CFTC Staff issues no-action relief to swap dealers for the timing of the posting and collection of variation margin from certain counterparties operating in Japan

Summary: CFTC Staff issues no-action relief to swap dealers for the timing of the posting and collection of variation margin from certain counterparties operating in Japan

CFTC Seal

U.S. COMMODITY FUTURES TRADING COMMISSION

Three Lafayette Centre

1155 21st Street, NW, Washington, DC 20581

Telephone: (202) 418-5326

eflaherty@cftc.gov

Division of Swap Dealer and

Intermediary Oversight

Eileen T. Flaherty

Director

CFTC Letter No. 17-13

No-Action

February 23, 2017

Division of Swap Dealer and Intermediary Oversight

Re:

Commission Regulation 23.153: Time-Limited No-Action Position for the Timing of

the Posting and Collection of Variation Margin from Certain Counterparties

Operating in Japan

Ladies and Gentlemen:

This letter is in response to a request dated February 14, 2017, for a no-action position received

by the Division of Swap Dealer and Intermediary Oversight (“DSIO”) of the U.S. Commodity

Futures Trading Commission (“Commission” or “CFTC”) from the International Swaps and

Derivatives Association (Japan) (“ISDA Japan”) on behalf of its members that are swap dealers

(“SDs”)1 registered with the Commission and subject to the Commission’s rules regarding mar­

gin requirements for uncleared swaps.2

Specifically, ISDA Japan requested relief for SDs that are subject to the uncleared swap margin

requirements of both the CFTC and the Financial Services Agency of Japan (“JFSA”) from the

CFTC’s requirement under Commission Regulation 23.1533 to post and collect variation margin

1 Although the relief contained herein was requested by ISDA (Japan) on behalf of its members that are

SDs, such relief

ecifically, ISDA Japan requested relief for SDs that are subject to the uncleared swap margin

requirements of both the CFTC and the Financial Services Agency of Japan (“JFSA”) from the

CFTC’s requirement under Commission Regulation 23.1533 to post and collect variation margin

1 Although the relief contained herein was requested by ISDA (Japan) on behalf of its members that are

SDs, such relief is available to all SDs that are subject to Japan’s uncleared OTC derivative margin re­

quirements.

2 The Commission’s margin requirements for uncleared swaps apply only to SDs and major swap partici­

pants for which there is not a prudential regulator. See 7 U.S.C. 6s(e)(1)(B). SDs and major swap partici­

pants for which there is a prudential regulator must meet the margin requirements for uncleared swaps

established by the applicable prudential regulator. 7 U.S.C. 6s(e)(1)(A). See also 7 U.S.C. 1a(39) (defining

the term “Prudential Regulator” to include the Board of Governors of the Federal Reserve System; the Of­

fice of the Comptroller of the Currency; the Federal Deposit Insurance Corporation; the Farm Credit Ad­

ministration; and the Federal Housing Finance Agency). The Prudential Regulators published final mar­

gin requirements in November 2015. See Margin and Capital Requirements for Covered Swap Entities, 80

FR 74840 (Nov. 30, 2015).

3 17 CFR § 23.153.

from certain financial counterparties within one business day of the execution of an uncleared

swap and on a daily basis thereafter.

I.

Regulatory Background

A.

CFTC Margin Rule

Pursuant to section 4s(e) of the Commodity Exchange Act (“CEA”), the Commission is required

to promulgate margin requirements for uncleared swaps applicable to each SD and MSP for

which there is no Prudential Regulator (collectively, “Covered Swap Entities” or “CSEs”)

Margin Rule

Pursuant to section 4s(e) of the Commodity Exchange Act (“CEA”), the Commission is required

to promulgate margin requirements for uncleared swaps applicable to each SD and MSP for

which there is no Prudential Regulator (collectively, “Covered Swap Entities” or “CSEs”). On

January 6, 2016, the Commission published margin requirements for such CSEs (“CFTC Mar­

gin Rule”).4

The CFTC Margin Rule requires SDs to exchange variation margin with CFTC-registered SDs

and MSPs, as well as financial end users, on or before the business day after execution of an un­

cleared swap with those counterparties.5 Further, SDs must continue to calculate and exchange

variation margin on a daily basis until the swap is terminated or expires (the timing of such re­

quired exchange together with the timing of the first required exchange of variation margin after

execution, “T+1”).6

B.

