[Federal Register Volume 80, Number 134 (Tuesday, July 14, 2015)]
[Proposed Rules]
[Pages 41376-41408]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-16718]
[[Page 41375]]
Vol. 80
Tuesday,
No. 134
July 14, 2015
Part VI
Commodity Futures Trading Commission
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17 CFR Part 23
Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants--Cross-Border Application of the Margin Requirements;
Proposed Rule
Federal Register / Vol. 80 , No. 134 / Tuesday, July 14, 2015 /
Proposed Rules
[[Page 41376]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 23
RIN 3038-AC97
Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants--Cross-Border Application of the Margin
Requirements
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rule.
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SUMMARY: On October 3, 2014, the Commission published proposed
regulations to implement section 4s(e) of the Commodity Exchange Act,
as added by section 731 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (``Dodd-Frank Act''). This provision requires
the Commission to adopt initial and variation margin requirements for
swap dealers (``SDs'') and major swap participants (``MSPs'') that do
not have a Prudential Regulator (collectively, ``CSEs'' or ``Covered
Swap Entities''). In the October 3, 2014 proposing release, the
Commission also issued an Advance Notice of Proposed Rulemaking
(``ANPR'') requesting public comment on the cross-border application of
such margin requirements. In this release, the Commission is proposing
a rule for the application of the Commission's margin requirements to
cross-border transactions.
DATES: Comments must be received on or before September 14, 2015.
ADDRESSES: You may submit comments, identified by RIN 3038-AC97 and
``Margin Requirements for Uncleared Swaps for Swap Dealers and Major
Swap Participants--Cross-Border Application of the Margin
Requirements'' by any of the following methods:
CFTC Web site: http://comments.cftc.gov. Follow the
instructions for submitting comments through the Comments Online
process on the Web site.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW., Washington, DC 20581.
Hand Delivery/Courier: Same as Mail, above.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Please submit your comments using only one of these methods.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
http://www.cftc.gov. You should submit only information that you wish
to make available publicly. If you wish the Commission to consider
information that may be exempt from disclosure under the Freedom of
Information Act, a petition for confidential treatment of the exempt
information may be submitted according to the established procedures in
Sec. 145.9 of the Commission's regulations, 17 CFR 145.9.
The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from www.cftc.gov that it may deem to be inappropriate for
publication, such as obscene language. All submissions that have been
redacted, or removed that contain comments on the merits of the
rulemaking will be retained in the public comment file and will be
considered as required under the Administrative Procedure Act and other
applicable laws, and may be accessible under the Freedom of Information
Act.
FOR FURTHER INFORMATION CONTACT: Laura B. Badian, Assistant General
Counsel, 202-418-5969, [email protected], or Paul Schlichting, Assistant
General Counsel, 202-418-5884, [email protected], Office of the
General Counsel, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Dodd-Frank Act and the Scope of This Rulemaking
B. Key Considerations in the Cross-Border Application of the
Margin Regulations
C. Advance Notice of Proposed Rulemaking
1. Guidance Approach
2. Prudential Regulators' Approach
3. Entity-Level Approach
4. Comments on the Alternative Approaches Discussed in the ANPR
II. The Proposed Rule
A. Overview
1. Use of Hybrid, Firm-Wide Approach
B. Key Definitions
1. U.S. Person
2. Guarantees
3. Foreign Consolidated Subsidiaries
C. Applicability of Margin Requirements to Cross-Border
Uncleared Swaps
1. Uncleared Swaps of U.S. CSEs or Non-U.S. CSEs Whose
Obligations Under the Relevant Swap Are Guaranteed by a U.S. Person
2. Uncleared Swaps of Non-U.S. CSEs (Including Foreign
Consolidated Subsidiaries) Whose Obligations Under the Relevant Swap
Are Not Guaranteed by a U.S. Person
3. Exclusion for Uncleared Swaps of Non-U.S. CSEs Where Neither
Counterparty's Obligations Under the Relevant Swap Are Guaranteed by
a U.S. Person and Neither Counterparty Is a Foreign Consolidated
Subsidiary Nor a U.S. Branch of a Non-U.S. CSE
4. U.S. Branches of Non-U.S. CSEs
D. Substituted Compliance
E. General Request for Comments
III. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost-Benefit Considerations
1. Introduction
2. Proposed Rule
a. U.S. Person
b. Availability of Substituted Compliance and Exclusion
i. Uncleared Swaps of U.S. CSEs or of Non-U.S. CSEs Whose
Obligations Under the Relevant Swap Are Guaranteed by a U.S. Person
ii. Uncleared Swaps of Non-U.S. CSEs Whose Obligations Under the
Relevant Swap Are Not Guaranteed by a U.S. Person
iii. Exclusion for Uncleared Swaps of Non-U.S. CSEs Where
Neither Counterparty's Obligations Under the Relevant Swap Are
Guaranteed by a U.S. Person and Neither Counterparty Is a Foreign
Consolidated Subsidiary Nor a U.S. Branch of a Non-U.S. CSE
iv. Foreign Consolidated Subsidiaries
v. U.S. Branch of a Non-U.S. CSE
c. Alternatives
d. Comparability Determinations
3. Section 15(a) Factors
a. Protection of Market Participants and the Public
b. Efficiency, Competitiveness, and Financial Integrity
i. Efficiency
ii. Competitiveness
iii. Financial Integrity of Markets
c. Price Discovery
d. Sound Risk Management Practices
e. Other Public Interest Considerations
4. General Request for Comment
I. Background
A. Dodd-Frank Act and the Scope of This Rulemaking
In the fall of 2008, as massive losses spread throughout the
financial system and many major financial institutions failed or
narrowly escaped failure with government intervention, confidence in
the financial system was replaced by panic, credit markets seized up,
and trading in many markets grounded to a halt. The financial crisis
revealed the vulnerability of the U.S. financial system to widespread
systemic risk resulting from, among other things, excessive leverage,
poor risk management practices at financial firms, and the lack of
integrated supervisory oversight of financial institutions and
[[Page 41377]]
financial markets.\1\ The financial crisis also highlighted the
contagion risks of under-collateralized counterparty exposures in a
highly interconnected financial system.\2\
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\1\ See Financial Crisis Inquiry Commission, ``The Financial
Crisis Inquiry Report: Final Report of the National Commission on
the Causes of the Financial and Economic Crisis in the United
States,'' Jan. 2011, at xviii-xxv, 307-8, 363-5, 386, available at
http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.
\2\ Id. at xxiv-xxv, 49-51.
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In the wake of the financial crisis, Congress enacted the
provisions of the Commodity Exchange Act (``CEA'') relating to swaps in
Title VII of the Dodd-Frank Act,\3\ which establishes a comprehensive
new regulatory framework for swaps. One of the cornerstones of this
regulatory framework is the reduction of systemic risk to the U.S.
financial system through the establishment of margin requirements for
uncleared swaps.\4\
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\3\ Pub. L. 111-203, 124 Stat. 1376 (2010).
\4\ The Financial Crisis Inquiry Commission stated in its report
that the failure of American International Group, Inc. (``AIG'') was
possible because the sweeping deregulation of over-the-counter
derivatives (including credit default swaps) effectively eliminated
federal and state regulation of these products, including capital
and margin requirements that would have reduced the likelihood of
AIG's failure. Id. at 352.
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Section 731 of the Dodd-Frank Act added a new section 4s, which
directs the Commission to adopt rules establishing minimum initial and
variation margin requirements for SDs and MSPs on all swaps that are
not cleared by a registered derivatives clearing organization. Section
4s(e) further provides that the margin requirements must: (i) Help
ensure the safety and soundness of the SD or MSP; and (ii) be
appropriate for the risk associated with the uncleared swaps held as a
SD or MSP.\5\
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\5\ Section 4s(e)(3)(A)(i) of the CEA, 7 U.S.C. 6s(e)(3)(A)(i).
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The Dodd-Frank Act also requires that the Prudential Regulators,\6\
in consultation with the Commission and the Securities and Exchange
Commission (``SEC''), adopt a joint margin rule. Accordingly, each SD
and MSP for which there is a Prudential Regulator must meet margin
requirements established by the applicable Prudential Regulator, and
each SD and MSP for which there is no Prudential Regulator must comply
with the Commission's margin requirements. Further, the Dodd-Frank Act
requires that the Commission, the Prudential Regulators and the SEC, to
the maximum extent practicable, establish and maintain comparable
minimum capital and minimum initial and variation margin requirements,
including the use of noncash collateral, for SDs and MSPs.\7\
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\6\ The term ``Prudential Regulator'' is defined in section
1a(39) of the CEA, as amended by section 721 of the Dodd-Frank Act.
This definition includes the Board of Governors of the Federal
Reserve System (``FRB''); the Office of the Comptroller of the
Currency (``OCC''); the Federal Deposit Insurance Corporation
(``FDIC''); the Farm Credit Administration; and the Federal Housing
Finance Agency.
\7\ See section 4s(e)(3)(D)(ii) of the CEA, 7 U.S.C.
6s(e)(3)(D)(ii), which was added by section 731 of the Dodd-Frank
Act. The Prudential Regulators, the Commission, and the SEC are also
required to consult periodically (but not less frequently than
annually) on minimum capital requirements and minimum initial and
variation margin requirements. See section 4s(e)(3)(D)(i) of the
CEA, 7 U.S.C. 6s(e)(3)(D)(i).
