain conditions included in a Comparability Order may be designed to ensure the

Commission's direct access to books and records required to be maintained by an SD registered with the Commission.

Other conditions may address areas where the foreign jurisdiction lacks analogous requirements.

The inclusion of conditions in a Comparability Order was contemplated as an integral part of the Commission's holistic, principle-based approach to conducting comparability assessments and is not inconsistent with a grant of substituted compliance. In particular, Commission Regulation 23.106(a)(5) states the Commission's authority to impose conditions in issuing a Comparability Determination in connection with the CFTC Capital Rules and the CFTC Financial Reporting Rules. As further discussed below, the conditions proposed in the 2022 Proposal are clearly of the nature contemplated by Commission Regulation 23.106(a)(5).

85 FR 57462 at 57520.

See also

Guidance at 45342-45344 and

Comparability Determination for the European Union: Certain Transaction Level Requirements,

78 FR 78878 (December 27, 2013) at 78880.

Comparability Determination for the European Union: Certain Transaction Level Requirements,

78 FR 78878 (December 27, 2013) at 78880.

Guidance at 45343.

The Commission also does not believe that the inclusion of the conditions in the proposed Comparability Order demonstrates “obvious gaps in the FSA framework” as asserted by Better Markets. Consistent with the Commission's policy described above, a majority of the conditions contained in the proposed Comparability Order are designed to ensure that: (i) the Japanese nonbank SD is eligible for substituted compliance based on the Japanese laws and regulations that were reviewed by the Commission in performing the comparability assessment, and (ii) the Commission and the NFA receive timely financial information and notices to effectively monitor a Japanese nonbank SD's compliance with the Comparability Order and to assess the ongoing safety and soundness of the Japanese nonbank SD. Specifically, there are 23 conditions in the final Comparability Order. Four conditions set forth criteria that a Japanese nonbank SD must meet to be eligible for substituted compliance pursuant to the Comparability Order.

The four conditions ensure that only Japanese nonbank SDs that are within the scope of, and comply with, the Japanese Capital Rules and Japanese Financial Reporting Rules that were part of the Commission's comparability assessment may apply for substituted compliance. Eight additional conditions require Japanese nonbank SDs within scope of the Comparability Order to provide notice to the Commission and NFA of certain defined events,

and a further three conditions require Japanese nonbank SDs to file with the Commission and NFA copies of certain unaudited and audited financial reports that the firms provide to the FSA.

In addition, two additional conditions reflect administrative matters necessary to implement the substituted compliance framework.

Lastly, five conditions impose obligations on Japanese nonbank SDs that align with certain of the Commission's requirements for nonbank SDs. The five conditions require a Japanese nonbank SD to: (i) maintain a minimum level of capital defined as Basic Items

in an amount equivalent to at least $20 million (Condition 5); (ii) prepare and keep current financial books and records (Condition 7); (iii) file a monthly schedule of the firm's financial positions on Schedule 1 of appendix B to Subpart E of part 23 of the Commission's regulations (Condition 11); (iv) file a monthly report listing the custodians holding margin posted by, and collected by, the Japanese nonbank SD, the amount of margin held by each custodian, and the aggregate amount of margin required to be posted and collected by the Japanese nonbank SD (Condition 13); and (v) submit, with each filing of financial information, a statement by an authorized representative that, to the best knowledge and belief of the person making the representation, the information is true and correct (Condition 14).

The four criteria provide that the Japanese nonbank SD: (i) is not subject to capital rules of a U.S. prudential regulator (Condition 1); (ii) is organized and domiciled in Japan (Condition 2); (iii) is registered as a FIBO (Condition 3); and (iv) is subject to the Japanese Capital Rules and Japanese Financial Reporting Rules that are part of the Commission's comparability assessment (Condition 4).

The eight conditions require a Japanese nonbank SD to provide notice to the Commission in the event that the firm: (i) is informed by the FSA that it failed to comply with any component of the Japanese Capital Rules or Japanese Financial Reporting Rules (Condition 15); (ii) fails to maintain regulatory capital in the form of Basic Items of at least the equivalent of $20 million (Condition 16); (iii) its capital adequacy ratio is below the early warning level of 140 percent (Condition 17); (iv) its capital adequacy ratio is below the minimum requirement of 120 percent (Condition 18); (v) fails to make or keep current financial books and records (Condition 19); (vi) fails to post or collect margin for uncleared swaps and non-cleared security-based swaps with one or more counterparties in amounts that exceed defined limits (Condition 20); (vii) changes its fiscal year-end date (Condition 21); and (viii) is subject to material changes to the Japanese Capital Rules, Japanese Financial Reporting Rules, or the supervisory authority of the Japanese Commission (Condition 22).

The three conditions provide that a Japanese nonbank SD must file with the Commission and NFA: (i) English language copies of certain financial reporting forms that the Japanese nonbank SD is required to submit to the FSA pursuant to Article 56-2(1) of the FIEA (Condition 8); (ii) an English language copy of the annual business report that the Japanese nonbank SDs is required to submit to the FSA pursuant to Article 46-3(1) of the FIEA and Article 172 of the COO (Condition 9); and (iii) English language copies of the Japanese nonbank SD's annual audited financial statements and management report that are required to be prepared pursuant to Article 435(2) of the Japanese Companies Act (Act No. 86 of 2005) (Condition 10).

One of the administrative conditions provides that a Japanese nonbank SD must provide a notice to the Commission of its intent to comply with the Comparability Order and the Japanese Capital Rules and Japanese Financial Reporting Rules in lieu of the CFTC Capital Rules and CFTC Financial Reporting Rules. The notice must include the Japanese nonbank SD's representation that the firm is organized and domiciled in Japan, is a registered FIBO, and is subject to and complies with the Japanese Capital Rules and the Japanese Financial Reporting Rules (Condition 6). The second administrative condition provides that a Japanese nonbank SD must file any documents with the Commission and NFA via electronic transmission (Condition 23). With respect to Condition 6, the Commission also notes that the language of the proposed condition required that a Japanese nonbank SD provide a notice of its intent to comply with “applicable” Japanese Capital Rules and Japanese Financial Reporting Rules. Given that “Japanese Capital Rules and Japanese Financial Reporting Rules” is a term defined in the Comparability Order to include laws and regulations that apply to Japanese nonbank SDs, the word “applicable” is superfluous and is, therefore, not included in final Condition 6 of the Comparability Order.

“Basic Items” are analogous to common equity tier 1 capital as defined in the CFTC Capital Rules.

See

discussion in section II.B.

Another condition specifies that Japanese nonbank SDs that are registered with the U.S. Securities and Exchange Commission (“SEC”) as security-based swap dealers (“SBSDs”) and required to file with the SEC, or its designee, Form X-17A-5 (“FOCUS Report”), must file a copy of such FOCUS Report with the Commission and NFA within 35 calendar days after the end of each month (Condition 12). A Japanese nonbank SD that files a FOCUS Report pursuant to Condition 12 will not be required to file the reports and schedules specified in Conditions 8 and 11. Currently, no Japanese nonbank SD is registered as a SBSD.

As the substance of these conditions demonstrates, the primary objective of a majority of the conditions is not to compensate for regulatory gaps in the Japanese capital and financial reporting framework, but rather to ensure that the Commission and NFA receive information to conduct ongoing monitoring of Japanese nonbank SDs for compliance with relevant capital and financial reporting requirements. As discussed above, in issuing the Comparability Order, the Commission is not ceding its supervisory and enforcement authorities. The Comparability Order permits Japanese nonbank SDs to satisfy the Commission's capital and financial reporting requirements by complying with certain laws and/or regulations of Japan that have been found comparable to the Commission's laws and/or regulations in purpose and effect. The Commission and NFA, however, have a continuing obligation to conduct

ongoing oversight, including potential examination, of Japanese nonbank SDs to ensure compliance with the Comparability Order, including its conditions. To that effect, the notice and financial reporting conditions set forth in the Comparability Order provide the Commission and NFA with information necessary to monitor for such compliance, and to evaluate the operational condition and ongoing financial condition of Japanese nonbank SDs. The Commission may also initiate an enforcement action against a Japanese nonbank SD that fails to comply with the conditions of the Comparability Order.

As the Commission stated in the 2022 Proposal, a non-U.S. nonbank SD that operates under a Comparability Order issued by the Commission remains subject to the Commission's examination and enforcement authority. Specifically, the Commission may initiate an enforcement action against a non-U.S. nonbank SD that fails to comply with its home-country capital adequacy and/or financial reporting requirements cited in a Comparability Order.

See

2022 Proposal at 48094-48095.

See also

17 CFR 23.106(a)(4)(ii), which provides that the Commission may examine all nonbank SDs, regardless of whether the nonbank SDs rely on substituted compliance, and that the Commission may initiate an enforcement action under the Commission's capital and financial reporting regulations against a non-U.S. nonbank SD that fails to comply with a foreign jurisdiction's capital adequacy and financial reporting requirements.

Furthermore, to the extent that a condition imposes a new obligation on Japanese nonbank SDs, the imposition of such condition is also consistent with Commission Regulation 23.106 and the Commission's established policy with regard to comparability determinations. As discussed above, the Commission contemplated that even in circumstances where the Commission finds two regulatory regimes comparable, the Commission may impose requirements on entities relying on substituted compliance where the Commission determines that the home jurisdiction's regime lacks comparable and comprehensive regulation on a specific issue.

The Commission's authority to impose such conditions is set out in Commission Regulation 23.106(a)(5), which states that the Commission may impose “any terms and conditions it deems appropriate, including certain capital adequacy and financial reporting requirements [on SDs].”

Guidance at 45343.

17 CFR 23.106(a)(5).

Better Markets further stated that if the Commission grants substituted compliance with regard to materially different regulatory requirements, it must make a well-supported comparability determination by, at a minimum, clearly and specifically setting forth the desired regulatory outcome and providing a detailed, evidence-based explanation as to how the jurisdiction's different legal requirements nonetheless lead to a comparable regulatory outcome.

Better Markets also stated that if the Commission grants the Comparability Determination and Comparability Order, it must, at a minimum, ensure that the conditions are applied and enforced with full force and without exception or dilution.

Better Markets asserted that “[a] determination that a foreign jurisdiction's nonbank SDs rules would produce comparable regulatory outcomes is the beginning, not the end, of the CFTC's obligation to ensure that the activities of the foreign nonbank SD entities do not pose risks to the U.S. financial system. As time goes on, regulatory requirements that, in theory, are expected to produce one regulatory outcome may, in practice, produce a different one. And, of course, the regulatory requirements may themselves be changed in a variety of ways. Finally, the effectiveness of an authority's supervision and enforcement program can become weakened for any number of reasons—the CFTC cannot assume that an enforcement program that is presently effective will continue to be effective.”

Better Markets further asserted that to fulfill its obligation to protect the U.S. financial system, the Commission must ensure, on an ongoing basis, that each grant of substituted compliance remains appropriate over time by, at a minimum, requiring each Comparability Order to impose an obligation on the applicant, as appropriate, to: (i) periodically apprise the Commission of the activities and results of its supervision and enforcement programs, to ensure that they remain sufficiently robust to deter and address violations of the law; and (ii) immediately apprise the Commission of any material changes to the regulatory regime, including changes to rules or interpretations of rules.

Better Markets at p. 6.

Id.

at p. 2.

Id.

at p. 6.

Id.