JFSA Margin Rules

Variation Margin with Counterparties Operating in Japan

Page 2

Japan’s margin requirements for over-the-counter derivatives (“OTC derivatives”) are governed

by the Financial Instruments and Exchange Act, the Cabinet Office Ordinance on Financial In­

struments Business, and various JFSA public notices (collectively, “JFSA FIEA”).7 The entities

subject to the JFSA FIEA include, but are not limited to, certain types of Financial Instruments

Business Operators and Registered Financial Institutions (collectively, “JFSA Covered Enti­

4 See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 FR

636 (Jan. 6, 2016) (“CFTC Margin Rule”). The CFTC Margin Rule is codified in part 23 of the Commis­

sion’s regulations

to the JFSA FIEA include, but are not limited to, certain types of Financial Instruments

Business Operators and Registered Financial Institutions (collectively, “JFSA Covered Enti­

4 See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 FR

636 (Jan. 6, 2016) (“CFTC Margin Rule”). The CFTC Margin Rule is codified in part 23 of the Commis­

sion’s regulations. See §§ 23.150-159, 161. The Commission’s regulations are found in Chapter 17 of the

Code of Federal Regulations, 17 CFR 1 et. seq.

5 See 17 CFR § 23.153(a); see also 17 CFR § 23.150 for the definition of “financial end user.”

6 See 17 CFR § 23.153(b).

7 See Financial Instruments and Exchange Act, No. 25 of 1948, as amended; Cabinet Office Ordinance on

Financial Instruments Business (Cabinet Office Ordinance No. 52 of August 6, 2007) (“FIB Ordi­

nance”); JFSA Public Notification No.15 of March 31, 2016; JFSA Public Notification No.16 of March 31,

2016; and JFSA Public Notification No.17 of March 31, 2016.

ties”).8 Additionally, the JFSA has published supervisory guidelines that supplement the content

and scope of the JFSA FIEA (“JFSA Supervisory Guidelines”).9

The JFSA FIEA requires JFSA Covered Entities to exchange variation margin with other JFSA

Covered Entities that exceed a minimum trading volume threshold (“Variation Margin Thresh-

10

11

old”)

as soon as practicable after the execution of an OTC derivative. Thereafter, JFSA Cov-

ered Entities must continue to calculate variation margin on a daily basis, and exchange variation

12

margin as soon as practicable

equires JFSA Covered Entities to exchange variation margin with other JFSA

Covered Entities that exceed a minimum trading volume threshold (“Variation Margin Thresh-

10

11

old”)

as soon as practicable after the execution of an OTC derivative. Thereafter, JFSA Cov-

ered Entities must continue to calculate variation margin on a daily basis, and exchange variation

12

margin as soon as practicable.

However, as represented by ISDA (Japan), SDs are not required to comply with the JFSA FIEA

with certain counterparties operating in Japan, such as those whose OTC derivatives activities

fall below the Variation Margin Threshold or counterparties that are not JFSA Covered Entities

(such entities are hereinafter referred to as “Supervised Counterparties”). Nevertheless, SDs

entering into transactions with Supervised Counterparties are subject to the JFSA Supervisory

Guidelines, which require the establishment of an appropriate risk management system in ac­

cordance with relevant margin requirements under the JFSA FIEA and BCBS/IOSCO framework

except that variation margin must be calculated and exchanged “with sufficient frequency” as

determined by the counterparties, rather than the more stringent “as soon as practicable” standard

under the JFSA FIEA.13

C.

Japan Comparability Determination

Variation Margin with Counterparties Operating in Japan

Page 3

On September 15, 2016, the Commission published the Japan Comparability Determination,

which found that, with the exception of inter-affiliate swap requirements, the JFSA FIEA is com­

8 Specifically, the JFSA FIEA applies to: (i) Type 1 Financial Instruments Business Operators (“FIBOs”);

Variation Margin with Counterparties Operating in Japan

Page 3

On September 15, 2016, the Commission published the Japan Comparability Determination,

which found that, with the exception of inter-affiliate swap requirements, the JFSA FIEA is com­

8 Specifically, the JFSA FIEA applies to: (i) Type 1 Financial Instruments Business Operators (“FIBOs”);

(ii) banks that are Registered Financial Institutions (“RFIs”); (iii) insurance companies that are RFIs; (iv)

trust accounts that are either FIBOs or RFIs; (v) Shoko Chukin Bank; (vi) the Development Bank of Ja­

pan; (vii) Shinkin Central Bank; and (viii) Norinchukin Bank.

9 See e.g., Comprehensive Guideline for Supervision of Major Banks, Comprehensive Guidelines for Su­

pervision of Regional Financial Institutions, Comprehensive Guideline for Supervision of Cooperative Fi­

nancial Institutions, Comprehensive Guideline for Supervision of Financial Instruments Business Opera­

tors, etc., Comprehensive Guidelines for Supervision of Insurance Companies, and Comprehensive Guide­

lines for Supervision of Trust Companies.