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In determining whether, and the extent to which, section 4s(e)
should apply to a CSE's swap activities outside the United States, the
Commission focused on the text and objectives of that provision
together with the language of section 2(i) of the CEA.\8\ As discussed
further below, the primary reason for the margin requirement is to
protect CSEs in the event of a counterparty default. That is, in the
event of a default by a counterparty, margin protects the CSE by
allowing it to absorb the losses using collateral provided by the
defaulting entity and to continue to meet all of its obligations. In
addition, margin functions as a risk management tool by limiting the
amount of leverage that a CSE can incur. Specifically, by requiring a
CSE to post margin to its counterparties, the margin requirements
ensure that a CSE has adequate eligible collateral to enter into an
uncleared swap.
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\8\ See 7 U.S.C. 2(i). Section 2(i) of the CEA states that the
provisions of the Act relating to swaps that were enacted by the
Wall Street Transparency and Accountability Act of 2010 (including
any rule prescribed or regulation promulgated under that Act), shall
not apply to activities outside the United States unless those
activities--(1) have a direct and significant connection with
activities in, or effect on, commerce of the United States; or (2)
contravene such rules or regulations as the Commission may prescribe
or promulgate as are necessary or appropriate to prevent the evasion
of any provision of the Act [CEA] that was enacted by the Wall
Street Transparency and Accountability Act of 2010.
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Risk arising from uncleared swaps can potentially have a
substantial adverse effect on any CSE--irrespective of its domicile or
the domicile of its counterparties--and therefore the stability of the
U.S. financial system because each CSE has a sufficient nexus to the
U.S. financial system to require registration as a CSE. In light of the
role of margin in ensuring the safety and soundness of CSEs and
preserving the stability of the U.S. financial system, and consistent
with section 2(i), section 4s(e)'s margin requirements extend to all
CSEs on a cross-border basis.
Pursuant to its new section 4s(e) authority, on October 3, 2014,
the Commission published reproposed regulations to implement initial
and variation margin requirements on uncleared swaps (``Proposed Margin
Rules'') for SDs and MSPs that do not have a Prudential Regulator
(collectively, ``CSEs'' or ``Covered Swap Entities'').\9\ In the same
release, the Commission also published an ANPR requesting public
comment on the cross-border application of such margin requirements. In
this release, the Commission is proposing a rule for the application of
the Commission's uncleared swap margin requirements to cross-border
transactions (referred to herein as the ``Proposed Rule'').
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\9\ The Commission's Proposed Margin Rules are set forth in
proposed rules Sec. Sec. 23.150 through 23.159 of part 23 of the
Commission's regulations, proposed as 17 CFR 23.150 through 23.159.
See Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants, 79 FR 59898 (Oct. 3, 2014). In September
2014, the Prudential Regulators published proposed regulations to
implement initial and variation margin requirements for SDs and MSPs
that have a Prudential Regulator. See Margin and Capital
Requirements for Covered Swap Entities, 79 FR 53748 (Sept. 24,
2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-09-24/pdf/2014-22001.pdf. The Commission originally proposed margin rules for
public comment in 2011. See Margin Requirements for Uncleared Swaps
for Swap Dealers and Major Swap Participants, 76 FR 23732 (April 28,
2011).
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B. Key Considerations in the Cross-Border Application of the Margin
Regulations
The swaps market is global in nature. Swaps are routinely entered
into between counterparties located in different jurisdictions. Dealers
and other market participants conduct their swaps business through
subsidiaries, affiliates, and branches dispersed across geographical
boundaries. The global and highly interconnected nature of the swaps
market heightens the potential that risks assumed by a firm overseas
can be transmitted across national borders to cause or contribute to
substantial losses to U.S. persons and threaten the stability of the
entire U.S. financial system. Therefore, it is important that margin
requirements for uncleared swaps apply on a cross-border basis in a
manner that effectively addresses risks to U.S. persons and the U.S.
financial system.
The Commission recognizes that non-U.S. CSEs and non-U.S.
counterparties may be subject to comparable or different rules in their
home jurisdictions. Conflicting and duplicative requirements between
U.S. and foreign margin regimes could potentially lead to market
inefficiencies
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and regulatory arbitrage, as well as competitive disparities that
undermine the relative position of U.S. CSEs and their counterparties.
Therefore, it is essential that a cross-border margin framework takes
into account the global nature of the swaps market and the supervisory
interests of foreign regulators with respect to entities and
transactions covered by the Commission's margin regime.\10\
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\10\ In developing the proposed cross-border framework, the
Commission is guided by principles of international comity, which
counsels due regard for the important interests of foreign
sovereigns. See Restatement (Third) of Foreign Relations Law of the
United States (the ``Restatement''). The Restatement provides that
even where a country has a basis for jurisdiction, it should not
prescribe law with respect to a person or activity in another
country when the exercise of such jurisdiction is unreasonable. See
Restatement section 403(1). The reasonableness of such an exercise
of jurisdiction, in turn, is to be determined by evaluating all
relevant factors, including certain specifically enumerated factors
where appropriate: (a) The link of the activity to the territory of
the regulating state, i.e., the extent to which the activity takes
place within the territory, or has substantial, direct, and
foreseeable effect upon or in the territory; (b) the connections,
such as nationality, residence, or economic activity, between the
regulating state and the persons principally responsible for the
activity to be regulated, or between that state and those whom the
regulation is designed to protect; (c) the character of the activity
to be regulated, the importance of regulation to the regulating
state, the extent to which other states regulate such activities,
and the degree to which the desirability of such regulation is
generally accepted; (d) the existence of justified expectations that
might be protected or hurt by the regulation; (e) the importance of
the regulation to the international political, legal, or economic
system; (f) the extent to which the regulation is consistent with
the traditions of the international system; (g) the extent to which
another state may have an interest in regulating the activity; and
(h) the likelihood of conflict with regulation by another state. See
Restatement section 403(2).
Notably, the Restatement does not preclude concurrent regulation
by multiple jurisdictions. However, where concurrent jurisdiction by
two or more jurisdictions creates conflict, the Restatement
recommends that each country evaluate its own interests in
exercising jurisdiction and those of the other jurisdiction, and
where possible, to consult with each other.
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In granting the Commission new authorities under the Dodd-Frank
Act, Congress also reaffirmed and called for coordination and
cooperation among domestic and foreign regulators. Section 752(a) of
the Dodd-Frank Act requires the Commission, the Prudential Regulators,
and the SEC to consult and coordinate with foreign regulatory
authorities on the ``establishment of consistent international
standards'' with respect to the regulation of swaps.\11\ In this
regard, the Commission recognizes that efforts are underway by other
domestic and foreign regulators to implement margin reform and that
regulatory harmonization and coordination are indispensable to
achieving a workable cross-border framework.
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\11\ 15 U.S.C. 8325(a) (added by section 752 of the Dodd-Frank
Act). Also, before commencing any rulemaking or issuing an order
regarding swaps, the Commission must consult and coordinate to the
extent possible with the SEC and the Prudential Regulators for the
purposes of assuring regulatory consistency and comparability, to
the extent possible. See 15 U.S.C. 8302(a)(1) (added by section
712(a)(1) of the Dodd-Frank Act).
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In developing a cross-border framework for margin regulations, the
Commission aims to strike the proper balance among these sometimes
competing considerations. To that end, the Commission has consulted and
coordinated with the Prudential Regulators and foreign regulatory
authorities. Commission staff worked closely with the staff of the
Prudential Regulators, and the Proposed Rule is closely aligned with
the cross-border proposal that was published by the Prudential
Regulators in September 2014. In addition, Commission staff has
participated in numerous bilateral and multilateral discussions with
foreign regulatory authorities addressing national efforts to implement
margin reform and the possibility of conflicts and overlaps between
U.S. and foreign regulatory regimes. Recognizing that systemic risks
arising from global and interconnected swaps market must be addressed
through coordinated regulatory requirements for margin across
international jurisdictions, the Commission has played an active role
in encouraging international harmonization and coordination of margin
requirements for uncleared swaps.
The Commission notes that its collaboration with the Basel
Committee on Banking Supervision (``BCBS'') and the Board of the
International Organization of Securities Commissions (``IOSCO'') as a
member of the Working Group on Margining Requirements (``WGMR'')
resulted in the issuance of a final margin policy framework for non-
cleared, bilateral derivatives in September 2013 (referred to herein as
the ``BCBS-IOSCO framework'').\12\ Individual regulatory authorities
across major jurisdictions (including the EU, Japan, and the United
States) have since started to develop their own margin rules.\13\ The
Proposed Rule is consistent with the standards in the final BCBS-IOSCO
framework, and we have been in continuous communication with regulators
in the EU and Japan as we developed our cross-border margin proposal.
Although at this time foreign jurisdictions do not yet have their
margin regimes in place, the Commission has participated in ongoing,
collaborative discussions with regulatory authorities in the EU and
Japan regarding their cross-border approaches to the margin rules,
including the anticipated scope of application of margin requirements
in their jurisdiction to cross-border swaps, their plans for
recognizing foreign margin regimes, and their anticipated timelines.
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\12\ See Margin Requirements for Non-centrally Cleared
Derivatives (Sept. 2013), available at http://www.bis.org/publ/bcbs261.pdf.
\13\ See European Banking Authority, European Securities and
Markets Authority, and European Insurance and Occupational Pensions
Authority, Consultation Paper on draft regulatory technical
standards on risk-mitigation techniques for OTC-derivative contracts
not cleared by a CCP under Article 11(15) of Regulation (EU) No 648/
2012 (for the European Market Infrastructure Regulation) (April 14,
2014), available at https://www.eba.europa.eu/documents/10180/655149/JC+CP+2014+03+%28CP+on+risk+mitigation+for+OTC+derivatives%29.pdf, and Second Consultation Paper on draft regulatory technical
standards on risk-mitigation techniques for OTC-derivative contracts
not cleared by a CCP under Article 11(15) of Regulation (EU) No 648/
2012 (for the European Market Infrastructure Regulation) (Jun. 10,
2015), available at https://www.eba.europa.eu/documents/10180/1106136/JC-CP-2015-002+JC+CP+on+Risk+Management+Techniques+for+OTC+derivatives+.pdf;
Financial Services Agency of Japan, draft amendments to the
``Cabinet Office Ordinance on Financial Instruments Business'' and
``Comprehensive Guidelines for Supervision'' with regard to margin
requirements for non-centrally cleared derivatives (July 3, 2014).