Although the Commission disagrees that the Japanese Capital Rules and the Japanese Financial Reporting Rules, as a whole, are materially different or do not achieve comparable regulatory outcomes, the Commission concurs that granting substituted compliance should be the result of a well-supported comparability assessment. Consistent with that view, the Commission believes that this final Comparability Determination articulates the Commission's analysis in sufficient detail and provides an appropriate explanation of how the foreign jurisdiction's requirements are comparable in purpose and effect with the Commission's requirements, and lead to comparable regulatory outcomes with the Commission's requirements. Specifically, Section III of the 2022 Proposal and Section II of the final Comparability Determination reflect, among other observations, the Commission's detailed analysis with respect to each of the elements for consideration listed in Commission Regulation 23.106(a)(3).

The Commission also concurs that the availability of substituted compliance is conditioned upon a non-US nonbank SD's ongoing compliance with the terms and conditions of the final Comparability Order, and the Commission's ongoing assessment that the Japanese Capital Rules and Japanese Financial Reporting Rules remain comparable in purpose and effect with the CFTC Capital Rules and CFTC Financial Reporting Rules. As noted above, and discussed in more detail in Sections II.D. and E. below, Japanese nonbank SDs are subject to notice and financial reporting requirements under the final Comparability Order that provide Commission and NFA staff with the ability to monitor the Japanese nonbank SDs' ongoing compliance with the conditions set forth in the final Comparability Order. In addition, the final Comparability Order requires Japanese nonbank SDs or the FSA to inform the Commission of changes to the relevant Japanese Capital Rules and Japanese Financial Reporting Rules so that the Commission may assess the continued effectiveness of the Comparability Order in ensuring that the Japanese laws and regulations have the comparable regulatory objectives of the CEA and Commission regulations of ensuring the safety and soundness of nonbank SDs.

Commission staff will also monitor the Japanese nonbank SDs directly as part of its supervisory program and will discuss with the firms any proposed or pending revisions to specific laws and rules cited in the final

Comparability Order. Lastly, in addition to assessing the effectiveness of the Comparability Order as a result of revisions or proposed revisions to the Japanese laws, regulations, or supervisory regime, the Commission further notes that future material changes to the CFTC Capital Rules or CFTC Financial Reporting Rules, or the Commission's or NFA's supervisory programs, may necessitate an amendment to the Comparability Determination and Comparability Order to reflect those changes.

Condition 22 of the final Comparability Order requires Japanese nonbank SDs or the FSA to notify the Commission of any material changes to the information submitted in the FSA Application, including, but not limited to, proposed and final material changes to the Japanese Capital Rules or Japanese Financial Reporting Rules and proposed and final material changes to the FSA's supervisory authority or supervisory regime over Japanese nonbank SDs. The Commission notes that it also made certain non-substantive, clarifying changes to the language of final Condition 22 as compared to the proposed condition.

2022 Proposal at 48098 (n. 72).

Another commenter, Harrington, stated that the Commission “must prevent every regulated [SD] globally from providing a swap contract with a “flip clause [. . .].”

Harrington further recommended that the Commission condition the Comparability Order on specifying that a Japanese nonbank SD that is party to a swap contract with a flip clause must hold additional capital determined based on the required margin and the contract market value.

Alternatively, Harrington argued that the Commission should prohibit a Japanese nonbank SD from entering into a new swap contract with a flip clause or extending an existing one.

Harrington has elsewhere referred to a description of a “flip clause” as a provision in swap contracts with structured debt issuers that reverses or “flips” the priority of payment obligations owed to the swap counterparty on the one hand and the noteholders on the other, following a specified event of default.

Based on Harrington's description, flip clauses present a risk to the SD in synthetic transactions where payments under a swap contract are secured with the same collateral that would serve to cover payments under the notes issued by a structured debt issuer. In such circumstances, an “event of default” by the SD would cause the SD's priority of payment from the collateral under a swap to “flip” to a more junior priority position, including for mark-to-market gains on “in the money” swaps.

Harrington 10/20/2022 Letter at p. 3.

Harrington 10/20/2022 Letter at p. 23.

Id.

William J. Harrington, Submission to the U.S. Securities and Exchange Commission Re: File No. S7-08-12 (Nov. 19, 2018) at p.8.

For additional information on the legal mechanics of a flip clause,

see

Lehman Brothers Special Financing Inc v. Bank of America N.A., No. 18-1079 (2nd Cir. 2020).

Harrington argued that no element of the CFTC Capital Rules or the Japanese Capital Rules addresses “the 100% self-exposure that [an SD] incurs with each swap with flip clause.”

Harrington recognized, however, that the CFTC margin requirements for uncleared swap transactions address his concerns associated with the inclusion of a flip clause.

Nonetheless, according to Harrington, risks arise in circumstances when non-U.S. margin rules exempt SDs from margin obligations in connection with swaps with a structured debt issuer.

Harrington 10/20/2022 Letter at p. 21-22.

Harrington 10/20/2022 Letter at p.3 (noting that the requirement for SDs to post and collect variation margin for swap contracts with a securitization or structured debt issuer “generates the immense benefit of inducing U.S. securitization and structured debt issuers to forswear all swap contracts, both with and without a flip clause”).

Harrington 10/20/2022 Letter at p.3 (arguing that “non-U.S. swap margin rules de facto exempt a swap provider from collecting or posting variation margin under a new contract with most securitization and structured debt issuers”).

The Commission recognizes that given some definitional differences and differences in the activity thresholds with respect to the scope of application of the CFTC margin requirements and non-U.S. margin requirements, some transactions that are subject to the CFTC margin requirements for uncleared swaps may not be subject to margin requirements in another jurisdiction. In connection with this Comparability Determination, however, the Commission notes that both under the CFTC Capital Rules and the Japanese Capital Rules, uncollateralized exposures from uncleared swap transactions would generate a higher counterparty credit risk charge than the exposures resulting from transactions under which the counterparties have posted collateral.

Accordingly, the Commission does not believe that the respective sets of rules adopt a conflicting approach or lead to a disparate outcome with respect to the capital treatment of uncollateralized uncleared swap exposures that would warrant a finding of non-comparability of the CFTC Capital Rules and the Japanese Capital Rules.

12 CFR 217.34 and 12 CFR 217.132 (indicating that nonbank SDs may recognize the risk-mitigating effects of financial collateral for collateralized derivatives contracts) and Notice on Capital, Article 15.5. and 15-2.5 (similarly indicating that Japanese nonbank SDs are allowed to recognize the risk-mitigating effect of collateral by deducting the amount of collateral from the exposure at default amount).

With regard to Harrington's general recommendations, also included in a submission by Harrington in connection with the adoption of the CFTC Capital Rules, that the Commission impose additional capital charges for swap contracts with a flip clause,

the Commission notes that any change in its capital requirements and approach, if deemed appropriate, would be addressed separately from the Comparability Determination. As the Commission stated in adopting the CFTC Capital Rules, over time the Commission may consider adjusting the capital charges applicable to nonbank SDs that engage in bespoke swap transactions, including contracts involving flip clauses, as a result of its experience and as market developments may warrant.

If the Commission proceeds with adjustments to the CFTC Capital Rules, the Commission may reconsider the comparability between the CFTC Capital Rules and the Japanese Capital Rules in light of these changes.

Harrington 10/20/2022 Letter at p.24.

85 FR 57462 at 57475. As stated in the adopting release to the CFTC Capital Rules, the Commission considered that its rules were appropriately calibrated to account for a wide variety of possible uncleared swap transactions, including bespoke transactions involving flip clauses or other unique features.

See id.

Finally, IBAJ proposed several technical amendments to the 2022 Proposal that were corrective or clarifying in nature.

As further discussed below, several of the proposed changes have been incorporated, as appropriate, throughout the final Comparability Determination and Comparability Order.

IBAJ Letter.

II. Final Capital and Financial Reporting Comparability Determination and Comparability Order

The following section provides the Commission's comparative analysis of the Japanese Capital Rules and the Japanese Financial Reporting Rules with the corresponding CFTC Capital Rules and CFTC Financial Reporting Rules, as described in the 2022 Proposal, further modified to address comments received. As emphasized in the 2022 Proposal, the capital and financial reporting regimes are complex structures comprised of a number of interrelated regulatory components.

Differences in how jurisdictions approach and implement these regimes are expected, even among jurisdictions that base their requirements on the principles and standards set forth in the BCBS framework.

See

2022 Proposal at 48098.

The Commission performed the analysis by assessing the comparability of the Japanese Capital Rules for Japanese nonbank SDs as set forth in the FSA Application and in the English language translation of certain applicable Japanese laws and regulations with the Commission's Bank-Based Approach for nonbank SDs.

The Commission understands that, as of the date of the final Comparability Determination and Comparability Order, the three Japanese nonbank SDs registered with the Commission are subject to a bank-based capital approach under the Japanese Capital Rules. Accordingly, when the Commission makes its final determination herein about the comparability of the Japanese Capital Rules with the CFTC Capital Rules, the determination pertains to the comparability of the Japanese Capital Rules with the Bank-Based Approach under the CFTC Capital Rules. The Commission notes that any material changes to the information submitted in the FSA Application, including, but not limited to, proposed and final material changes to the Japanese Capital Rules or Japanese Financial Reporting Rules, as well as any proposed and final material changes to the FSA's supervisory authority or supervisory regime, will require notification to the Commission and NFA pursuant to Condition 22 of the final Comparability Order.

Therefore, if there are subsequent material changes to the Japanese Capital Rules, Japanese Financial Reporting Rules, or the supervisory authority or supervisory regime, the Commission will review and assess the impact of such changes on the final Comparability Determination and Comparability Order as they are then in effect, and may amend or supplement the Comparability Order as appropriate.

Condition 22 of the final Comparability Order. The Commission notes that it made certain non-substantive, clarifying changes to the language of final Condition 22 as compared to the proposed condition.

See

2022 Proposal at 48098. As stated in the 2022 Proposal, the Commission may also amend or supplement the Comparability Order to address any material changes to the CFTC Capital Rules and CFTC Financial Reporting Rules, including rule amendments to capital rules of the Federal Reserve Board that are incorporated into the CFTC capital Rules' Bank-Based Approach under Commission Regulation 23.101(a)(1)(i), that are adopted after the final Comparability Order is issued.

See id.

(fn. 72).

A. Regulatory Objectives of CFTC Capital Rules and CFTC Financial Reporting Rules and Japanese Capital Rules and Japanese Financial Reporting Rules

1. Preliminary Determination

As reflected in the 2022 Proposal and discussed above, the Commission preliminarily determined that the overall objectives of the Japanese Capital Rules and the CFTC Capital Rules are comparable in that both sets of rules are intended to ensure the safety and soundness of nonbank SDs by establishing regulatory regimes that require nonbank SDs to maintain a sufficient amount of qualifying regulatory capital to absorb losses, including losses from swaps and other trading activities, and to absorb decreases in the value of firm assets and increases in the value of firm liabilities without the nonbank SDs becoming insolvent.

The Commission further noted that the Japanese Capital Rules and CFTC Capital Rules are also based on, and consistent with, the BCBS framework, which was designed to ensure that banking entities hold sufficient levels of capital to absorb losses and decreases in the value of firm assets and increases in the value of firm liabilities without the banks becoming insolvent.

See

2022 Proposal at 48099.

Id.