10 In general, a JFSA Covered Entity has exceeded the Variation Margin Threshold if the average total

amount of the notional principal of its OTC derivatives for a one‐year period from April two years before

the year in which calculation is required (or one year if calculated in December) exceeds JPY 300 billion

(approximately $2.7 billion).

11 See FIB Ordinance, Article 123(1)(xxi)-5(a)-(c). The JFSA has represented to the Commission that, as a

supervisory matter, it would expect most entities subject to the JFSA FIEA to collect margin within one to

two business days, with some flexibility for cross-border transactions. The JFSA also represented that Ja­

pan has committed to moving towards a T+1 settlement of financial instruments by 2018. See Compara­

bility Determination for Japan: Margin Requirements for Uncleared Swaps for Swap Dealers and Major

Swap Participants, 81 FR 63376, 63386 (Sept

to the JFSA FIEA to collect margin within one to

two business days, with some flexibility for cross-border transactions. The JFSA also represented that Ja­

pan has committed to moving towards a T+1 settlement of financial instruments by 2018. See Compara­

bility Determination for Japan: Margin Requirements for Uncleared Swaps for Swap Dealers and Major

Swap Participants, 81 FR 63376, 63386 (Sept. 15, 2016) (“Japan Comparability Determination”).

12 See FIB Ordinance, Article 123(1)(xxi)-5(a)-(c).

13 See JFSA Supervisory Guidelines at IV-2-4(4)(i).

parable to the CFTC Margin Rule.14 Accordingly, where a transaction is subject to the margin

rules of both jurisdictions, an SD may choose to comply with the JFSA FIEA in place of the

CFTC Margin Rule. Given that the Commission has not made a comparability determination for

the JFSA Supervisory Guidelines, substituted compliance is not available for transactions involv­

ing Supervised Counterparties.

II.

Summary of Request for Relief

In its letter dated February 14, 2017, ISDA Japan acknowledged that transactions that are subject

to the JFSA Supervisory Guidelines, rather than the JFSA FIEA, only require variation margin to

be calculated and exchanged with “sufficient frequency,” as determined by the counterparties.

SDs in Japan are encountering regulatory compliance challenges with respect to the requirements

under the CFTC Margin Rule pertaining to the timeframe in which variation margin must be col­

lected and/or posted under § 23.153(a) and § 23.153(b).

Specifically, as mentioned in the Japan Comparability Determination, transactions in Japanese

Government Bonds (‘‘JGBs”) currently settle in 2 or 3 business days

an are encountering regulatory compliance challenges with respect to the requirements

under the CFTC Margin Rule pertaining to the timeframe in which variation margin must be col­

lected and/or posted under § 23.153(a) and § 23.153(b).

Specifically, as mentioned in the Japan Comparability Determination, transactions in Japanese

Government Bonds (‘‘JGBs”) currently settle in 2 or 3 business days. While the timing of mar­

gin collection and posting is expected to naturally shorten over a relatively brief period of time

and become T+1 for JGBs by 2018, smaller institutions and funds may need additional time to

become capable of settling JGBs on a T+1 basis due to operational or other infrastructure con­

straints. If JGBs become ineligible for use as collateral by Supervised Counterparties whenever

the CFTC Margin Rule is applicable, the market will lose a safe and highly liquid form of eligi­

ble collateral, perhaps increasing certain types of risk.

ISDA Japan further noted that dual SDs/JFSA Covered Entities act as primary liquidity providers

for non-JPY instruments in the Japanese market. ISDA Japan also represented that some Super­

vised Counterparties may find it operationally difficult to calculate and exchange variation mar­

gin on a daily basis. Accordingly, ISDA Japan stated that, absent a no-action position from

DSIO, dual SDs/JFSA Covered Entities may have to discontinue trading with Supervised Coun­

terparties, potentially leading to substantial losses for such counterparties.

When the Commission adopted the CFTC Margin Rule, it stated that “the daily exchange of var­

iation margin is an important risk mitigant” that is also reflective of current market practices.15

DSIO acknowledges, however, that daily variation margin exchange does not reflect the current

market practices in Japan for all transactions involving Supervised Counterparties.

III

ounterparties.

When the Commission adopted the CFTC Margin Rule, it stated that “the daily exchange of var­

iation margin is an important risk mitigant” that is also reflective of current market practices.15

DSIO acknowledges, however, that daily variation margin exchange does not reflect the current

market practices in Japan for all transactions involving Supervised Counterparties.

III.