Available in Japanese at http://www.fsa.go.jp/news/26/syouken/20140703-3.html.
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The Commission believes that its ongoing bilateral and multilateral
discussions with foreign regulatory authorities in major jurisdictions
(including the EU and Japan) are critical to fostering international
cooperation and harmonization and in reducing conflicting and
duplicative regulatory requirements. The Commission expects that these
discussions will continue as it finalizes and then implements its
framework for the application of margin requirements to cross-border
transactions, and as other jurisdictions develop their own respective
approaches.
C. Advance Notice of Proposed Rulemaking
The ANPR sought public comment on three potential alternative
approaches to the cross-border application of its margin requirements:
(1) A transaction-level approach that is consistent with the
Commission's cross-border guidance (``Guidance Approach''); \14\ (2) an
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approach that is consistent with the approach proposed by the
Prudential Regulators (the ``Prudential Regulators' Approach''); \15\
and (3) an entity-level approach described in the ANPR (``Entity-Level
Approach''). To provide context for the discussion of the Proposed
Rule, the three alternative approaches discussed in the ANPR are
summarized below.
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\14\ Interpretative Guidance and Policy Statement Regarding
Compliance with Certain Swap Regulations, 78 FR 45292 (July 26,
2013) (``Guidance''). The Commission addressed, among other things,
how the swap provisions in the Dodd-Frank Act (including the margin
requirement for uncleared swaps) generally would apply on a cross-
border basis. In this regard, the Commission stated that as a
general policy matter it expected to apply the margin requirement as
a transaction-level requirement.
\15\ See Margin and Capital Requirements for Covered Swap
Entities, 79 FR 53748 (Sept. 24, 2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-09-24/pdf/2014-22001.pdf.
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1. Guidance Approach
Under the first alternative discussed in the ANPR, the Commission's
margin requirements would be applied on a transaction-level basis,
consistent with its cross-border Guidance.\16\ The Commission stated in
the Guidance that it would generally treat its margin requirements for
uncleared swaps as a transaction-level requirement. Consistent with the
rationale stated in the Guidance, under this transaction-level
approach, the Commission's Proposed Margin Rules would apply to a U.S.
SD/MSP (other than a foreign branch of a U.S. bank that is a SD/MSP)
for all of its uncleared swaps, regardless of whether its counterparty
is a U.S. person,\17\ without substituted compliance.
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\16\ See Interpretative Guidance and Policy Statement Regarding
Compliance with Certain Swap Regulations, 78 FR 45292 (July 26,
2013).
\17\ The scope of the term ``U.S. person'' as used in the Cross-
Border Guidance Approach and the Entity-Level Approach would be the
same as under the Guidance. See Guidance at 45316-45317 for a
summary of the Commission's interpretation of the term ``U.S.
person.''
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However, under this approach the margin requirements would apply to
a non-U.S. SD/MSP (whether or not it is a ``guaranteed affiliate'' \18\
or an ``affiliate conduit'' \19\) only with respect to its uncleared
swaps with a U.S. person counterparty and a non-U.S. counterparty that
is a guaranteed affiliate or an affiliate conduit; the margin
requirements would not apply to uncleared swaps with a non-U.S. person
counterparty that is not a guaranteed affiliate or an affiliate
conduit. Where the non-U.S. counterparty is a guaranteed affiliate or
an affiliate conduit, the Commission would allow substituted compliance
(i.e., the non-U.S. SD/MSP would be permitted to comply with the margin
requirements of its home country's regulator if the Commission
determines that such requirements are comparable to the Commission's
margin requirements).\20\
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\18\ Under the Guidance, id. at 45318, the term ``guaranteed
affiliate'' refers to a non-U.S. person that is an affiliate of a
U.S. person and that is guaranteed by a U.S. person. The scope of
the term ``guarantee'' under the Guidance Approach and the Entity-
Level Approach would be the same as under note 267 of the Guidance
and accompanying text.
\19\ Under the approach discussed in the Guidance, id. at 45359,
the factors that are relevant to the consideration of whether a
person is an ``affiliate conduit'' include whether: (i) The non-U.S.
person is majority-owned, directly or indirectly, by a U.S. person;
(ii) the non-U.S. person controls, is controlled by, or is under
common control with the U.S. person; (iii) the non-U.S. person, in
the regular course of business, engages in swaps with non-U.S. third
party(ies) for the purpose of hedging or mitigating risks faced by,
or to take positions on behalf of, its U.S. affiliate(s), and enters
into offsetting swaps or other arrangements with such U.S.
affiliate(s) in order to transfer the risks and benefits of such
swaps with third-party(ies) to its U.S. affiliates; and (iv) the
financial results of the non-U.S. person are included in the
consolidated financial statements of the U.S. person. Other facts
and circumstances also may be relevant.
\20\ Where the uncleared swap is between a non-U.S. SD/MSP
(whether or not it is a guaranteed affiliate or an affiliate
conduit) and a foreign branch of a U.S. bank that is a SD/MSP,
substituted compliance would be available if certain conditions are
met.
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2. Prudential Regulators' Approach
The second alternative discussed in the ANPR was the Prudential
Regulators' Approach to cross-border application of the margin
requirements.\21\ Under the Prudential Regulators' proposal issued in
September 2014 (the ``September proposal''), the Prudential Regulators
would apply the margin requirements to all uncleared swaps of CSEs
under their supervision with a limited exception.\22\ Specifically, the
Prudential Regulators would not apply their margin requirements to any
foreign non-cleared swap of a foreign covered swap entity.\23\ This
exclusion would only be available where neither the non-U.S. SD/MSP's
nor the non-U.S. counterparty's obligations under the relevant swap are
guaranteed by a U.S. person and neither party is ``controlled'' by a
U.S. person. Under the ``control'' test used in the September proposal,
the term ``control'' of another company means: (1) Ownership, control,
or power to vote 25 percent or more of a class of voting securities of
the company, directly or indirectly or acting through one or more other
persons; (2) ownership or control of 25 percent or more of the total
equity of the company, directly or indirectly or acting through one or
more other persons; or (3) control in any manner of the election of a
majority of the directors or trustees of the company.
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\21\ See section 9 of the proposed rule on Margin and Capital
Requirements for Covered Swap Entities, 12 CFR part 237 (Sept. 24,
2014) for a complete description of the proposed cross-border
application of margin requirements to swaps by the Prudential
Regulators, available at http://www.gpo.gov/fdsys/pkg/FR-2014-09-24/pdf/2014-22001.pdf.
\22\ A summary of the Prudential Regulators' Approach to the
cross-border application of their proposed margin requirements is
included in the ANPR. See Margin Requirements for Uncleared Swaps
for Swap Dealers and Major Swap Participants, 79 FR 59917(Oct. 3,
2014). For further information on the Prudential Regulators'
Approach generally, see Margin and Capital Requirements for Covered
Swap Entities, 79 FR 53748 (Sept. 24, 2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-09-24/pdf/2014-22001.pdf.
\23\ The Prudential Regulators define a ``foreign covered swap
entity'' as any covered swap entity that is not (i) an entity
organized under U.S. or State law, including a U.S. branch, agency,
or subsidiary of a foreign bank; (ii) a branch or office of an
entity organized under U.S. or State law; or (iii) an entity
controlled by an entity organized under U.S. or State law. Under the
Prudential Regulators' proposal, a ``foreign non-cleared swap''
would include any non-cleared swap of a foreign covered swap entity
to which neither the counterparty nor any guarantor (on either side)
is (i) an entity organized under U.S. or State law, including a U.S.
branch, agency, or subsidiary of a foreign bank; (ii) a branch or
office of an entity organized under U.S. or State law; or (iii) a
covered swap entity controlled by an entity organized under U.S. or
State law.
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3. Entity-Level Approach
Under the third alternative discussed in the ANPR, margin
requirements would be treated as an entity-level requirement. Under
this Entity-Level Approach, the Commission would apply its proposed
cross-border rules on margin on a firm-wide level--that is, to all
uncleared swaps activities of a SD/MSP registered with the Commission,
irrespective of whether the counterparty is a U.S. person, and with no
possibility of exclusion. This approach takes into account that a non-
U.S. SD/MSP entering into uncleared swaps faces counterparty credit
risk regardless of where the swap is executed or whether the
counterparty is a U.S. person.\24\ That risk, if it leads to a default
by the non-U.S. SD/MSP, could cause adverse consequences to its U.S.
counterparties and the U.S. financial system. At the same time, in
recognition of international comity, under this approach the Commission
would consider, where appropriate, allowing CSEs to avail themselves of
substituted compliance.
---------------------------------------------------------------------------
\24\ A summary of the Entity-Level Approach to the cross-border
application of the Proposed Margin Rules is included in the ANPR.
See Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants, 79 FR 59917 (Oct. 3, 2014).
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4. Comments on the Alternative Approaches Discussed in the ANPR
After publishing the ANPR, the Commission received comments that
responded to the three alternative approaches.\25\ There was no
consensus
[[Page 41380]]
among commenters on a preferable approach.