The Commission also preliminarily found that the Japanese Capital Rules are comparable in purpose and effect to the CFTC Capital Rules given that both regulatory approaches compute the minimum capital requirements based on the level of a nonbank SD's on-balance sheet and off-balance sheet exposures, with the objective and purpose of ensuring that the nonbank SD's capital is adequate to absorb losses or decreases in the value of firm assets or increases in the value of firm liabilities resulting from such exposures.

100

The Commission observed that the Japanese Capital Rules and CFTC Capital Rules provide for a comparable approach to the calculation of on-balance sheet and off-balance sheet risk exposures using standardized or internal model-based approaches.

101

In addition, as discussed in the 2022 Proposal, the Japanese Capital Rules' and CFTC Capital Rules' requirements for identifying and measuring on-balance sheet and off-balance sheet exposures under standardized or internal model-based approaches are also consistent with the requirements set forth under the BCBS framework for identifying and measuring on-balance sheet and off-balance sheet exposures.

102

100

Id.

101

Id.

102

Id.

Finally, the Commission preliminarily noted that the Japanese Capital Rules and CFTC Capital Rules further achieve comparable outcomes and are comparable in purpose and effect in that both sets of rules limit the types of capital instruments that qualify as regulatory capital to cover the on-balance sheet and off-balance sheet risk exposures to high quality equity capital and qualifying subordinated debt instruments that meet conditions designed to ensure that the holders of the debt have effectively subordinated their claims to other creditors of the nonbank SD.

103

As discussed in the 2022 Proposal and in Section II.B. below, both the Japanese Capital Rules and the CFTC Capital Rules define high quality capital by the degree to which the capital represents permanent capital that is contributed, or readily available to a nonbank SD, on an unrestricted basis to absorb unexpected losses, including losses from swaps trading and other activities, without the nonbank SD becoming insolvent.

104

103

Id.

at 48099-48100.

104

Id.

The Commission further stated that it preliminarily found the Japanese Financial Reporting Rules to be comparable in purpose and effect to the CFTC Financial Reporting Rules as both the FSA and CFTC require nonbank SDs to file periodic financial reports, including unaudited financial reports and an annual audited financial report, detailing their financial operations and demonstrating their compliance with minimum capital requirements.

105

As discussed in the 2022 Proposal, in addition to providing the CFTC and FSA with information necessary to comprehensively assess the financial condition of a nonbank SD on an ongoing basis, the financial reports further provide the CFTC and FSA with information regarding potential changes in a nonbank SD's risk profile by disclosing changes in account balances reported over a period of time.

106

Such changes in account balances may indicate, among other things, that the nonbank SD has entered into new lines of business, has increased its activity in an existing line of business relative to other activities, or has terminated a previous line of business.

107

105

Id.

at 48100.

106

Id.

107

Id.

In assessing the comparability between the CFTC Financial Reporting Rules and the Japanese Financial Reporting Rules, the Commission noted that the prompt and effective monitoring of the financial condition of nonbank SDs through the receipt and review of periodic financial reports supports the Commission and FSA in meeting their respective objectives of ensuring the safety and soundness of nonbank SDs. In this regard, the Commission stated that the early identification of potential financial issues provides the Commission and FSA with an opportunity to address such issues with the nonbank SD before they develop to a state where the financial condition of the firm is

impaired such that it may no longer hold a sufficient amount of qualifying regulatory capital to absorb decreases in the value of firm assets, absorb increases in the value of firm liabilities, or cover losses from its business activities, including the firm's swap dealing activities and obligations to swap counterparties.

108

Id.

2. Comment Analysis and Final Determination

In response to the Commission's request for comment, Better Markets identified certain differences between the CFTC Capital Rules and CFTC Financial Reporting Rules and the Japanese Capital Rules and Japanese Financial Reporting Rules and stated that the differences mandated denial of the request for a comparability determination.

109

Better Markets further stated that the imposition of conditions to achieve comparability between the regimes implicitly concedes that the regimes are not comparable, and is suboptimal and undesirable, as it creates a set of capital and reporting requirements that Japanese nonbank SDs must abide by and that the Commission must monitor.

110

109

Better Markets Letter at pp. 7-11. For example, Better Markets asserts that while the CFTC requires non-bank SDs to hold qualifying capital in an amount equal to at least 8 percent of the nonbank SDs uncleared swap margin amount, Japan's capital rules are based on an “arbitrary percentage” of a company's operating expenses. Better Markets also asserted that while the CFTC's capital rules require nonbank SDs to “maintain regulatory capital in the form of common equity tier 1 capital, additional tier 1 capital, and tier 2 capital, Japan's capital rules require nonbank SDs to maintain a “capital adequacy amount” in the form of “Basic Items and Supplemental Items” and that the Japanese framework has no dollar minimum capital requirement. These distinctions between the CFTC Capital Rules and Financial Reporting Rules, and the Japanese Capital and Financial Reporting Rules are discussed in detail in sections II.C. and II.B., respectively, below.

110

Id.

As described herein and in the 2022 Proposal, Commission staff has engaged in a detailed, comprehensive study and evaluation of the Japanese capital and financial reporting framework and has confirmed that its understanding of the elements and application of the framework is accurate. The Commission has also concluded, based on its evaluation, that the FSA has a comprehensive oversight program for monitoring Japanese nonbank SD's compliance with relevant Japanese Capital Rules.

Furthermore, as discussed in Section I.E. above, the conditions set forth in the Comparability Order are generally intended to ensure that: (i) only Japanese nonbank SDs that are subject to the laws and regulations assessed under the Comparability Determination are eligible for substituted compliance; (ii) the Japanese nonbank SDs are subject to supervision by the FSA; and (iii) the Japanese nonbank SDs provide information to the Commission and NFA that is relevant to the ongoing supervision of their operations and financial condition. Considering this thorough analysis and the ongoing requirement for Japanese nonbank SDs to provide information to the Commission and NFA demonstrating compliance with the Comparability Order, the Commission is confident that it is capable of effectively conducting, together with NFA, appropriately tailored oversight of the Japanese nonbank SDs. In light of the Commission's ultimate conclusion that the Japanese capital and financial reporting requirements are comparable based on the standards articulated in Commission Regulation 23.106(a)(3), the Commission believes that a failure to issue a Comparability Determination and Comparability Order would in fact be “suboptimal and undesirable” as it would impose duplicative requirements that would result in increased costs for registrants and market participants without a commensurate benefit from an oversight perspective.

As discussed in Sections I.B. and E. above, and detailed herein, the Commission finds that the CFTC Capital Rules and Financial Reporting Rules and the Japanese Capital Rules and Financial Reporting Rules are comparable in purpose and effect, and have overall comparable objectives, notwithstanding the identified differences. In this regard, the Commission notes that instead of conducting a line-by-line assessment or comparison of the Japanese Capital and Japanese Financial Reporting Rules and the CFTC Capital and CFTC Financial Reporting Rules, it has applied in the assessment set forth in this determination and order, a principles-based, holistic approach in assessing the comparability of both regimes, consistent with the standard of review it adopted in Commission Regulation 23.106(a)(3). Based on that principles-based, holistic assessment, the individual elements of which are described in more detail in Sections II.B. through II.F below, the Commission has determined that both sets of rules are designed to ensure the safety and soundness of nonbank SDs and achieve comparable outcomes. As such, the Commission adopts the Comparability Determination and Comparability Order as proposed with respect to the analysis of the regulatory objectives of the CFTC Capital Rules and Financial Reporting Rules and the Japanese Capital and Financial Reporting Rules.

B. Nonbank Swap Dealer Qualifying Capital

1. Preliminary Determination

As discussed in the 2022 Proposal, the Commission preliminarily determined that the Japanese Capital Rules are comparable in purpose and effect to CFTC Capital Rules with regard to the types and characteristics of a nonbank SD's equity that qualifies as regulatory capital in meeting its minimum requirements.

111

The Commission explained that the Japanese Capital Rules and the CFTC Capital Rules for nonbank SDs both require a nonbank SD to maintain a quantity of high-quality and permanent capital that, based on the firm's activities and on-balance sheet and off-balance sheet exposures, is sufficient to absorb losses and decreases in the value of firm assets and increases in the value of firm liabilities without resulting in the firm becoming insolvent.

112

The Commission observed that the Japanese Capital Rules and the CFTC Capital Rules permit nonbank SDs to recognize comparable forms of equity capital and qualifying subordinated debt instruments toward meeting minimum capital requirements, with both the Japanese Capital Rules and the CFTC Capital Rules emphasizing high quality capital instruments.

113

111

See

2022 Proposal at 48101.

112

Id.

113

Id.

In support of its preliminary Comparability Determination, the Commission noted that the CFTC Capital Rules require a nonbank SD electing the Bank-Based Approach to maintain regulatory capital in the form of common equity tier 1 capital, additional tier 1 capital, and tier 2 capital in amounts that meet certain stated minimum requirements set forth in Commission Regulation 23.101.

114

Common equity tier 1 capital is generally composed of an entity's common stock instruments, and any related surpluses, retained earnings, and accumulated other comprehensive income, and is a more conservative or permanent form of capital that is last in line to receive distributions in the event of the entity's insolvency.

115

Additional tier 1 capital is generally composed of

equity instruments such as preferred stock and certain hybrid securities that may be converted to common stock if triggering events occur and may have a preference in distributions over common equity tier 1 capital in the event of an insolvency.

116

Total tier 1 capital is composed of common equity tier 1 capital and further includes additional tier 1 capital. Tier 2 capital includes certain types of instruments that include both debt and equity characteristics such as qualifying subordinated debt.

117

Subordinated debt must meet certain conditions to qualify as tier 2 capital under the CFTC Capital Rules.

118

114

17 CFR 23.101(a)(1)(i) and 2022 Proposal at 48100. The terms “common equity tier 1 capital,” “additional tier 1 capital,” and “tier 2 capital” are defined in the bank holding company regulations of the Federal Reserve Board.

See

12 CFR 217.20.

115

12 CFR 217.20(b).

116

12 CFR 217.20(c).

117

12 CFR 217.20(d).

118

Subordinated debt must meet requirements set forth in SEC Rule 18a-1d. Specifically, subordinated debt instruments must have a term of at least one year (with the exception of approved revolving subordinated debt agreements which may have a maturity term that is less than one year), and contain terms that effectively subordinate the rights of lenders to receive any payments, including accrued interest, to other creditors of the firm. 17 CFR 23.101(a)(1)(i)(B) and 17 CFR 240.18a-1d.

The preliminary Comparability Determination also noted that the Japanese Capital Rules require each Japanese nonbank SD to maintain a “capital adequacy amount” (

i.e.,

an aggregate of Basic Items and Supplemental Items, after deducting carrying value of fixed assets, with Basic Items representing at least 50 percent of the total capital adequacy amount)

119

that equals or exceeds 120 percent of the firm's “risk equivalent amount,” which is the sum of the firm's market risk, credit risk, and basic risk.

120

Basic Items are composed of the Japanese nonbank SD's balance sheet capital, including: (i) issued and outstanding shares; (ii) the payment for an application for new shares; (iii) the capital surplus; (iv) the earned surplus; (v) the negative valuation difference on available-for-sale securities; and (vi) the firm's own treasury stock.

121

Supplemental Items include the positive valuation difference on available-for-sale securities and certain subordinated debt instruments.

122

Subordinated debt instruments also must meet certain conditions to qualify as Supplemental Items under the Japanese Capital Rules, including containing appropriate provisions subordinating the rights of the lender to the payment of principal and interest to other creditors of the Japanese nonbank SD.