DSIO No-Action Position

Variation Margin with Counterparties Operating in Japan

Page 4

Based on the foregoing, DSIO believes that a time-limited no-action position is warranted. Ac­

cordingly, DSIO will not recommend an enforcement action against an SD that is a dual

SD/JFSA Covered Entity for failure to comply with the variation margin posting and collection

14 See Japan Comparability Determination, 81 FR at 63386.

15 See CFTC Margin Rule at 665.

Variation Margin with Counterparties Operating in Japan

Page 5

timing requirements of Commission Regulation 23.153(a) and (b) with respect to an uncleared

swap with a Supervised Counterparty, subject to the following conditions:

(1)

Subject to any minimum transfer amount not exceeding the amount permitted under

Commission Regulation 23.153(c),16 the SD posts or collects any variation margin

amount required pursuant to Commission Regulation 23.153(a),17 within three business

days of the execution of the uncleared swap (“T+3”);

to an uncleared

swap with a Supervised Counterparty, subject to the following conditions:

(1)

Subject to any minimum transfer amount not exceeding the amount permitted under

Commission Regulation 23.153(c),16 the SD posts or collects any variation margin

amount required pursuant to Commission Regulation 23.153(a),17 within three business

days of the execution of the uncleared swap (“T+3”);

(2)

Subject to any minimum transfer amount not exceeding the amount permitted under

Commission Regulation 23.153(c), the SD posts or collects any variation margin amount

required pursuant to Commission Regulation 23.153(b)18 at least T+3 until the uncleared

swap is terminated or expires;

(3)

The SD uses its best efforts to comply with the T+1 requirement of Commission Regula­

tion 23.153(a) and (b) for transactions with Supervised Counterparties as soon as possi­

ble; and

(4)

No later than March 1, 2020, the SD complies with the T+1 requirement of Commission

Regulation 23.153(a) and (b) for all transactions with Supervised Counterparties.

This letter, and the positions taken herein, represent the views of DSIO and do not necessarily

represent the positions or views of the Commission or of any other office or division of the

Commission. The relief issued by this letter does not excuse persons relying on it from compli­

ance with any other applicable requirements contained in the CEA or in the Regulations issued

16 See 17 CFR § 23.153(c), stating:

Minimum transfer amount. A covered swap entity is not required to collect or to post

variation margin pursuant to §§ 23.150 through 23.161 with respect to a particular coun­

terparty unless and until the combined amount of initial margin and variation margin

that is required pursuant to §§ 23.150 through 23.161 to be collected or posted and that

has not been collected or posted with respect to the counterparty is greater than

$500,000.

17 See 17 CFR § 23.153(a), stating:

Initial obligation

in pursuant to §§ 23.150 through 23.161 with respect to a particular coun­

terparty unless and until the combined amount of initial margin and variation margin

that is required pursuant to §§ 23.150 through 23.161 to be collected or posted and that

has not been collected or posted with respect to the counterparty is greater than

$500,000.

17 See 17 CFR § 23.153(a), stating:

Initial obligation. On or before the business day after the day of execution of an un­

cleared swap between a covered swap entity and a counterparty that is a swap entity or a

financial end user, the covered swap entity shall collect the variation margin amount from

the counterparty when the amount is positive, or post the variation margin amount with

the counterparty when the amount is negative as calculated pursuant to § 23.155 and in a

form that complies with § 23.156.

18 See 17 CFR § 23.153(b), stating:

Continuing obligation. The covered swap entity shall continue to collect the variation

margin amount from, or to post the variation margin amount with, the counterparty as

calculated each business day pursuant to § 23.155 and in a form that complies with

§ 23.156 each business day until such uncleared swap is terminated or expires.

Variation Margin with Counterparties Operating in Japan

Page 6

thereunder. This letter does not create or confer any rights or obligations on any person or per­

sons subject to compliance with the CEA that bind the Commission or any of its other offices or

divisions. As with all no-action letters, DSIO retains the authority to condition further, modify,

suspend, terminate, or otherwise restrict the terms of the no-action relief provided herein, at its

discretion.

Should you have any questions, please do not hesitate to contact me at (202) 418-5326 or Frank

Fisanich, Chief Counsel, at (202) 418-5949

the Commission or any of its other offices or

divisions. As with all no-action letters, DSIO retains the authority to condition further, modify,

suspend, terminate, or otherwise restrict the terms of the no-action relief provided herein, at its

discretion.

Should you have any questions, please do not hesitate to contact me at (202) 418-5326 or Frank

Fisanich, Chief Counsel, at (202) 418-5949.

Very Truly Yours,

Eileen Flaherty

Director

Division of Swap Dealer and Intermediary Oversight

Cc:

Regina Thoele, Compliance

National Futures Association, Chicago

Jamila A. Piracci, OTC Derivatives

National Futures Association, New York