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\25\ Comment letters received in response to the ANPR may be
found on the Commission's Web site at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1528.
---------------------------------------------------------------------------
Several commenters supported the Guidance Approach, with
modifications, on the basis that margin rules should not apply to swaps
between a foreign swap dealer and a foreign, non-guaranteed
counterparty.\26\ Some of these commenters suggested modifications to
the availability of substituted compliance in the approach described in
the Guidance.\27\ For example, one commenter suggested that the
Commission should treat non-U.S. margin requirements that conform to
the BCBS-IOSCO framework as ``essentially identical'' to the
Commission's regime and therefore accessible to all SDs as a means of
complying with the Commission's margin requirements.\28\ Another
commenter suggested that the Commission modify its approach to
substituted compliance outlined in the Guidance to allow substituted
compliance for trades between U.S. persons and non-U.S. persons at such
parties' mutual agreement.\29\ In addition, some commenters that
supported the Guidance Approach expressed the view that it should
include an emerging markets exception.\30\ Still another commenter
argued that the Commission's Guidance correctly classified margin as a
transaction-level rather than an entity-level requirement because, as
with the clearing requirement, it is practicable to separate out
transactions which are subject to the margin requirements and
transactions which are not. This commenter stated that it would be an
odd result if the Commission were to determine that the reach of the
clearing requirement was not as great as that of the margin
requirement, given that both requirements are intended to address
counterparty credit risk.\31\
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\26\ See International Swaps and Derivatives Association, Inc.
(``ISDA'') (Nov. 24, 2014), Managed Funds Association (``MFA'')
(Dec. 2, 2014), and INTL FCStone Inc. (Dec. 3, 2014).
\27\ See ISDA (Nov. 24, 2014) and MFA (Dec. 2, 2014).
\28\ See ISDA (Nov. 24, 2014).
\29\ See MFA (Dec. 2, 2014).
\30\ See ISDA (Nov. 24, 2014) and American Bankers Association
(Nov. 25, 2014).
\31\ See INTL FCStone Inc. (Dec. 3, 2014).
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In contrast, some commenters argued against adopting the Guidance
Approach. One commenter argued that the Guidance Approach has become a
significant driver of conflict between U.S. and European regulatory
requirements, and is undermining the goal of a globally coordinated
regulatory framework.\32\ Another commenter argued that this approach
provides an excessively broad exemption for ``non-guaranteed'' foreign
affiliates of U.S. banks, and that it is completely inappropriate to
apply such an exemption to a crucial prudential requirement such as
derivatives margin, which could pose major risks to the financial
system by encouraging a race to the bottom among jurisdictions
concerning margin requirements.\33\
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\32\ See Alternative Investment Management Association
(``AIMA'') (Dec. 2, 2014).
\33\ See Americans for Financial Reform (``AFR'') (Dec. 2,
2014).
---------------------------------------------------------------------------
Other commenters generally supported the Entity-Level Approach,
with modifications, on the basis that it captures all registrants'
uncleared trades, regardless of the domicile of the registrant or the
counterparty. These commenters generally favored this approach because,
rather than exempting foreign to foreign transactions, it makes
substituted compliance available for these transactions. One commenter
stated that the Entity-Level Approach is the most appropriate choice
because it provides market participants with more certainty in
determining which jurisdiction's margin requirements apply. Further,
this commenter stated that the Entity-Level Approach is consistent with
how collateral is currently handled under a single master agreement and
would mitigate legal uncertainty and operational errors that can arise
if trades are subject to different margin requirements under the same
master agreement.\34\ Another commenter favored the Entity-Level
Approach because it imposes prudential rules on all swaps activities of
U.S.-headquartered firms, regardless of where the swap transaction is
booked. This commenter stated that both the Prudential Regulators'
Approach and the Guidance Approach provide a means for U.S. firms to
escape U.S. oversight.\35\
---------------------------------------------------------------------------
\34\ See Securities Industry and Financial Markets Association,
Asset Management Group (Nov. 24, 2014).
\35\ See Public Citizen (Dec. 2, 2014).
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Another commenter supported a cross-border approach that combines
the Guidance Approach with certain enhancements found in the Entity-
Level Approach. This commenter suggested that the Entity-Level Approach
correctly subjects certain non-U.S. SDs and MSPs to U.S. regulations--
at least with respect to variation margin and the collection of initial
margin--where the Guidance Approach would permit substituted compliance
to both parties in all respects. However, this commenter stated that
the Entity-Level Approach also contains provisions that are
significantly weaker than the Guidance Approach, such as making
substituted compliance available to certain non-U.S. counterparties of
U.S. SDs or MSPs. This commenter also expressed the view that the
Guidance Approach correctly requires both counterparties to fully
comply with U.S. rules in all transactions involving a U.S. SD or
MSP.\36\
---------------------------------------------------------------------------
\36\ See Better Markets, Inc. (Dec. 2, 2014).
---------------------------------------------------------------------------
Commenters generally did not support the Prudential Regulators'
Approach as their first choice, but two commenters thought it might be
workable with modifications. The first commenter stated that if the
Commission elects not to adopt the ``Entity-Level'' Approach, the
Prudential Regulators' Approach might be workable, although this
commenter had reservations about situations where different
jurisdictions' regimes apply to the same transaction.\37\ The other
commenter argued that if its first choice, the Entity-Level Approach,
is not adopted, the Prudential Regulators' Approach is greatly superior
to the Guidance Approach, as it would apply margin requirements to
foreign affiliates of U.S. banks that are classified as SDs or MSPs,
regardless of whether such affiliates are nominally guaranteed.
However, this commenter argued that the Prudential Regulators' Approach
is flawed in that, like the Guidance Approach, it would exempt
controlled foreign subsidiaries of U.S. banks that are not registered
with the Commission as swaps entities.\38\
---------------------------------------------------------------------------
\37\ See AIMA (Dec. 2, 2014).
\38\ See AFR (Dec. 2, 2014).
---------------------------------------------------------------------------
Two commenters specifically argued against the Prudential
Regulators' Approach. One commenter contended that the Prudential
Regulators' Approach provides limited clarity on how the ``control''
test should be applied, which means that foreign bank subsidiaries of
U.S. banks cannot be certain whether they are subject to U.S. rules or
foreign rules, and provides limited guidance as to how foreign covered
swaps entities can determine whether a financial end-user counterparty
is a U.S. entity or a foreign entity, in comparison to the clear ``U.S.
person'' standard in the Guidance.\39\ The other commenter is concerned
with the Prudential Regulators' Approach as it relates to funds. This
commenter stated that the Prudential Regulators' definition of
``foreign non-cleared swap'' effectively classifies funds organized
outside of the United States, but with a U.S. principal place of
business (e.g., funds with a U.S.-based manager), as foreign entities.
This
[[Page 41381]]
commenter stated that if funds with a U.S.-based manager are not
considered ``U.S. persons'' subject to U.S. derivatives regulation,
even though they have a substantial U.S. nexus, they would likely be
required to margin their covered swaps in accordance with the foreign
margin rules to which their non-U.S. CSE counterparty is subject, which
would give too much deference to the foreign regulatory regime.\40\
---------------------------------------------------------------------------
\39\ See Committee on Capital Markets Regulation (Nov. 24,
2014).
\40\ See MFA (Dec. 2, 2014).
---------------------------------------------------------------------------
One commenter asserted that both the Prudential Regulators'
Approach and the Guidance Approach would appropriately exclude swaps
between foreign-headquartered swap entities that are not controlled or
guaranteed by a U.S. person and a non-U.S. person that is not
guaranteed by a U.S. person from the scope of the margin rules, noting
that if U.S. rules require the foreign-headquartered swap entity to
post margin, this would create the potential for conflicts or
inconsistencies with its home country margin requirements.\41\
---------------------------------------------------------------------------
\41\ See Institute of International Bankers (Nov. 24, 2014).
This commenter also stated that these foreign swaps would have
little effect on the U.S. financial system in the event of a
default; further, under the Dodd-Frank Act, the risk to the United
States of a default by the foreign-headquartered swap entity on its
swaps with U.S. counterparties would already be mitigated by capital
and margin collection requirements.
---------------------------------------------------------------------------
One commenter did not explicitly support any of the three
approaches, noting that all of the proposals diverge in potentially
significant ways from the final framework developed by BCBS and IOSCO
and the OTC margin framework proposed in April 2014 by European
supervisory agencies, and that none of the proposals embrace
substituted compliance in a comprehensive manner that would address
cross-border conflicts or inconsistencies that could arise. This
commenter suggested that the Commission should use an outcomes-based
approach that looks to whether giving full recognition to an equivalent
foreign OTC margin framework as a whole would ensure an acceptable
reduction of aggregate unmargined risk.\42\
---------------------------------------------------------------------------
\42\ See Securities Industry and Financial Markets Association
(``SIFMA'') (Nov. 24, 2014).
---------------------------------------------------------------------------
II. The Proposed Rule
A. Overview
Based on, among other things, consideration of the comments to the
ANPR and after close consultation with the Prudential Regulators, the
Commission is proposing a rule for the application of the Commission's
Proposed Margin Rules to cross-border transactions (as noted above, the
proposed cross-border margin rule is referred to herein as the
``Proposed Rule''). As discussed above, a cross-border framework for
margin necessarily involves consideration of significant, and sometimes
competing, legal and policy considerations, including the impact on
market efficiency and competition.\43\ The Commission, in developing
the Proposed Rule, aims to balance these considerations to effectively
address the risk posed to the safety and soundness of CSEs, while
creating a workable framework that reduces the potential for undue
market disruptions and promotes global harmonization. The Commission
also recognizes that there are other possible approaches to applying
the margin rules in the cross-border context. Accordingly, the
Commission invites public comment regarding all aspects of the Proposed
Rule.