123

In addition, any accelerated payment of the subordinated debt may only be made on a voluntarily basis by the Japanese nonbank SD after obtaining approval from the FSA.

124

119

See

2022 Proposal at 48100. The phrase “after deducting carrying value of fixed assets” has been added after “Supplemental Items” in response to a technical comment by IBAJ. IBAJ Letter at p. 5. As the Commission explained in the 2022 Proposal, the deduction of the carrying value of fixed assets is a conservative approach to the computation of a Japanese nonbank SD's capital adequacy amount as it excludes the value of non-liquid fixed assets from the firm's total Basic Items.

See

2022 Proposal at 48101.

120

Article 46-6(2) of the FIEA, Article 176 of the COO and section IV-2-1 (Preciseness of Capital Adequacy Ratio) of the Supervisory Guidelines for FIBO.

121

Article 176(1)(i) through (vi) of the COO.

122

Article 176(1)(vii) of the COO.

123

Article 176(2) and (3) of the COO.

124

Id.

Based on its comparative assessment, the Commission preliminarily found that the types and characteristics of the equity instruments included in Basic Items under the Japanese Capital Rules are comparable to the types and characteristics of equity instruments comprising common equity tier 1 capital and additional tier 1 capital under the CFTC Capital Rules.

125

Specifically, the Commission noted that the Japanese Capital Rules' Basic Items and the CFTC Capital Rules' common equity tier 1 capital and additional tier 1 capital are comparable in that these forms of equity capital have similar characteristics (

e.g.,

the equity must be in the form of high-quality, committed, and permanent capital) and represent contributed equity capital that generally has no priority to the distribution of firm assets or income with respect to other shareholders or creditors of the firm, which allows a nonbank SD to use this equity to absorb decreases in the value of firm assets, absorb increases in the value of firm liabilities, and cover losses from business activities, including the firm's swap dealing activities.

126

125

See

2022 Proposal at 48101.

126

Id.

The Commission also found the Supplemental Items under the Japanese Capital Rules to be comparable to tier 2 capital under the CFTC Capital Rules.

127

Specifically, the Commission noted that the qualifying conditions imposed on subordinated debt instruments are comparable under the Japanese Capital Rules and the CFTC Capital Rules in that they are designed to ensure that the debt has qualities supporting its recognition by a nonbank SD as equity for capital purposes, including by effectively subordinating the lenders' claims for repayment on the debt, or interest payments on the debt, to the claims of other creditors of the nonbank SD, and by limiting or restricting repayment or accelerated payments of the subordinated loans if such repayments or accelerated prepayments would result in the nonbank SD's equity falling below certain defined thresholds.

128

The Commission preliminarily concluded that the terms and conditions provided assurances that the subordinated debt was appropriate to be recognized as regulatory capital available to a nonbank SD to meet its regulatory obligations and to absorb business losses and decreases in the value of firm assets and increases in the value of firm liabilities.

129

127

Id.

128

Id.

129

Id.

The Commission also noted that the Japanese Capital Rules differ from the CFTC Capital Rules in that the Japanese Capital Rules require Japanese nonbank SDs to exclude the carrying value of fixed assets from the sum of the Basic Items and Supplemental Items in computing the capital adequacy amount, whereas the CFTC Capital Rules do not require a nonbank SD to exclude the carrying value of fixed assets from the firm's common equity tier 1 capital or additional tier 1 capital.

130

As discussed in the 2022 Proposal, the deduction of the carrying value of fixed assets under the Japanese Capital Rules is a more conservative standard as it imposes an obligation on Japanese nonbank SDs to meet minimum regulatory capital requirements with capital that reflects or represents balance sheet assets that are more liquid than fixed assets.

131

130

The IBAJ noted that the Japanese Capital Rules require the carrying value of fixed assets to be deducted from both Basic Items and Supplemental Items (and not just Basic Items as stated in the 2022 Proposal). The Commission has incorporated this clarification into the final Comparability Determination. IBAJ Letter at p. 5.

131

See

Article 177 of the COO for a breakdown of the fixed assets to be deducted.

2. Comment Analysis and Final Determination

In response to the Commission's request for comment on the qualifying capital analysis, Better Markets objected to the Commission's determination that the Japanese Capital Rules are comparable to the CFTC Capital Rules with respect to the type and characteristics of equity that qualifies as regulatory capital.

132

Better Markets asserted that the Commission did not adequately analyze the differences between the two regulatory regimes with respect to the items of qualifying capital.

133

More specifically, Better Markets stated that Basic Items under the Japanese Capital Rules include treasury stock, whereas, under the CFTC Capital Rules, which are based on definitions of capital from the Federal

Reserve Board, common equity tier 1 capital is net of treasury stock.

134

132

Better Markets Letter at p. 9.

133

Id.

at p. 8.

134

Id.

at p. 9.

The Commission recognizes that the Japanese Capital Rules list treasury stock, which represents previously issued shares of stock that have been repurchased by the firm, as a Basic Item.

135

In application of the Japanese Rules of Corporate Accounting, however, treasury stock must be deducted from the shareholders' equity component of the firms' balance sheet.

136

As such, consistent with the treatment received under the CFTC Capital Rules, the treasury stock is not counted towards the Japanese nonbank SD's Basic Items or Supplemental Items in meeting its minimum regulatory capital requirement. Accordingly, the Commission does not find that the CFTC Capital Rules and the Japanese Capital Rules diverge with respect to their respective approach to exclude treasury stock from regulatory capital.

135

Article 176 of the COO.

136

Article 76(2) of Rules of Corporate Accounting (Ordinance of the Ministry of Justice No. 13 of February 7, 2006). To account for the accurate treatment of treasury stock, the Commission has revised final Condition 4 of the final Comparability Order to include Article 76 of the Rules of Corporate Accounting to the list of laws comprising the Japanese Capital Rules that a Japanese nonbank SD must comply with under the Comparability Order.

In addition, upon further analysis, the Commission not only reiterates its observations that the Japanese Capital Rules' Basic Items present characteristics that are comparable to the characteristics of common equity tier 1 and additional tier 1 capital, but the Commission further concludes that, despite certain definitional differences, the Japanese Capital Rules' Basic Items are more closely equated to common equity tier 1 capital. In particular, the Basic Items' categories of “issued and outstanding shares,” “capital surplus,” and “earned surplus,” correspond to the CFTC Capital Rules' common equity tier 1 categories of “common stock and related surpluses,” and “retained earnings” as the categories represent equity contributions and earnings that have been retained by the nonbank SDs and represent residual ownership interest in the nonbank SDs. Similarly, whereas the CFTC Capital Rules provide for the inclusion of unrealized losses and gains on available-for-sale securities in the common equity tier 1 category of “accumulated other comprehensive income,” the Japanese Capital Rules require that the positive valuation of available-for-sale securities (

i.e.,

unrealized gain) be excluded and the negative valuation difference (

i.e.,

unrealized loss) of available-for-sale securities be included in Basic Items, thus mandating a similar, if not more conservative, treatment for this category of capital items. Finally, as clarified above, the CFTC Capital Rules and the Japanese Capital Rules treat treasury stock consistently for purposes of determining qualifying capital. More generally, the Commission is of the view that the Japanese Capital Rules' Basic Items are comparable to the CFTC Capital Rules' common equity tier 1 items in that both categories represent a more conservative, permanent form of capital that is last in line to receive distributions in the event of the entity's insolvency.

In conclusion, the Commission finds that the Japanese Capital Rules and the CFTC Capital Rules, are comparable in purpose and effect, and achieve comparable regulatory outcomes, with respect to the types of capital instruments that qualify as regulatory capital. Both the Japanese Capital Rules and the CFTC Capital Rules limit regulatory capital to permanent and conservative forms of capital, including common equity, capital surpluses, retained earnings, and subordinate debt where debt holders effectively subordinate their claims to repayment to all other creditors of the nonbank SD in the event of the firm's insolvency. Limiting regulatory capital to the above categories of equity and debt instruments promotes the safety and soundness of the nonbank SD by helping to ensure that the regulatory capital is not withdrawn or converted to other equity instruments that may have rights or priority with respect to payments, such as dividends or distributions in insolvency, over other creditors, including swap counterparties. The Commission, therefore, is adopting the Comparability Order as proposed with respect to the types and characteristics of equity and subordinated debt that qualify as regulatory capital to meet minimum capital requirements under the Japanese Capital Rules.

C. Nonbank Swap Dealer Minimum Capital Requirement

1. Introduction to Nonbank Swap Dealer Minimum Capital Requirements

As reflected in the 2022 Proposal, the CFTC Capital Rules require a nonbank SD electing the Bank-Based Approach to maintain regulatory capital that satisfies each of the following criteria: (i) an amount of common equity tier 1 capital of at least $20 million; (ii) an aggregate amount of common equity tier 1 capital, additional tier 1 capital, and tier 2 capital equal to or greater than 8 percent of the nonbank SD's total risk-weighted assets, provided that common equity tier 1 capital comprises at least 6.5 percent of the 8 percent; (iii) an aggregate of common equity tier 1 capital, additional tier 1 capital, and tier 2 capital in an amount equal to or in excess of 8 percent of the nonbank SD's uncleared swap margin amount;

137

and (iv) the amount of capital required by NFA.

138

137

The term “uncleared swap margin” is defined in Commission Regulation 23.100 to generally mean the amount of initial margin that a nonbank SD would be required to collect from each counterparty for each outstanding swap position of the nonbank SD. 17 CFR 23.100. A nonbank SD must include all swap positions in the calculation of the uncleared swap margin amount, including swaps that are exempt or excluded from the scope of the Commission's uncleared swap margin regulations. A nonbank SD must compute the uncleared swap margin amount in accordance with the Commission's margin rules for uncleared swaps. 17 CFR 23.154.

138

17 CFR 23.101(a)(1)(i)(D).

See also

2022 Proposal at 48101 and 48104. Commission Regulation 23.101(a)(1)(i) sets forth one of the minimum thresholds that a nonbank SD must meet as the “the amount of capital required by a registered futures association.” As previously noted, NFA is currently the only entity that is a registered futures association. NFA has adopted the Commission's capital requirements as its own requirements, and has not adopted any additional or stricter minimum capital requirements.

See

NFA rulebook, Financial Requirements section 18 Swap Dealer and Major Swap Participant Financial Requirements, available at

nfa.futures.org.

In comparison, the Japanese Capital Rules require each Japanese nonbank SD to maintain a “capital adequacy amount” that equals or exceeds 120 percent of the firm's “risk equivalent amount.”

139

As explained in the 2022 Proposal, the “capital adequacy amount” is calculated as the Japanese nonbank SD's qualifying balance sheet equity capital in the form of Basic Items and Supplemental Items, after deducting the carrying value of fixed assets from both Basic Items and Supplemental Items.

140

The Commission noted that the Japanese Capital Rules further require that at least 50 percent of the Japanese nonbank SD's capital used to meet the 120 percent minimum requirement must be composed of Basic Items, and any subordinated debt included in Supplemental Items must meet regulatory requirements designed to ensure that the debt is adequately subordinated to claims of other potential creditors of the firm.

141

139

See

2022 Proposal at 48103.

140

Id.