---------------------------------------------------------------------------
\43\ The Commission's consideration of the costs and benefits
associated with the Proposed Rule is discussed in section III.C.
below.
---------------------------------------------------------------------------
1. Use of Hybrid, Firm-Wide Approach
The Proposed Rule is a combination of the entity- and transaction-
level approaches and is closely aligned with the Prudential Regulators'
Approach. In general, under the Proposed Rule, margin requirements are
designed to address the risks to a CSE, as an entity, associated with
its uncleared swaps (entity-level); nevertheless, certain uncleared
swaps would be eligible for substituted compliance or excluded from the
Commission's margin rules based on the counterparties' nexus to the
United States relative to other jurisdictions (transaction-level).
Although margin is calculated for individual transactions or
positions, and therefore, could be applied on a transaction-level
basis, the Commission believes that as a general matter margin
requirements should apply on a firm-wide basis, irrespective of the
domicile of the counterparties or where the trade is executed. The
primary reason for collecting margin from counterparties is to protect
an entity in the event of a counterparty default. That is, in the event
of a default by a counterparty, margin protects the non-defaulting
counterparty by allowing it to absorb the losses using collateral
provided by the defaulting entity and to continue to meet all of its
obligations. In addition, margin functions as a risk management tool by
limiting the amount of leverage that a CSE can incur. Specifically, by
requiring a CSE to post margin to its counterparties, the margin
requirements ensure that a CSE has adequate eligible collateral to
enter into an uncleared swap. In this way, margin serves as a first
line of defense to protect a CSE as a whole from risk arising from
uncleared swaps.
The source of counterparty credit risk to a CSE, however, is not
confined to its uncleared swaps with U.S. counterparties. Risk arising
from uncleared swaps involving non-U.S. counterparties can potentially
have a substantial adverse effect on a CSE--including a non-U.S. CSE--
and therefore the stability of the U.S. financial system because CSEs
have a sufficient nexus to the U.S. financial system to require
registration as a CSE. Given the function of margin, the Commission
believes that margin should be treated as an entity-level requirement
in the cross-border context, and thus not take into account the
domicile of CSE counterparties or where the trade is executed.
The Commission also believes that treating margin as an entity-
level requirement is consistent with the role of margin in a CSE's
overall risk management program. Margin, by design, is complementary to
capital.\44\ That is, margin and capital requirements serve different
but equally important risk mitigation functions that are best
implemented at the entity-level. Unlike margin, capital is difficult to
rapidly adjust in response to changing risk exposures; thus, capital
can be viewed as a backstop, in the event that the margin is not enough
to cover all of the losses that resulted from the counterparty default.
Standing alone, either capital or margin may not be enough to prevent a
CSE from failing, but together, they are designed to reduce the
probability of default by the CSE and limit the amount of leverage that
can be undertaken by CSEs (and other market participants), which
ultimately mitigates the possibility of a systemic event.\45\
---------------------------------------------------------------------------
\44\ See BCBS and IOSCO, Margin requirements for non-centrally
cleared derivatives (Sept. 2013) at 3, available at http://www.bis.org/publ/bcbs261.pdf.
\45\ Section 4s(e) of the CEA, 7 U.S.C. 6s(e), directs the
Commission to adopt capital requirements for SDs and MSPs. The
Commission proposed capital rules in 2011. See Capital Requirements
for Swap Dealers and Major Swap Participants, Notice of proposed
rulemaking, 76 FR 27802 (May 12, 2011).
---------------------------------------------------------------------------
At the same time, the Commission recognizes that a CSE's uncleared
swaps with a particular counterparty may implicate the supervisory
interests of foreign regulators and it is important to calibrate the
cross-border application of the margin requirements to mitigate, to the
extent possible and consistent with the Commission's regulatory
interests, the potential for conflicts or duplication with other
jurisdictions. Therefore, the Proposed Rule, while applying margin
[[Page 41382]]
requirements to a CSE as a whole, also permits a U.S. CSE or non-U.S.
CSE to avail itself of substituted compliance (to the extent applicable
under the Proposed Rule) by complying with the margin requirements of
the relevant foreign jurisdiction in lieu of compliance with the
Commission's margin requirements, provided that the Commission finds
that such jurisdiction's margin requirements are comparable to the
Commission's margin requirements, as further discussed in section II.D.
below.
In addition, the Proposed Rule provides for a limited exclusion of
uncleared swaps between non-U.S. CSEs and non-U.S. counterparties (the
``Exclusion'') in certain circumstances. The Commission recognizes that
the supervisory interest of foreign regulators in certain uncleared
swaps between non-U.S. CSEs and their non-U.S. counterparties may equal
or exceed the supervisory interest of the United States. The Proposed
Rule takes into account the interests of other jurisdictions and
balances those interests with the supervisory interests of the United
States in order to calibrate the application of margin rules to non-
U.S. CSEs' swaps with non-U.S. counterparties. Accordingly, the
Commission believes that it would be appropriate to not apply the
Commission's margin rules to uncleared swaps meeting the criteria for
the Exclusion, which is described in section II.C.3. below.
B. Key Definitions
The Proposed Rule uses certain key definitions to establish a
proposed framework for the application of margin requirements in a
cross-border context. Specifically, the Proposed Rule defines the terms
``U.S. person,'' ``guarantee,'' and ``Foreign Consolidated Subsidiary''
in order to identify those persons or transactions that, because of
their substantial connection or impact on the U.S. market, raise or
implicate greater supervisory interest relative to other CSEs,
counterparties, and uncleared swaps that are subject to the
Commission's margin rules. These definitions are discussed below.
1. U.S. Person
Generally speaking, the term ``U.S. person'' would be defined to
include those individuals or entities whose activities have a
significant nexus to the U.S. market by virtue of their organization or
domicile in the United States or the depth of their connection to the
U.S. market, even if domiciled or organized outside the United States.
The proposed definition generally follows the traditional, territorial
approach to defining a U.S. person, and the Commission believes that
this definition provides an objective and clear basis for determining
those individuals or entities that should be identified as a U.S.
person.\46\
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\46\ In addition, the Commission notes that the proposed
definition of ``U.S. person'' is similar to the definition of ``U.S.
person'' used by the SEC in the context of cross-border security-
based swaps. In the SEC's August 2014 release adopting rules and
providing guidance regarding the application of Title VII of the
Dodd-Frank Act to cross-border security-based swap activities and
persons engaged in those activities, the SEC defined the term ``U.S.
person'' in Rule 240.3a71-3(a)(4)(i) under the Securities Exchange
Act of 1934 to mean, except as provided in paragraph (a)(4)(iii) of
the rule, any person that is (1) A natural person resident in the
United States (Rule 240.3a71-3(a)(4)(i)(A)); (2) A partnership,
corporation, trust, investment vehicle, or other legal person
organized, incorporated, or established under the laws of the United
States or having its principal place of business in the United
States (Rule 240.3a71-3(a)(4)(i)(B)); (3) An account (whether
discretionary or non-discretionary) of a U.S. person (Rule 240.3a71-
3(a)(4)(i)(C)); or (4) An estate of a decedent who was a resident of
the United States at the time of death(Rule 240.3a71-3(a)(4)(i)(D)).
Paragraph (a)(4)(ii) of SEC Rule 240.3a71-3 also defines, for
purposes of that section, ``principal place of business'' to mean
the location from which the officers, partners, or managers of the
legal person primarily direct, control, and coordinate the
activities of the legal person. With respect to an externally
managed investment vehicle, this location is the office from which
the manager of the vehicle primarily directs, controls, and
coordinates the investment activities of the vehicle.
Paragraph (a)(4)(iii) of SEC Rule 240.3a71-3 states that the
term ``U.S. person'' does not include the International Monetary
Fund, the International Bank for Reconstruction and Development, the
Inter-American Development Bank, the Asian Development Bank, the
African Development Bank, the United Nations, and their agencies and
pension plans, and any other similar international organizations,
their agencies and pension plans.
Paragraph (a)(4)(iv) of SEC Rule 240.3a71-3 states that a person
shall not be required to consider its counterparty to a security-
based swap to be a U.S. person if such person receives a
representation from the counterparty that the counterparty does not
satisfy the criteria set forth in paragraph (a)(4)(i) of that
section, unless such person knows or has reason to know that the
representation is not accurate; for the purposes of this final rule
a person would have reason to know the representation is not
accurate if a reasonable person should know, under all of the facts
of which the person is aware, that it is not accurate.
See Application of ``Security-Based Swap Dealer'' and ``Major
Security-Based Swap Participant'' Definitions to Cross-Border
Security-Based Swap Activities; Final rule; interpretation
(Republication), 79 FR 47371 (Aug. 12, 2014).
---------------------------------------------------------------------------
The Proposed Rule would define a ``U.S. person'' for purposes of
the cross-border application of the margin rules to mean:
(1) Any natural person who is a resident of the United States
(Proposed Rule Sec. 23.160(a)(10)(i));
(2) Any estate of a decedent who was a resident of the United
States at the time of death (Proposed Rule Sec. 23.160(a)(10)(ii));
(3) Any corporation, partnership, limited liability company,
business or other trust, association, joint-stock company, fund or any
form of entity similar to any of the foregoing (other than an entity
described in paragraph (a)(10)(iv) or (v) of proposed Sec. 23.160) (a
legal entity), in each case that is organized or incorporated under the
laws of the United States or having its principal place of business in
the United States, including any branch of the legal entity (Proposed
Rule Sec. 23.160(a)(10)(iii));
(4) Any pension plan for the employees, officers or principals of a
legal entity described in paragraph (a)(10)(iii) of proposed Sec.
23.160, unless the pension plan is primarily for foreign employees of
such entity (Proposed Rule Sec. 23.160(a)(10)(iv));
(5) Any trust governed by the laws of a state or other jurisdiction
in the United States, if a court within the United States is able to
exercise primary supervision over the administration of the trust
(Proposed Rule Sec. 23.160(a)(10)(v));
(6) Any legal entity (other than a limited liability company,
limited liability partnership or similar entity where all of the owners
of the entity have limited liability) owned by one or more persons
described in paragraphs (a)(10)(i) through (a)(10)(v) of proposed Sec.
23.160 who bear(s) unlimited responsibility for the obligations and
liabilities of the legal entity, including any branch of the legal
entity (Proposed Rule Sec. 23.160(a)(10)(vi)); and
(7) Any individual account or joint account (discretionary or not)
where the beneficial owner (or one of the beneficial owners in the case
of a joint account) is a person described in paragraphs (a)(10)(i)
through (a)(10)(vi) of proposed Sec. 23.160 (Proposed Rule Sec.
23.160(a)(10)(vii)).\47\
---------------------------------------------------------------------------
\47\ See Sec. 23.160(a)(10) of the Proposed Rule.
---------------------------------------------------------------------------
A non-U.S. person is defined to be any person that is not a U.S.
person.\48\
---------------------------------------------------------------------------
\48\ See Sec. 23.160(a)(5) of the Proposed Rule.
---------------------------------------------------------------------------
The proposed definition is generally consistent with the definition
of this term set forth in the Guidance, with certain exceptions
discussed below.
Prongs (1), (2), (3), (4), (5), and (7) (Proposed Rule Sec.
23.160(a)(10)(i), (ii), (iii), (iv), (v), and (vii)) identify certain
persons as a ``U.S. person'' by virtue of their domicile or
organization within the United States. The Commission has traditionally
looked to where a legal entity is organized or incorporated (or in the
case of a natural person, where he or she resides) to determine whether
it
[[Page 41383]]
is a U.S. person.\49\ In the Commission's view, these persons--by
virtue of their decision to organize or locate in the United States and
because they are likely to have significant financial and legal
relationships in the United States--are appropriately included within
the definition of ``U.S. person'' for purposes of the proposed cross-
border margin framework.
---------------------------------------------------------------------------
\49\ See, e.g., 17 CFR 4.7(a)(1)(iv) (defining ``Non-United
States person'' for purposes of part 4 of the Commission regulations
relating to commodity pool operators).
---------------------------------------------------------------------------
Under prong (3) (Proposed Rule Sec. 23.160(a)(10)(iii)),
consistent with its traditional approach, the Commission proposes to
define ``U.S. person'' also to include persons that are organized or
incorporated outside the United States, but have their principal place
of business in the United States. For purposes of this prong, the
Commission proposes to interpret ``principal place of business'' to
mean the location from which the officers, partners, or managers of the
legal person primarily direct, control, and coordinate the activities
of the legal person. This interpretation is consistent with the Supreme
Court's decision in Hertz Corp. v. Friend, which described a
corporation's principal place of business, for purposes of diversity
jurisdiction, as the ``place where the corporation's high level
officers direct, control, and coordinate the corporation's
activities.'' \50\
---------------------------------------------------------------------------
\50\ See Hertz Corp. v. Friend, 559 U.S. 77, 80 (2010).
---------------------------------------------------------------------------
The Commission is of the view that the application of the principal
place of business concept to a fund may require consideration of
additional factors beyond those applicable to operating companies. In
the case of a fund, the Commission notes that the senior personnel that
direct, control, and coordinate a fund's activities are generally not
the persons who are named as directors or officers of the fund, but
rather are persons who work for the fund's investment adviser or the
fund's promoter. Therefore, consistent with the Guidance, the
Commission generally would consider the principal place of business of
a fund to be in the United States if the senior personnel responsible
for either (1) the formation and promotion of the fund or (2) the
implementation of the fund's investment strategy are located in the
United States, depending on the facts and circumstances that are
relevant to determining the center of direction, control and
coordination of the fund.\51\
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\51\ See the Guidance, 78 FR 45309-45312, for guidance on
application of the principal place of business test to funds and
other collective investment vehicles in the context of cross-border
swaps, including examples of how the Commission's approach could
apply to a consideration of whether the ``principal place of
business'' of a fund is in the United States in particular
hypothetical situations. However, because of variations in the
structure of collective investment vehicles as well as the factors
that are relevant to the consideration of whether a collective
investment vehicle has its principal place of business in the United
States under the Guidance, these examples were included in the
Guidance for illustrative purposes only.
---------------------------------------------------------------------------
Prong (6) (Proposed Rule Sec. 23.160(a)(10)(vi)) of the proposed
definition of ``U.S. person'' would include certain legal entities
owned by one or more U.S. person(s) and for which such person(s) bear
unlimited responsibility for the obligations and liabilities of the
legal entity. As noted above, the Guidance included a similar concept
in the definition of the term ``U.S. person;'' however the definition
contained in the Guidance would generally characterize a legal entity
as a U.S. person if the entity were ``directly or indirectly majority-
owned'' by one or more persons falling within the term ``U.S. person''
and such U.S. person(s) bears unlimited responsibility for the
obligations and liabilities of the legal entity. Where a U.S. person
serves as a financial backstop for all of a legal entity's obligations
and liabilities, creditors and counterparties look to the U.S. person
when assessing the risk in dealing with the entity, regardless of the
amount of equity owned by the U.S. person. Under such circumstances,
because the U.S. person has unlimited responsibility for all of the
legal entity's obligations, the Commission believes that the legal
entity should be deemed to be a U.S. person.
The Proposed Rule would not include the U.S. majority-ownership
prong that was included in the Guidance (50% U.S. person ownership of a
fund or other collective investment vehicle).\52\ Some commenters have
argued that a majority ownership test for funds should not be included
on the basis that ownership alone is not indicative of whether the
activities of a non-U.S. fund with a non-U.S.-based manager has a
direct and significant effect on the U.S. financial system, and that it
is difficult to determine the identity of the beneficial owner of a
fund in certain fund structures (e.g., fund-of-funds or master-feeder).
Alternatively, an argument for retaining the majority-ownership test
would be that many of these funds have large U.S. investors, who can be
adversely impacted in the event of a counterparty default. On balance,
the Commission believes the majority-ownership test should not be
included in the definition of U.S. person for purposes of the margin
rules. Non-U.S. funds with U.S. majority-ownership, even if treated as
a non-U.S. person, would be excluded from the Commission's margin rules
only in limited circumstances (namely, when these funds trade with a
non-U.S. CSE that is not a consolidated subsidiary of a U.S. entity or
a U.S. branch of a non-U.S. CSE). This, coupled with the implementation
issues raised by commenters, persuades the Commission not to propose to
define those funds that are majority-owned by U.S. persons (and that
would otherwise not fall within the definition of a ``U.S. person''),
as U.S. persons.
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\52\ The Commission's definition of the term ``U.S. person'' as
used in the Guidance included a prong (iv) which covered ``any
commodity pool, pooled account, or collective investment vehicle
(whether or not it is organized or incorporated in the United
States) of which a majority ownership is held, directly or
indirectly, by a U.S. person(s).''
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The proposed definition of ``U.S. person'' determines a legal
person's status at the entity level and thus includes any foreign
operations that are part of the U.S. legal person, regardless of their
location. Consistent with this approach, the definition of ``U.S.
person'' under the Proposed Rule would include a foreign branch of a
U.S. person.
Under the proposed definition, the status of a legal person as a
U.S. person would not affect whether a separately incorporated or
organized legal person in the affiliated corporate group is a U.S.
person. Therefore, an affiliate or a subsidiary of a U.S. person that
is organized or incorporated in a non-U.S. jurisdiction would not be
deemed a ``U.S. person'' solely by virtue of its relationship with a
U.S. person.
The proposed ``U.S. person'' definition does not include the
prefatory phrase ``includes, but is not limited to'' that was included
in the Guidance. The Commission believes that this prefatory phrase
should not be included in order to provide legal certainty regarding
the application of U.S. margin requirements to cross-border swaps.
The Commission understands that the information necessary for a
swap counterparty to accurately assess the status of its counterparties
as U.S. persons may not be available, or may be available only through
overly burdensome due diligence. For this reason, the Commission
believes that a swap counterparty generally should be permitted to
reasonably rely on its counterparty's written representation in
determining whether the counterparty is within the definition of the
term ``U.S. person.'' In this context, the Commission's policy is to
interpret the ``reasonable'' standard to be satisfied
[[Page 41384]]
when a party to a swap conducts reasonable due diligence on its
counterparties, with what is reasonable in a particular situation to
depend on the relevant facts and circumstances.\53\
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\53\ The Commission notes that under the External Business
Conduct Rules, a SD or MSP generally meets its due diligence
obligations if it reasonably relies on counterparty representations,
absent indications to the contrary. As in the case of the External
Business Rules, the Commission believes that allowing for reasonable
reliance on counterparty representations encourages objectivity and
avoids subjective evaluations, which in turn facilitates a more
consistent and foreseeable determination of whether a person is
within the Commission's interpretation of the term ``U.S. person.''