141

See

2022 Proposal at 48099 and Article 176(1)(vii) of the COO.

2. Preliminary Determination and Comment Analysis

While noting certain differences in the minimum capital requirements and

calculation of regulatory capital between the Japanese Capital Rules and the CFTC Capital Rules, the Commission preliminarily found that the Japanese Capital Rules and CFTC Capital Rules achieve, subject to the proposed conditions in the proposed Comparability Determination and proposed Comparability Order, comparable outcomes by requiring a nonbank SD to maintain a minimum level of qualifying regulatory capital and subordinated debt to absorb losses from the firm's business activities, including its swap dealing activities, and decreases in the value of the firm's assets and increases in the firm's liabilities without the nonbank SD becoming insolvent.

142

As further discussed below, the Commission's preliminary finding of comparability was based on a principles-based, holistic comparative analysis of the three minimum capital requirement thresholds of the CFTC Capital Rules' Bank-Based Approach referenced above and the respective elements of the Japanese Capital Rules' requirements.

142

See

2022 Proposal at 48104.

a. Fixed Amount Minimum Capital Requirement

As noted above, prong (i) of the CFTC Capital Rules requires each nonbank SD electing the Bank-Based Approach to maintain a minimum of $20 million of common equity tier 1 capital. The Commission's $20 million fixed-dollar minimum capital requirement is intended to ensure that each nonbank SD maintains a level of regulatory capital, without regard to the level of the firm's dealing and other activities, sufficient to meet its obligations to swap market participants given the firm's status as a CFTC-registered nonbank SD, and to help ensure the safety and soundness of the nonbank SD.

143

In contrast, the Japanese Capital Rules do not impose a capital requirement on Japanese nonbank SDs based on a minimum dollar amount.

143

85 FR 57462 at 57492.

The Commission expressed the preliminary view that each CFTC-registered nonbank SD should maintain a minimum level of regulatory capital to help ensure that it satisfies its regulatory obligations and meets its financial commitments to swap counterparties and creditors without the firm becoming insolvent.

144

Accordingly, the Commission proposed to condition the Comparability Order to require each Japanese nonbank SD to maintain, at all times, a minimum level of regulatory capital in the form of Basic Items, as defined in Article 176 of the COO, in an amount denominated in yen that is equivalent to, or greater than, $20 million in U.S. dollars.

145

144

See

2022 Proposal at 48106.

145

Id.

The Commission also proposed to allow a Japanese nonbank SD to convert the yen-denominated amount of its Basic Items to the U.S. dollar equivalent based on a commercially reasonable and observed exchange rate.

One commenter, Better Markets, argued that the absence of a base level requirement in the Japanese Capital Rules that is equivalent to the CFTC Capital Rules' requirement for each nonbank SD to maintain a minimum of $20 million of common equity tier 1 capital “demonstrates a fatal lack of comparability.”

146

Better Markets further asserted that the Commission's proposed condition requiring that Japanese nonbank SDs maintain a minimum level of regulatory capital of at least $20 million inadequately compensates for the gap in the Japanese framework.

147

Specifically, Better Markets argued that by allowing Japanese nonbank SD to meet the proposed minimum capital level with Basic Items, which the Commission preliminarily found to be equivalent to the combination of common equity tier 1 and additional tier 1 capital, instead of limiting the qualifying items to the higher form of common equity tier 1 capital, the Commission would impose a materially weaker capital requirement.

148

146

Better Markets Letter at p. 9.

147

Id.

148

Id.

As noted above, the Commission recognized the difference between the Japanese Capital Rules and the CFTC Capital Rules with respect to the $20 million minimum dollar amount of regulatory capital a nonbank SD is required to maintain. The Commission's proposed condition, however, effectively addresses this difference by providing that a Japanese nonbank SD may not avail itself of substituted compliance unless it maintains a minimum of $20 million of regulatory capital in the form of Basic Items. The imposition of the condition was consistent with the Commission authority under Commission Regulation 23.106(a)(5). Furthermore, as discussed in Section I.E. above, the Commission has stated that entities relying on substituted compliance may be required to comply with certain Commission-imposed requirements in situations where comparable regulations in their home country jurisdiction are deemed to be lacking.

149

Guidance at 45343.

As discussed in Section II.B.2. above, the Commission is also of the view that the Japanese Capital Rules' Basic Items are comparable to the CFTC Capital Rules' common equity tier 1 items in that both categories represent a conservative, permanent form of capital that is last in line to receive distributions in the event of the entity's insolvency. Specifically, the capital that may be recognized by a nonbank SD and Japanese nonbank SD to meet its common equity tier 1 capital requirement and Basic Items requirement, respectively, is generally limited to common stock, related common stock surpluses, and retained earnings. As such, the Commission concludes that the requirement for Japanese nonbank SDs to maintain an amount of regulatory capital in the form of Basic Items equal to or in excess of the equivalent of $20 million will impose a comparable standard to the analogue requirement under the CFTC Capital Rules and will appropriately address the lack of a minimum fixed amount capital requirement under the Japanese Capital Rules.

In conclusion, the Commission finds that the Japanese Capital Rules and the CFTC Capital Rules, with the imposition of the condition for Japanese nonbank SDs to maintain a minimum level of Basic Items in an amount equivalent to at least $20 million, are comparable in purpose and effect and achieve comparable regulatory outcomes with respect to capital requirements based on a minimum dollar amount. The requirement for a nonbank SD with limited swap dealing or other business activities to maintain a minimum level of regulatory capital equivalent to $20 million helps to ensure the firm's safety and soundness by allowing it to absorb decreases in firm assets, absorb increases in firm liabilities, and meet obligations to swap counterparties, other creditors, and market participants, without the firm becoming insolvent.

b. Minimum Capital Requirement Based on Risk-Weighted Assets

Prong (ii) of the CFTC Capital Rules' minimum capital requirements described above requires each nonbank SD electing the Bank-Based Approach to maintain an aggregate of common equity tier 1 capital, additional tier 1 capital, and tier 2 capital in an amount equal to or greater than 8 percent of the nonbank SD's total risk-weighted assets, with common equity tier 1 capital comprising at least 6.5 percent of the 8 percent.

150

Risk-weighted assets are a nonbank SD's on-balance sheet and off-balance sheet exposures, including market risk and credit risk exposures, and include

exposures associated with proprietary swap, security-based swap, equity, and futures positions, weighted according to risk. The requirements and capital ratios set forth in prong (ii) are based on the Federal Reserve Board's capital requirements for bank holding companies

151

and are consistent with the BCBS framework.

152

The requirement for each nonbank SD to maintain regulatory capital in an amount that equals or exceeds 8 percent of the firm's total risk-weighted assets is intended to help ensure that the nonbank SD's level of capital is sufficient to absorb decreases in the value of the firm's assets, absorb increases in the value of the firm's liabilities, and cover unexpected losses resulting from the firm's business activities, including losses resulting from collateralized and uncollateralized defaults from swap counterparties, without the nonbank SD becoming insolvent.

153

150

17 CFR 23.101(a)(1)(i)(B).

151

12 CFR 217.10(a)(1). The minimum capital requirement for a bank holding company under the Federal Reserve Board's rules requires bank holding companies to satisfy their 8 percent minimum capital ratio requirement with a minimum of 4.5 percent of common equity tier 1 capital. The CFTC Capital Rules, however, require a nonbank SD to meet its minimum 8 percent capital ratio with at least 6.5 percent of common equity tier 1 capital. 17 CFR 23.101(a)(1)(i)(B).

152

Risk-based capital requirements RBC20, Calculation of minimum risk-based capital requirements

(Version effective as of 01 January 2023), published by the BCBS and available here:

https://www.bis.org/basel_framework/chapter/RBC/20.htm?inforce=20230101&published=20201126

153

See generally

85 FR 57462 at 57530.

The Japanese Capital Rules contain capital requirements for Japanese nonbank SDs that the Commission preliminarily found comparable in purpose and effect to the requirements in prong (ii) of the CFTC Capital Requirements.

154

Specifically, the Japanese Capital Rules require a Japanese nonbank SD to maintain regulatory capital in an amount equal to or in excess of 120 percent of the firm's risk “risk equivalent amount” (

i.e.,

the firm's risk-weighted assets).

155

A Japanese nonbank SD's “risk equivalent amount” is calculated as the sum of the firm's: (i) market risk equivalent amount (

i.e.,

the amount equivalent to possible risks which may accrue due to fluctuations in the prices of securities and other proprietary assets and transactions held);

156

(ii) counterparty risk equivalent amount (

i.e.,

the amount equivalent to possible risks which may accrue due to the default in performance of contracts by the counterparties to transactions or any other reason);

157

and (iii) basic risk equivalent amount (

i.e.,

the amount equivalent to possible risk which may accrue in the ordinary course of executing business, such as errors in business handling).

158

154

See

2022 Proposal at 48105.

155

See

discussion in 2022 Proposal at 48105. The Japanese Capital Rules require a Japanese nonbank SD to maintain a capital adequacy amount that equals or exceeds 120 percent of its “risk equivalent amount.” Article 46-6(2) of the FIEA, Article 176 of the COO, and section IV-2-1 (Preciseness of Capital Adequacy Ratio) of the Supervisory Guidelines for FIBO.

156

Article 178(1)(i) of the COO and Articles 10 through 14 of the Notice on Capital. The “market risk equivalent amount” corresponds to “market risk” in the CFTC Capital Rules' Bank-Based Approach and the BCBS framework.

157

Article 178(1)(ii) of the COO and Articles 15 through 15-7 of the Notice on Capital. The “counterparty risk equivalent amount” corresponds to “credit risk” in the BCBS and Bank-Based Approach frameworks.

158

Article 178(1)(iii) of the COO and Article 16 of the Notice on Capital.

The Commission also preliminarily found that the Japanese Capital Rules and the CFTC Capital Rules are comparable with respect to the approaches used in the calculation of risk-weighted amounts for market risk and credit risk in determining the nonbank SD's risk-weighted assets.

159

In this connection, the Commission noted that both regimes require a nonbank SD to use standardized approaches to compute market risk and credit risk amounts, unless the firm is approved to use internal models.

160

159

See

2022 Proposal at 48105.

160

Id.

As the Commission observed, the standardized approaches to calculating risk-weighted asset amounts for market risk and credit risk under both the Japanese Capital Rules and the CFTC Capital Rules follow the same structure that is now the common global standard: (i) allocating assets to categories according to risk and assigning each a risk weight; (ii) allocating counterparties according to risk assessments and assigning each a risk factor; (iii) calculating gross exposures based on valuation of assets; (iv) calculating a net exposure allowing offsets following well defined procedures and subject to clear limitations; (v) adjusting the net exposure by the market risk weights; and finally, (vi) for credit risk exposures, multiplying the sum of net exposures to each counterparty by their corresponding risk factor.

161

More specifically, with respect to the calculation of standardized risk-weighted asset amounts for market risk, the Commission explained that the CFTC Capital Rules incorporate by reference the standardized market risk charges set forth in Commission Regulation 1.17 for FCMs and SEC Rule 18a-1 for nonbank security-based swap dealers (“SBSDs”).

162

The standardized market risk charges under Commission Regulation 1.17 and SEC Rule 18a-1 are calculated as a percentage of the market value or notional value of the nonbank SD's assets, including marketable securities and derivatives positions, with the percentages applied to the market value or notional value increasing as the expected or anticipated risk of the positions increases.

163

For example, the CFTC Capital Rules require nonbank SDs to calculate standardized market risk-weighted asset amounts for uncleared swaps based on notional values of the swap positions multiplied by percentages set forth in the applicable rules.

164

In addition, market risk-weighted asset amounts for readily marketable equity securities are calculated by multiplying the fair market value of the securities by 15 percent.

165

162

See

paragraph (3) of the definition of the term

BHC equivalent risk-weighted assets

in 17 CFR 23.100.

163

17 CFR 1.17(c)(5) and 17 CFR 240.18a-1(c)(1).

164

17 CFR 1.17(c)(5)(iii).

165

17 CFR 1.17(c)(5)(v), referencing SEC Rule 15c3-1(c)(2)(vi) (17 CFR 240.15c3-1(c)(2)(vi)).

Under the CFTC Capital Rules, the resulting total market risk-weighted asset amount is multiplied by a factor of 12.5 to cancel the effect of the 8 percent multiplication factor applied to all of the nonbank SD's risk-weighted assets under prong (ii) of the rules' minimum capital requirements described above. As a result, a nonbank SD is effectively required to hold qualifying regulatory capital equal to or greater than 100 percent of the amount of its market risk exposure amount.

166

See

17 CFR 23.100 (definition of

BHC equivalent risk-weighted assets

). As noted, a nonbank SD is required to maintain qualifying capital (

i.e.,

an aggregate of common equity tier 1 capital, additional tier 1 capital, and tier 2 capital) in an amount that equals or exceeds 8 percent of its risk-weighted assets. The regulations, however, require the nonbank SD to effectively maintain qualifying capital equal to or in excess of 100 percent of its market risk-weighted assets by requiring the nonbank SD to multiply its market-risk weighted assets by a factor of 12.5. For example, the market risk exposure amount for marketable equity securities with a current fair market value of $250,000 is $37,500 (market value of $250,000 × .15 standardized market risk factor). The nonbank SD is required to maintain regulatory capital equal to or in excess of full market risk exposure amount of $37,500 (risk exposure amount of $37,500 × 8 percent regulatory capital requirement equals $3,000; the regulatory capital requirement is then multiplied by a factor of 12.5, which effectively requires the nonbank SD to hold regulatory capital in an amount equal to at least 100 percent of the market risk exposure amount ($3,000 × 12.5 factor equals $37,500)).

Comparable to the CFTC Capital Rules, the Japanese Capital Rules

require a Japanese nonbank SD to calculate its standardized market risk equivalent amount by multiplying specified market risk weights set forth in the Japanese Capital Rules by the notional or market value of the relevant assets and positions.

167

A Japanese nonbank SD is further required to include the full value of its market risk equivalent amount in its aggregate risk equivalent amount, which effectively requires the Japanese nonbank SD to hold qualifying equity capital and subordinated debt in an amount that equals or exceeds 120 percent of the market risk equivalent amount.

168

167

See

2022 Proposal at 48103.

168

Id.

Using the example above, if the market risk exposure amount for the equity securities under the Japanese Capital Rules was calculated to be $37,500, the Japanese nonbank SD would be required to hold an amount of regulatory capital equal to or in excess of $45,000 (market risk exposure amount of $37,500 × 120 percent).

With respect to standardized risk-weighted asset amounts for credit risk from non-derivatives positions, the Commission explained that under the CFTC Capital Rules, a nonbank SD must compute its on-balance sheet and off-balance sheet exposures in accordance with the standardized risk-weighting requirements adopted by the Federal Reserve Board and set forth in Subpart D of 12 CFR 217 as if the SD itself were a bank holding company subject to Subpart D.

169

Standardized risk-weighted asset amounts for credit risk are computed by multiplying the amount of the exposure by defined counterparty credit risk factors that range from 0 percent to 150 percent.

170

A nonbank SD with off-balance sheet exposures is required to calculate a risk-weighted asset amount for credit risk by multiplying each exposure by a credit conversion factor that ranges from 0 percent to 100 percent, depending on the type of exposure.

171

169

23.101(a)(1)(i)(B) and paragraph (1) of the definition of the term

BHC equivalent risk-weighted assets

in 17 CFR 23.100.

See also

2022 Proposal at 48102.

170

12 CFR 217.32. Lower credit risk factors are assigned to entities with lower credit risk and higher credit risk factors are assigned to entities with higher credit risk. For example, a credit risk factor of 0 percent is applied to exposures to the U.S. government, the Federal Reserve Bank, and U.S. government agencies (12 CFR 217.32(a)(1)), and a credit risk factor of 100 percent is assigned to an exposure to foreign sovereigns that are not members of the Organization of Economic Co-operation and Development (12 CFR 217.32(a)(2)).

See also

discussion in 2022 Proposal at 48102.

171

12 CFR 217.33.

See also

discussion in 2022 Proposal at 48102.

In comparison, the Commission noted that Japanese Capital Rules require a Japanese nonbank SD to calculate its standardized counterparty risk equivalent amount by multiplying its exposure under a given transaction by the specific risk weight applicable to the counterparty under the provisions of the Japanese Capital Rules.

172

In this regard, the Japanese Capital Rules impose risk weights ranging from 0 percent to 25 percent on exposures to governmental financial institutions, non-governmental financial institutions, general corporations, and individuals.

173

For certain exposures, credit ratings are used to determine the percentage of the counterparty credit risk exposure and, if no credit ratings are available, the Japanese nonbank SD generally applies a 25 percent risk weight.

174

A Japanese nonbank SD is required to include the full amount of the counterparty risk equivalent amount in its aggregate risk equivalent amount.

175

As noted above, a Japanese nonbank SD is also required to maintain a “capital adequacy amount” that equals or exceeds 120 percent of the firm's “risk equivalent amount.” Therefore, a Japanese nonbank SD is effectively required to maintain an amount of qualifying capital that is equal to or in excess of 120 percent of its credit risk equivalent amount.

172

See

2022 Proposal at 48103-48104.

173

Article 15(3) of the Notice on Capital.

See also

discussion in 2022 Proposal at 48104.

174

Id.

175

Id.

With respect to credit risk for derivatives positions, the Commission explained that under the CFTC Capital Rules, a nonbank SD may compute standardized credit risk exposures, using either the current exposure method (“CEM”) or the standardized approach for measuring counterparty credit risk (“SA-CCR”).

176

Both CEM and SA-CCR are non-model, rules-based approaches to calculating counterparty credit risk exposures for derivatives positions. Credit risk exposure under CEM is the sum of: (i) the current exposure (

i.e.,

the positive mark-to-market) of the derivatives contract; and (ii) the potential future exposure, which is calculated as the product of the notional principal amount of the derivatives contract multiplied by a standard credit risk conversion factor set forth in the rules of the Federal Reserve Board.

177

Credit risk exposure under SA-CCR is defined as the exposure at default amount of a derivatives contract, which is computed by multiplying a factor of 1.4 by the sum of: (i) the replacement costs of the contract (

i.e.,

the positive mark-to market); and (ii) the potential future exposure of the contract.

178

176

17 CFR 217.34 and 17 CFR 23.100 (defining the term

BHC risk-weighted assets

and providing that a nonbank SD that does not have model approval may use either CEM or SA-CCR to compute its exposures for over-the-counter derivative contracts without regard to the status of its affiliate with respect to the use of a calculation approach under the Federal Reserve Board's capital rules).

See also

discussion in 2022 Proposal at 48102.

177

12 CFR 217.34.

178

12 CFR 217.132(c).

In comparison, the Japanese Capital Rules require a Japanese nonbank SD that is not approved to use credit risk models to calculate its exposure using the CEM.

179

Under the CEM, a Japanese nonbank SD calculates its exposures for over-the-counter derivatives using a standardized rules-based approach, and is required to hold an amount of qualifying capital that equals or exceeds 120 percent of the aggregate derivatives exposures.

179

See

2022 Proposal at 48104.

As discussed in the 2022 Proposal, both the CFTC Capital Rules and the Japanese Capital Rules also provide that, if approved by NFA or the FSA, respectively, nonbank SDs may also use internal models to calculate market and/or credit risk exposures.

180

The Commission noted that the internal market and credit risk models under the Japanese Capital Rules and the CFTC Capital Rules are based on the BCBS framework and preliminarily found that such models must meet comparable quantitative and qualitative requirements covering the same risks, including comparable model risk management requirements.

181

In this regard, the Commission observed that both rule sets address the same types of risk, with similar allowed methodologies, calibrated to similar risk levels and under similar controls.

182

The Commission also noted that the Japanese Capital Rules and the CFTC Capital Rules contain comparable

requirements for the management of model risk, which depend on a series of controls, including the independence of validation, ongoing monitoring and audit.

180

Id.

at 48102-48104.

181

Id.

For a discussion of the qualitative and quantitative requirements that models must meet under the CFTC Capital Rules and the Japanese Capital Rules,

see

2022 Proposal at 48102-48103 and 48104, respectively. In this context, the Commission notes that, as emphasized by IBAJ, the expected exposure method is the only internal model allowed for purposes of calculating credit risk under the Japanese Capital Rules. IBAJ Letter at pp. 5-6. The Commission had erroneously indicated, in referring to credit risk models under the Japanese Capital Rules, that internal credit risk models can also further include estimation of the likelihood of default of counterparties and that credit risk models may include internal ratings based on the estimation of default probabilities, consistent with the Basel framework and subject to the same model risk management guidelines. 2022 Proposal at 48098 and 48104. The Commission hereby rectifies its summary of the relevant Japanese Capital Rules and specifies that these statements do not apply to credit risk models under the Japanese Capital Rules. The Commission, however, maintains its conclusion that model requirements under the CFTC Capital Rules and the Japanese Capital Rules are comparable.

182

See

2022 Proposal at 48105.

In addition, the Japanese Capital Rules require a Japanese nonbank SD to calculate a basic risk equivalent amount (

i.e.,

an operational risk exposure amount) as a component of the firm's risk equivalent amount. The basic risk equivalent amount is computed as an amount equal to 25 percent of the Japanese nonbank SD's defined annual operating expenses, and is intended to provide a capital cushion to cover risks that may occur in the course of executing ordinary business operations, such as errors in business transactions.

183

Article 178(1)(iii) of the COO and Article 16 of the Notice on Capital.

See also

discussion in 2022 Proposal at 48104.

One commenter, Better Markets, noted that the CFTC Bank-Based Approach requires nonbank SDs to maintain an aggregate of common equity tier 1 capital, additional tier 1 capital, and tier 2 capital equal to or greater than 8 percent of the non-bank SD's total risk-weighted assets, provided that common equity tier 1 capital must comprise at least 6.5 percent of the 8 percent of risk-weighted assets.

184

Better Markets stated that, in contrast, the Japanese Capital Rules require Japanese nonbank SDs to hold capital equal to or greater than 120 percent of their risk-weighted assets, including 50 percent that must be held in Basic Items.

185

Better Markets further asserted that in stating that the 120 percent of risk-weighted assets required by the Japanese capital rules equates to an “effective minimum capital requirement of 9.6 percent of risk-weighted assets,” the Commission did not provide an analysis of how the CFTC calculated that effective minimum and did not disclose how much of the 9.6 percent is held in Basic Items as opposed to Supplementary Items.

186

In Better Markets' view, without this information and analysis, no comparability determination can be made because U.S. nonbank SDs are required to maintain 6.5 percent of the total 8 percent of risk-weighted assets in the highest form of capital, namely common equity tier 1 capital.

187

184

Better Markets Letter at p 9.

185

Id.

at p. 10.

186

Id.

187

Id.

Another commenter, IBAJ, offered a contrasting view, stating that Japanese nonbank SDs must maintain capital equal to 120 percent of market risk, credit risk, and basic risk equivalent amounts and that such amount of capital translated into an effective capital ratio requirement of 9.6 percent of risk weighted assets, which is higher than the 8 percent capital ratio required by the Basel standards or CFTC Capital Rules.