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Under the Proposed Rule, a ``non-U.S. person'' is any person that
is not a ``U.S. person'' (as defined in the Proposed Rule).\54\
References in this preamble to a ``U.S. counterparty'' are to a swap
counterparty that is a ``U.S. person'' under the Proposed Rule, and
references to a ``non-U.S. counterparty'' are to a swap counterparty
that is a ``non-U.S. person'' under the Proposed Rule.\55\
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\54\ See Sec. 23.160(a)(5) of the Proposed Rule.
\55\ Under the Proposed Rule, a ``U.S. CSE'' is a CSE that is a
U.S. person. The term ``U.S. CSE'' includes a foreign branch of a
U.S. CSE. A ``non-U.S. CSE'' is any CSE that is not a U.S. person.
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Request for Comment. The Commission requests comment on all aspects
of the proposed definition of ``U.S. person,'' including the following:
1. Does the proposed definition of ``U.S. person'' appropriately
identify all individuals or entities that should be designated as U.S.
persons? Is the proposed definition too narrow or broad? Why?
2. Should the definition of ``U.S. person'' include the U.S.
majority-ownership prong for funds and other collective investment
vehicles, as set forth in the Guidance? Please explain.
3. Should the definition of ``U.S. person'' include certain legal
entities owned by one or more persons described in prongs (1), (2),
(3), (4), or (5) (Proposed Rule Sec. 23.160(a)(10)(i), (ii), (iii),
(iv) or (v)) of the proposed U.S. person definition who bear(s)
unlimited responsibility for the obligations and liabilities of the
legal entity? Please explain.
4. Should the definition of ``U.S. person'' be identical to the
definition of ``U.S. person'' that the SEC adopted in its August 2014
rulemaking? For example:
a. Should the definition of ``U.S. person'' exclude certain
designated (and any similar) international organizations, their
agencies and pension plans, with headquarters in the United States?
b. Should the Commission define the term ``principal place of
business'' as the location from which the officers, partners, or
managers of a legal person primarily direct, control, and coordinate
the activities of the legal person, and specify that in the case of an
externally managed investment vehicle, this location is the office from
which the manager of the vehicle primarily directs, controls, and
coordinates the investment activities of the vehicle?
c. Should the Commission delete prong (6) (Proposed Rule Sec.
23.160(a)(10)(vi)) of the proposed definition of ``U.S. person'' which
includes certain legal entities owned by one or more U.S. person(s) and
for which such person(s) bear unlimited responsibility for the
obligations and liabilities of the legal entity and instead treat such
arrangements as recourse guarantees?
d. Should any other changes be made to the proposed definition of
``U.S. person'' to conform it to the definition adopted by the SEC?
2. Guarantees
Under the Proposed Rule, uncleared swaps of non-U.S. CSEs, where
the non-U.S. CSE's obligations under the uncleared swap are guaranteed
by a U.S. person, would be treated the same as uncleared swaps of a
U.S. CSE. The Commission believes that this treatment is appropriate
because the swap of a non-U.S. CSE whose obligations under the swap are
guaranteed by a U.S. person is identical, in relevant respects, to a
swap entered directly by a U.S. person. That is, by virtue of the
guarantee, the U.S. guarantor is responsible for the swap it guarantees
in a manner similar to a direct counterparty to the swap. The U.S.
person guarantor effectively acts jointly with the non-U.S. person
whose swap it guarantees to engage in swaps transactions. The
counterparty, pursuant to the recourse guarantee, looks to both the
direct non-U.S. counterparty and its U.S. guarantor in entering into
the swap.
The Proposed Rule would define the term ``guarantee'' as an
arrangement pursuant to which one party to a swap transaction with a
non-U.S. counterparty has rights of recourse against a U.S. person
guarantor (whether such guarantor is affiliated with the non-U.S.
counterparty or is an unaffiliated third party) with respect to the
non-U.S. counterparty's obligations under the relevant swap
transaction. Under the Commission's proposal, a party to a swap
transaction has rights of recourse against the U.S. person guarantor if
the party has a conditional or unconditional legally enforceable right,
in whole or in part, to receive payments from, or otherwise collect
from, the U.S. person in connection with the non-U.S. person's
obligations under the swap.\56\ Accordingly, the term ``guarantee''
would apply whenever a party to the swap has a legally enforceable
right of recourse against the U.S. guarantor of a non-U.S.
counterparty's obligations under the relevant swap, regardless of
whether such right of recourse is conditioned upon the non-U.S.
counterparty's insolvency or failure to meet its obligations under the
relevant swap, and regardless of whether the counterparty seeking to
enforce the guarantee is required to make a demand for payment or
performance from the non-U.S. counterparty before proceeding against
the U.S. guarantor.
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\56\ See Sec. 23.160(a)(2) of the Proposed Rule.
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Under the Proposed Rule, the terms of the guarantee need not
necessarily be included within the swap documentation or even otherwise
reduced to writing (so long as legally enforceable rights are created
under the laws of the relevant jurisdiction), provided that a swap
counterparty has a conditional or unconditional legally enforceable
right, in whole or in part, to receive payments from, or otherwise
collect from, the U.S. person in connection with the non-U.S. person's
obligations under the swap.\57\
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\57\ Further, the definition of ``guarantee'' is intended to
encompass any swap of a non-U.S. person where the counterparty to
the swap has rights of recourse, regardless of the form of the
arrangement, against at least one U.S. person (either individually
or jointly or severally with others) for the non-U.S. person's
obligations under the swap.
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Further, the Commission's proposed definition of guarantee would
not be affected by whether the U.S. guarantor is an affiliate of the
non-U.S. CSE because, in each case, the swap counterparty has a
conditional or unconditional legally enforceable right, in whole or in
part, to receive payments from, or otherwise collect from, the U.S.
person in connection with the non-U.S. person's obligations under the
swap.
The Commission notes that the definition of ``guarantee'' in the
Proposed Rule is narrower in scope than the one used in the
Guidance.\58\ In proposing this definition, the Commission is cognizant
that many other types of financial arrangements or support, other than
a guarantee as defined in the Proposed Rule, may be provided by a U.S.
person to a non-U.S. CSE (e.g., keepwells and liquidity puts,
[[Page 41385]]
certain types of indemnity agreements, master trust agreements,
liability or loss transfer or sharing agreements). The Commission
understands that these other financial arrangements or support transfer
risk directly back to the U.S. financial system, with possible
significant adverse effects, in a manner similar to a guarantee with a
direct recourse to a U.S. person. The Commission, however, believes
that application of a narrower definition of guarantee for purposes of
identifying those uncleared swaps that should be treated like uncleared
swaps of a U.S. CSEs would reduce the potential for conflict with the
non-U.S. CSE's home regulator. Moreover, the Commission believes that a
non-U.S. CSE that has been provided with financial arrangements or
support from a U.S. person that do not fall within the term
``guarantee'' as defined in the Proposed Rule in many cases is likely
to meet the definition of a ``Foreign Consolidated Subsidiary'' and
therefore, as discussed in the next section, would be subject to the
Commission's margin requirements, with substituted compliance (but not
the Exclusion) available. Therefore, the Commission believes that a
narrow definition of guarantee would achieve a more workable framework
for non-U.S. CSEs, without undermining protection of U.S. persons and
U.S. financial system.
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\58\ In the Guidance, the Commission interpreted the term
``guarantee'' generally to include not only traditional guarantees
of payment or performance of the related swaps, but also other
formal arrangements that, in view of all the facts and
circumstances, support the non-U.S. person's ability to pay or
perform its swap obligations with respect to its swaps.
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The Commission is aware that some non-U.S. CSEs removed guarantees
in order to fall outside the scope of certain Dodd-Frank requirements.
The proposed coverage of foreign subsidiaries of a U.S. person as a
``Foreign Consolidated Subsidiary,'' which is discussed in the next
section, and whose swaps would not be eligible for the Exclusion under
any circumstances (as discussed in section II.C.3. below), would
address the concern that even without a guarantee, as defined under the
Guidance or in the Proposed Rule, foreign subsidiaries of a U.S. person
with a substantial nexus to the U.S. financial system are adequately
covered by the margin requirements.
Request for Comment. The Commission seeks comment on all aspects of
the proposed definition of ``guarantee,'' including the following:
1. Should the broader use of the term ``guarantee'' in the Guidance
be used instead of the proposed definition, and if so, why? Would an
alternative definition be more effective in light of the purpose of the
margin requirements, and if so, why?
2. Is the Commission's assumption that a non-U.S. CSE is likely to
meet the definition of a ``Foreign Consolidated Subsidiary'' when it
has been provided with financial arrangements or support from a U.S.
person that do not fall within the term ``guarantee'' (as defined in
the Proposed Rule) correct? If not, why not?
3. Is it appropriate to distinguish, for purposes of the Proposed
Rule, between those arrangements under which a party to the swap has a
legally enforceable right of recourse against the U.S. guarantor and
those arrangements where there is not direct recourse against a U.S.
guarantor?
3. Foreign Consolidated Subsidiaries
The Proposed Rule uses the term ``Foreign Consolidated Subsidiary''
in order to identify swaps of those non-U.S. CSEs whose obligations
under the relevant uncleared swap are not guaranteed by a U.S. person
but that raise substantial supervisory concern in the United States, as
a result of the possible negative impact on their U.S. parent entities
and the U.S. financial system. Consolidated financial statements report
the financial position, results of operations and statement of cash
flows of a parent entity together with subsidiaries in which the parent
entity has a controlling financial interest (which are required to be
consolidated under U.S. generally accepted accounting principles
(``GAAP'')). In the Commission's view, the fact that an entity is
included in the consolidated financial statements of another is an
indication of potential risk to the other entity that offers a clear
and objective standard for the application of margin requirements.