188

As discussed immediately below, the Commission agrees with the IBAJ that the capital ratio required by the Japanese Capital Rules exceeds the capital ratio required by the CFTC Capital Rules under the Bank-Based Approach.

188

IBAJ Letter at p. 2.

In response to the comment asserting that the Commission did not provide an analysis supporting the statement that the Japanese Capital Rules impose on Japanese nonbank SDs “an effective minimum requirement of 9.6 percent of the risk-weighted assets,” the Commission notes that the 9.6 percent figure is intended to express the Japanese minimum capital as a capital ratio in a manner consistent with the CFTC Capital Rules for purposes of a comparison. Specifically, the Japanese Capital Rules require a Japanese nonbank SD to maintain regulatory capital in an amount that equals or exceeds 120 percent of the aggregate of the firm's risk-weighted assets. In contrast, the CFTC Capital Rules require a nonbank SD to maintain a minimum capital ratio to total risk-weighted assets of 8 percent. Converting the Japanese Capital Rules' requirement to an equivalent capital ratio under the CFTC Capital Rules would result in the capital ratio of 8 percent being increased by 20 percent, effectively requiring nonbank SDs to maintain a ratio of total regulatory capital to risk-weighted assets of 9.6 percent (

i.e.,

8 percent plus 20 percent of 8 percent).

189

See

2022 Proposal at 48104 and fn. 125.

In addition, the Japanese Capital Rules' standardized approach to calculating minimum capital requirements also results in a higher regulatory capital requirement for counterparty credit risk. Although the standardized credit risk weights under the Japanese Capital Rules range from 0 to 25 percent, whereas those applicable under the CFTC Capital Rules range from 0 to 150 percent, the Japanese Capital Rules' requirement that Japanese nonbank SDs hold 120 percent of the firm's risk-weighted assets would yield a higher capital requirement. For example, for an exposure that is subject to the highest risk weight for counterparty credit risk, the Japanese Capital Rules would require a Japanese nonbank SD to hold capital equal to 30 percent of the exposure amount (

i.e.,

25 percent risk weight multiplied by 120 percent capital requirement), whereas the CFTC Capital Rules would require a nonbank SD to hold capital equal to 12 percent of the exposure amount (

i.e.,

150 percent risk weight multiplied by 8 percent capital requirement).

Furthermore, the Commission notes that under the Japanese Capital Rules, the total risk-weighted assets include amounts for operational and similar risks arising from a Japanese nonbank SD's activities (

i.e.,

basic risk equivalent amount). These risk-weighted asset amounts are included in the risk equivalent amount in all circumstances, whether the nonbank SD uses a standardized approach or a model approach to calculating risk-weighted assets.

190

As such, the basic risk equivalent amount increases the amount of the risk-weighted assets and thus the amount of regulatory capital that a Japanese nonbank SD is required to maintain. Taking these factors into account in the computation of risk-weighted assets and regulatory capital under the Japanese Capital Rules, the Commission believes that a nonbank SD is generally required to maintain a higher level of regulatory capital under the Japanese Capital Rules than it would be under the CFTC Capital Rules.

190

In contrast, the CFTC Capital Rules do not require nonbank SDs to include an operational risk charge in the firm's risk-weighted assets if the firm uses a standardized approach to calculating risk-weighted asset amounts. An operational risk component is included in the firm's risk-weighted assets only if the firm uses a model to calculate risk-weighted asset amounts for credit risk.

See

definition of

BHC equivalent risk-weighted assets

in Commission Regulation 23.100 (cross referencing subparts E and D of 12 CFR part 217). 17 CFR 23.100.

Moreover, to the extent the Japanese Capital Rules might require a lesser amount of common equity tier 1 capital than the CFTC Capital Rules, the Commission believes that the difference will be generally offset and mitigated by the higher amount of regulatory capital required by the Japanese Capital Rules. Accordingly, the Commission finds that the Japanese Capital Rules and the CFTC Capital Rules are comparable in purpose and effect with respect to the minimum amount of capital and type of capital required by these rules.

In conclusion, the Commission finds that the Japanese Capital Rules and the CFTC Capital Rules are comparable in purpose and effect with respect to the computation of minimum capital requirements based on a nonbank SD's risk-weighted assets. The Commission finds that notwithstanding the differences discussed above, the Japanese Capital Rules and the CFTC Capital rules have a comparable approach to the computation of market

risk exposure amounts and credit risk exposure amounts for on-balance sheet and off-balance sheet exposures, which are intended to achieve comparable regulatory outcomes by ensuring that a nonbank SD maintains a sufficient level of regulatory capital to absorb decreases in firm assets, absorb increases in firm liabilities, and meet obligations to counterparties and creditors, without the firm becoming insolvent.

c. Minimum Capital Requirement Based on the Uncleared Swap Margin Amount

As noted above, prong (iii) of the CFTC Capital Rules' Bank-Based Approach requires a nonbank SD to maintain regulatory capital in an amount equal to or greater than 8 percent of the firm's total uncleared swaps margin amount associated with its uncleared swap transactions to address potential operational, legal, and liquidity risks.

191

More specifically, in establishing the requirement that a nonbank SD must maintain a level of regulatory capital in excess of 8 percent of the uncleared swap margin amount associated with the firm's swap transactions, the Commission stated that the intent of the uncleared swap margin amount was to establish a method of developing a minimum amount of capital for a nonbank SD to meet its obligations as an SD to market participants, and to cover potential operational risk, legal risk and liquidity risk, and not just the risks of its trading portfolio.

See

85 FR 57462 at 57485.

The Japanese Capital Rules differ from the CFTC Capital Rules in that they do not impose a capital requirement on Japanese nonbank SDs based on a percentage of the margin for uncleared swap transactions.

192

In the 2022 Proposal, the Commission described, however, how certain Japanese capital and liquidity requirements may compensate for the lack of direct analogue to the 8 percent uncleared swap margin amount requirement.

193

Specifically, the Commission noted that under the Japanese Capital Rules the risk equivalent amount (

i.e.,

the firm's risk-weighted assets) is calculated as the sum of the market risk equivalent amount, the counterparty risk equivalent amount, and the basic risk equivalent amount.

194

As discussed, the basic risk equivalent amount is computed as an amount equal to 25 percent of the Japanese nonbank SD's defined annual operating expenses, and is intended to provide a capital cushion to cover risks that may accrue in the course of executing ordinary business operations, such as errors in business transactions.

195

In addition, the Japanese Capital Rules require a Japanese nonbank SD to deduct the carrying value of fixed assets from its Basic Items and Supplemental Items in computing its regulatory capital, which promotes a degree of liquidity into the Japanese nonbank SD's regulatory capital by requiring assets that are more liquid than fixed assets to support the Basic Items and Supplemental Items that are used to meet the Japanese nonbank SD's minimum capital requirement. As stated in the 2022 Proposal, the Commission preliminarily determined that the inclusion of an operational risk charge as a separate component of the risk equivalent amount, including by Japanese nonbank SDs that do not use internal models, and the deduction of the carrying value of fixed assets from regulatory capital, would achieve a comparable outcome to the Commission's requirement for nonbank SDs to hold regulatory capital in excess of 8 percent of its uncleared swap margin amount.

196

192

See

2022 Proposal at 48104.

193

Id.

at 48105.

194

Article 178(1)(iii) of the COO and Article 16 of the Notice on Capital. The basic risk equivalent amount is calculated as 25 percent of certain defined operating expenses incurred by the Japanese nonbank SD over a 12-month period, and includes general expenses, selling expenses, and financial expenses.

195

See

2022 Proposal at 48105.

196

Id.

Focusing on the absence of a capital requirement based on a percentage of the margin for uncleared swap transactions under the Japanese Capital Rules, Better Markets asserted that the Japanese Capital Rules are not only different from the CFTC Capital Rules in form and substance, but lead to a regulatory outcome that is not comparable.

197

In support, Better Markets noted that, whereas the CFTC relies on an approach that requires nonbank SDs to hold qualifying capital in an amount equal to at least 8 percent of the nonbank SD's uncleared swap margin amount, the Japanese Capital Rules are based on “an arbitrary percentage of a company's operating expenses, which would be closer in concept to liquidity needs.”

198

197

Better Markets Letter at p. 7.

198

Id.

Other commenters agreed with the Commission's preliminary determination that the Japanese Capital Rules and CFTC Capital Rules are comparable notwithstanding the absence in the Japanese Capital Rules of a capital requirement based on uncleared swap margin.

199

In this regard, FSA asserted that the Japanese Capital Rules are largely comparable in outcome even in the absence of the uncleared swap margin requirement because the Japanese capital adequacy ratio takes into account operational risk.

200

199

Associations Letter at p. 2; FSA Letter at p. 1; IBAJ Letter at p. 2.

200

FSA Letter at p. 1.

The Associations and IBAJ expressed the view that the Japanese Capital Rules are comparable in purpose and effect to the Commission's requirements for a nonbank SD to hold regulatory capital equal to or greater than 8 percent of its uncleared swap margin amount.

201

The commenters explained that under the Japanese Capital Rules, liquidity risk is covered through the deduction of the balance sheet carrying value of fixed assets, and operational risk and legal risk are covered by the basic risk equivalent amount, which is a simplified but conservative approach to calculating a proxy for operational risks under the Basel standards.

202

Under the approach, basic risk is incrementally added to market risk and credit risk, which further increases the required capital amount under the Japanese Capital Rules.

203

The commenters further explained that the Japanese Capital Rules' basic risk equivalent amount is computed as an amount equal to 25 percent of the Japanese nonbank SD's defined annual operating expenses, and is intended to provide a capital cushion to cover risk that may accrue in the course of executing ordinary business operations, such as errors in business transactions.

204

According to the commenters, such amount combined with market risk, credit risk, and the deduction of the carrying value of fixed assets will broadly capture obligations to market participants, potential operational risk, legal risk, and liquidity risk, as well as market risk and credit risk.

205

The commenters further noted that the calculation will capture both the trading portfolio as well as non-trading assets, whereas the CFTC's requirement to hold 8 percent of nonbank SD's uncleared swap margin amount will not capture non-trading assets.

206

As such, the commenters concluded that the Japanese Capital Rules' basic risk equivalent requirement is sufficiently comparable to the CFTC Capital Rules' uncleared swap margin requirement.

207

201

Associations Letter at p. 2; IBAJ Letter at p. 2.

202

Id.

203

Id.

204

Associations Letter at p. 3; IBAJ Letter at p. 3.

205

Id.

206

Id.

207

Id.

The Commission believes that the Japanese Capital Rules' approach to calculating the basic risk equivalent amount, which accounts for operational risk and legal risk, and the deduction of the balance sheet carrying value of fixed

assets to reflect liquidity risk, support the comparability of the Japanese Capital Rules and the CFTC Capital Rules even in the absence of a separate capital requirement in the Japanese Capital Rules requiring Japanese nonbank SDs to have qualified capital equal to or greater than 8 percent of the amount of uncleared swap margin.

In conclusion, the Commission finds that the Japanese Capital Rules and the CFTC Capital Rules are comparable in purpose and effect with respect to the requirement that a nonbank SD's minimum level of regulatory capital reflects potential operational risk exposures in addition to market risk and credit risk exposures. The Commission emphasizes that the intent of the minimum capital requirement based on a percentage of the nonbank SD's uncleared swap margin is to establish a minimum capital requirement that would help ensure that the nonbank SD meets its obligations as an SD to market participants, and to cover potential operational risk, legal risk, and liquidity risk in addition to the risks associated with its trading portfolio.

208

The Commission further notes that the minimum capital requirement based on a percentage of the nonbank SD's uncleared swap margin amount was conceived as a proxy, not an exact measure, for inherent risk in the SD's positions and operations, including operational risk, legal risk, and liquidity risk.

209

As the Commission noted in adopting the CFTC Capital Rules, although the amount of capital required of a nonbank SD under the uncleared swap margin calculation is directly related to the volume, size, complexity, and risk of the covered SD's positions, the minimum capital requirement is intended to cover a multitude of potential risks faced by the SD.

210

The Commission understands that other jurisdictions may adopt alternative measures to cover the same risks. In this regard, the Japanese Capital Rules address comparable risks albeit not through a requirement based on a Japanese nonbank SD's uncleared swap margin amount. Specifically, Japanese nonbank SDs are required to maintain a minimum level of regulatory capital based on an aggregate of the firm's total risk-weighted asset exposure amounts for market risk, credit risk, and operational risk. The Commission further notes that a Japanese nonbank SD is required to maintain regulatory capital in an amount that exceeds 120 percent of the total risk-weighted assets, which is 20 percent higher than the CFTC Capital Rules. Accordingly, the Commission has determined that, notwithstanding the differences in approaches, the Japanese Capital Rules and CFTC Capital Rules are comparable in purpose and effect, and achieve comparable regulatory outcomes, by requiring nonbank SDs to maintain a sufficient minimum level of regulatory capital to addresses potential market risk, credit risk, and operational risk, and to help ensure the safety and soundness of the firm by requiring it to hold capital to absorb decreases in firm assets, absorb increases in firm liabilities, and meet its obligations to counterparties and creditors, without the firm becoming insolvent.

208

See

2022 Proposal at 48102 (referencing 85 FR 57462).

209

85 FR 57462 at 57497.

210

85 FR 57462 at 57485 and 57497.

3. Final Determination

Based on its analysis of comments and its holistic assessment of the respective requirements discussed in Section II.C.2.a., b., and c. above, the Commission adopts the Comparability Determination and Comparability Order as proposed with respect to the minimum capital requirements and calculation of regulatory capital, subject to the condition that Japanese nonbank SDs must maintain a minimum level of regulatory capital in the form of Basic Items that equals or exceeds the equivalent of $20 million U.S. dollars.

D. Nonbank Swap Dealer Financial Reporting Requirements

1. Proposed Determination

The Commission detailed the requirements of the CFTC Financial Reporting Rules in the 2022 Proposal.

211

Specifically, the 2022 Proposal notes that the CFTC Financial Reporting Rules require nonbank SDs to file with the Commission and NFA periodic unaudited and annual audited financial reports.

212

The unaudited financial reports must include: (i) a statement of financial condition; (ii) a statement of income/loss; (iii) a statement demonstrating compliance with, and calculation of, the applicable regulatory minimum capital requirement; (iv) a statement of changes in ownership equity; (v) a statement of changes in liabilities subordinated to claims of general creditors; and (vi) such further material information necessary to make the required statements not misleading.

213

The annual audited financial reports must include the same financial statements that are required to be included in the unaudited financial reports, and must further include: (i) a statement of cash flows; (ii) appropriate footnote disclosures; and (iii) a reconciliation of any material differences between the financial statements contained in the annual audited financial reports and the financial statements contained in the unaudited financial reports prepared as of the nonbank SD's year-end date.

214

In addition, a nonbank SD must attach to each unaudited and audited financial report an oath or affirmation that to the best knowledge and belief of the individual making the affirmation the information contained in the financial report is true and correct.

215

The individual making the oath or affirmation must be a duly authorized officer if the nonbank SD is a corporation, or one of the persons specified in the regulation for business organizations that are not corporations.

216

211

2022 Proposal at 48106-48107.

212

Id.

and 17 CFR 23.105(d) and (e).

213

Id.

and 17 CFR 23.105(d)(2).

214

Id.

and 17 CFR 23.105(e)(4).

215

Id.

and 17 CFR 23.105(f).

216

Id.

The CFTC Financial Reporting Rules also require a nonbank SD to file the following financial information with the Commission and NFA on a monthly basis: (i) a schedule listing the nonbank SD's financial positions reported at fair market value;

217

(ii) schedules showing the nonbank SD's counterparty credit concentration for the 15 largest exposures in derivatives, a summary of its derivatives exposures by internal credit ratings, and the geographic distribution of derivatives exposures for the 10 largest countries;

218

and (iii) for nonbank SDs approved to use internal capital models, certain model metrics, such as aggregate value-at-risk (“VaR”) and counterparty credit risk information.

219

217

Id.

and 17 CFR 23.105(l) and Schedule 1 of Appendix B to Subpart E of part 23 (“Schedule 1”). Schedule 1 includes a nonbank SD's holding of U.S Treasury securities, U.S. government agency debt securities, foreign debt and equity securities, money market instruments, corporate obligations, spot commodities, and cleared and uncleared swaps, security-based swaps, and mixed swaps in addition to other position information.

218

Id.

and schedules 2, 3 and 4, respectively, of Commission Regulation 23.105(l). 17 CFR 23.105(l).

219

Id.

and 17 CFR 23.105(k) and (l), and appendix B to Subpart E of part 23.

The CFTC Financial Reporting Rules further require a nonbank SD to provide the Commission and NFA with information regarding the custodianship of margin for uncleared swap transactions (“Margin Report”).

220

The Margin Report must contain: (i) the name and address of each custodian holding initial margin or variation margin on behalf of the nonbank SD or

its swap counterparties; (ii) the amount of initial and variation margin required by the uncleared margin rules held by each custodian on behalf of the nonbank SD and on behalf its swap counterparties; and (iii) the aggregate amount of initial margin that the nonbank SD is required to collect from, or post with, swap counterparties for uncleared swap transactions subject to the uncleared margin rules.

221

220

Id.

and 17 CFR 23.105(m).

221

Id.

A nonbank SD electing the Bank-Based Capital Approach is required to file the unaudited financial report, Schedule 1, schedules of counterparty credit exposures, and the Margin Report with the Commission and NFA no later than 17 business days after the applicable month end reporting date.

222

A nonbank SD must file its annual report with the Commission and NFA no later than 60 calendar days after the end of its fiscal year.

223

222

Id.

223

Id.

The 2022 Proposal also detailed relevant financial reporting requirements of the Japanese Financial Reporting Rules.

224

The Japanese Financial Reporting Rules require a Japanese nonbank SD to submit monthly monitoring survey reports (“Monthly Monitoring Report”) to the FSA.

225

The Monthly Monitoring Report must include information on the Japanese nonbank SD's capital adequacy ratio, and the status of the firm's business operations and accounting (including a balance sheet and profit/loss statement), market risk, counterparty risk, operational risk, and liquidity risk.

226

The Monthly Monitoring Report are typically submitted by a Japanese nonbank SD within two to three weeks of the end of each month.

227

224

2022 Proposal at 48106-48110.

225

Id.

and section II-1-4 (General Supervisory Process) of the Supervisory Guidelines for FIBO, which directs the FSA as part of its offsite monitoring to require FIBOs (including the Japanese nonbank SDs) to submit a monitoring survey report regarding the following matters: capital adequacy ratio, status of business operations and accounting (including a balance sheet and profit and loss statement), status of segregated management of customer assets, market risk, counterparty risk, operational risk, and liquidity risk. The FSA has, pursuant to Article 56-2(1) of the FIEA, ordered the Japanese nonbank SDs to submit monthly monitoring reports to the FSA.

226

Id.

227

The Commission noted that there are various types of reports which are required of the Japanese nonbank SDs under “Reporting orders” issued by the FSA in accordance with Article 56-2(1) of the FIEA. Some of these reports are required to be submitted on a monthly basis, whereas other reports are required to be submitted on a quarterly basis, semi-annual basis, or annual basis. The FSA typically does not set a specific filing deadline and instead requests all reports to be submitted “without delay.” In case of monthly reports, the normal practice is for firms to submit such reports within two to three weeks from the prior month-end.

A Japanese nonbank SD is also required to submit a business report to the Commissioner of the FSA within three months of the end of the firm's fiscal year (“Annual Business Report”).

228

The Annual Business Report must include a balance sheet, profit/loss statement, statement of changes in shareholders' equity, balance of subordinated debt, and a statement of capital adequacy ratio.

229

Furthermore, a Japanese nonbank SD is required to prepare financial statements and business reports every business year pursuant to the Japanese Companies Act (“Annual Audited Financial Report”).

230

The Annual Audited Financial Report includes the firm's balance sheet, profit/loss statement, and statement of changes in shareholders' equity, and such statements are required to be audited by an accounting auditor.

231

The Annual Audited Financial Report must be submitted to, and approved by, the shareholders at a meeting within three months of the Japanese nonbank SD's fiscal year-end.

232

228

2022 Proposal at 48107 and Article 46-3(1) of the FIEA and Article 172 of the COO.

229

2022 Proposal at 48107 and Appended Forms No. 12 of the COO.

230

2022 Proposal at 48107 and Japanese Companies Act (Act No. 86 of 2005).

231

2022 Proposal at 48107 and Article 328(1) and (2), Article 435(2), and 436(2)(i) of the Companies Act, and Article 59 of the Rules of Corporate Accounting (Ordinance of the Ministry of Justice No. 13 of 2006). The audit requirement applies to a “Large Company,” which is defined by Article 2(vi) of the Companies Act as a stock company that satisfies any of the following requirements: (i) that the amount of stated capital in the balance sheet as of the end of the firm's most recent business year is JPY 500 million or more; or (ii) that the total sum of the liabilities section of the balance sheet as of the end of the firm's most recent business year is JPY 20 billion or more. The FSA has represented that each of the current CFTC-registered Japanese nonbank SDs is a Large Company under the Companies Act, and is subject to the audit requirement for its financial statements. FSA Application p. 18.

232

Id.

Based on its review of the FSA Application and the relevant Japanese laws and regulations, the Commission preliminarily determined that, subject to the conditions specified in the 2022 Proposal and discussed below, the Japanese Financial Reporting Rules are comparable to CFTC Financial Reporting Rules in purpose and effect.

233

The Commission noted that both sets of rules provide the FSA and the Commission with financial information necessary to monitor a nonbank SD's compliance with capital requirements and to assess a nonbank SD's overall safety and soundness. Specifically, both CFTC Financial Reporting Rules and the Japanese Financial Reporting Rules require a nonbank SD to file statements of financial condition, statements of profit and loss, and statements of regulatory capital that, collectively, provide information for the FSA, Commission, and NFA to assess a nonbank SD's overall ability to absorb decreases in the value of firm assets, absorb increases in the value of firm liabilities, and cover losses from business activities, including swap dealing activities, without the firm becoming insolvent.

234

233

See

2022 Proposal at 48106-48110.

234

Id.

The proposed conditions in the proposed Comparability Order were intended to ensure that the Commission and NFA receive appropriate and timely financial information from Japanese nonbank SDs in order to monitor the firms' compliance with FSA capital requirements and to assess the firms' overall safety and soundness. The proposed conditions would require a Japanese nonbank SD to provide the Commission and NFA with copies of its Monthly Monitoring Repor

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