Specifically, the Proposed Rule defines the term ``Foreign
Consolidated Subsidiary'' as a non-U.S. CSE in which an ultimate parent
entity \59\ that is a U.S. person has a controlling interest, in
accordance with U.S. GAAP, such that the U.S. ultimate parent entity
includes the non-U.S. CSE's operating results, financial position and
statement of cash flows in the U.S. ultimate parent entity's
consolidated financial statements, in accordance with U.S. GAAP.
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\59\ Under the Proposed Rule, the term ``ultimate parent
entity'' means the parent entity in a consolidated group in which
none of the other entities in the consolidated group has a
controlling interest, in accordance with U.S. GAAP.
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In the case of Foreign Consolidated Subsidiaries whose obligations
under the relevant swap are not guaranteed by a U.S. person,
substituted compliance would be broadly available under the Proposed
Rule to the same extent as other non-U.S. CSEs whose obligations under
the relevant swap are not guaranteed by a U.S. person, even though the
financial position, operating results, and statement of cash flows of
the Foreign Consolidated Subsidiary have a direct impact on the
financial position, risk profile and market value of the consolidated
group (which includes a U.S. parent entity); however, the Exclusion
would not be available for swaps with a Foreign Consolidated Subsidiary
because their swap activities have a direct impact on the financial
position, risk profile, and market value of a U.S. parent entity that
consolidates the Foreign Consolidated Subsidiary's financial statements
and a potential spill-over effect on the U.S. financial system.\60\
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\60\ The Exclusion under the Proposed Rule is discussed in
section II.C.3. below.
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The Commission believes that not extending the Exclusion to Foreign
Consolidated Subsidiaries under the Proposed Rule would be appropriate
because the U.S. parent entity that consolidates the Foreign
Consolidated Subsidiary's financial statements may have an incentive to
provide support to a Foreign Consolidated Subsidiary, or the Foreign
Consolidated Subsidiary may pose financial risk to the U.S. parent
entity. In addition, market participants (including counterparties) may
have the expectation that the parent entity will provide support to the
Foreign Consolidated Subsidiary although, whether the U.S. parent
entity actually steps in to fulfill the obligations of the Foreign
Consolidated Subsidiary would depend on a business judgment rather than
a legal obligation.\61\ Notably, although consolidation has a direct
impact on the U.S. parent entity, the U.S. parent entity stands in a
different legal position than a U.S. guarantor because, in the absence
of a direct recourse guarantee, the U.S. parent entity has no legal
obligation to pay or perform under the relevant swap if the Foreign
Consolidated Subsidiary defaults on its swap obligations. Therefore,
the Commission believes that, in the absence of a direct recourse
[[Page 41386]]
guarantee from a U.S. person, uncleared swaps with a Foreign
Consolidated Subsidiary should not be treated the same as swaps with a
U.S. CSE or a non-U.S. CSE whose obligations under the relevant swap
are guaranteed by a U.S. person.
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\61\ For example, when General Electric announced on April 10,
2015 that it would guarantee repayment of approximately $210 billion
of debt from GE Capital, the prices of some GE Capital bonds
reportedly went up as much as 1.5% even though previously the parent
company had provided other support but not an unconditional
guarantee. According to an article in the Wall Street Journal,
Russell Solomon, an analyst at Moody's Investors Service, stated:
``We've always assumed that GE would support GE Capital almost no
matter what . . . But now this says they'll support it no matter
what.'' Similarly, the article reports that Standard & Poor's Rating
Services stated that General Electric's decision to back GE Capital
debt ``strengthens our view of GE's support, by buttressing the
parent's proven willingness and ability to support its subsidiary
with a contractual obligation to do so.'' See Mike Cherney and Katy
Burne, WSJ, Apr. 10, 2015, available at http://www.wsj.com/articles/ges-move-alters-the-bond-market-1428707800.
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The Commission considered proposing a ``control'' test similar to
that proposed by the Prudential Regulators. The ``control test'' in the
Prudential Regulators' proposal is based solely on an entity's
ownership level and control of the election of the board,\62\ which may
or may not clearly identify, depending on the facts and circumstances,
those non-U.S. CSEs that are likely to raise greater supervisory
concerns than other non-U.S. CSEs (in each case whose obligations under
the relevant swap are not guaranteed by a U.S. person). Therefore, the
Commission is using a ``consolidation test'' rather than a ``control
test'' in the proposed definition of a ``Foreign Consolidated
Subsidiary'' in order to provide a clear, bright-line test for
identifying those non-U.S. CSEs whose uncleared swaps are likely to
raise greater supervisory concerns.
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\62\ Under the Prudential Regulators' proposal, the term
``control'' of another company means: (1) Ownership, control, or
power to vote 25 percent or more of a class of voting securities of
the company, directly or indirectly or acting through one or more
other persons; (2) ownership or control of 25 percent or more of the
total equity of the company, directly or indirectly or acting
through one or more other persons; or (3) control in any manner of
the election of a majority of the directors or trustees of the
company.
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Request for Comment. The Commission seeks comment on all aspects of
the Proposed Rule's definition of ``Foreign Consolidated Subsidiary,''
including:
1. Does the proposed definition of a ``Foreign Consolidated
Subsidiary'' appropriately capture those non-U.S. CSEs that should not
be eligible for the Exclusion? If not, please explain and provide an
alternative(s).
2. The consolidation test in the definition of a ``Foreign
Consolidated Subsidiary'' is intended to provide a clear, bright-line
test for identifying those non-U.S. CSEs whose uncleared swaps are
likely to raise greater supervisory concerns relative to other non-
guaranteed non-U.S. CSEs. Should the proposed consolidation test be
used in lieu of the control test proposed by the Prudential Regulators?
Why or why not? Should the Commission use both a consolidation test and
a control test? If so, please explain. Would any other tests or
criteria be more appropriate? If so, please explain what tests or
criteria should be used and why they are more appropriate.
3. Under the definition of Foreign Consolidated Subsidiary, the
Commission is using U.S. GAAP as the standard for purposes of
determining whether an entity consolidates another entity. In reviewing
registration data of CSEs, the Commission believes that this definition
balances the goals of the statute and the burdens placed on the
industry; however, should the Commission also consider including in the
definition of Foreign Consolidated Subsidiary, non-U.S. CSEs whose U.S.
ultimate parent entity uses a different standard than U.S. GAAP in
determining whether a parent entity must consolidate an entity for
financial reporting purposes? If so, please explain why.
4. Should the Commission also include in the definition of
``Foreign Consolidated Subsidiary'' those non-U.S. CSEs whose U.S.
ultimate parent entity is not required to prepare consolidated
financial statements under any accounting standard or for any other
reason (e.g., the U.S. ultimate parent entity is not a public company
under federal securities laws and is not required to prepare
consolidated financial statements by private investors or debtholders
as a condition to investing or financing), but which would consolidate
the non-U.S. CSE if it were required to prepare consolidated financial
statements in accordance with U.S. GAAP? If so, please explain why?
5. Under the definition of Foreign Consolidated Subsidiary, the
Commission is only including non-U.S. CSEs whose financial statements
are consolidated by an ultimate parent entity that is a U.S. person.
Should the Commission also include immediate and intermediate parent
entities of the non-U.S. CSE in the definition? If so, please explain
why?
C. Applicability of Margin Requirements to Cross-Border Uncleared Swaps
The following section describes the application of the Commission's
margin rules to cross-border swaps between CSEs and various types of
counterparties, as well as when the Exclusion from the Commission's
margin requirements would be applicable. Table A to this release (see
below) illustrates how the Proposed Rule would apply to specific
transactions between various types of counterparties, and should be
read in conjunction with the rest of the preamble and the text of the
Proposed Rule.
1. Uncleared Swaps of U.S. CSEs or Non-U.S. CSEs Whose Obligations
Under the Relevant Swap Are Guaranteed by a U.S. Person
Under the Proposed Rule, the Commission's margin rules \63\ would
apply to all uncleared swaps of U.S. CSEs,\64\ with no exclusions. By
their nature, U.S. CSEs have a significant impact on the U.S. swaps
market, and the Commission therefore has a strong interest in ensuring
their viability. However, substituted compliance would be available
with respect to initial margin posted to (but not collected from) any
non-U.S. counterparty (including a non-U.S. CSE) whose obligations
under the uncleared swap are not guaranteed by a U.S. person. The
Commission proposes to provide substituted compliance in this situation
(assuming that the non-U.S. counterparty is subject to comparable
margin requirements in a foreign jurisdiction) because the swap
counterparty is a non-U.S. person and where its swap obligations are
not guaranteed by a U.S. person, the foreign regulator may have equal
or greater interest in the collection of margin by the non-U.S.
counterparty. However, substituted compliance would not apply to the
collection of margin by the U.S. CSE from the non-U.S. counterparty, as
the Commission has a significant regulatory interest in the collection
of margin by the U.S. CSE, which protects the U.S. CSE and the U.S.
financial system from counterparty credit risk.
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\63\ The Commission's Proposed Margin Rules are set forth in
proposed Sec. Sec. 23.150 through 23.159 of part 23 of the
Commission's regulations, proposed as 17 CFR 23.150 through 23.159.
\64\ Foreign branches of a U.S. CSE are treated as part of the
related principal entity and hence an uncleared swap executed by or
through a foreign branch would be treated as an uncleared swap of a
U.S. CSE.
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The same treatment that applies to U.S. CSEs would also apply to a
non-U.S. CSE whose obligations under the relevant swap are guaranteed
by a U.S. person. The Commission believes that this result is
appropriate because the economics of the transaction are no different
from a trade entered directly by the U.S. guarantor, as discussed in
section II.B.2. above. In addition, the Commission believes that
treating uncleared swaps of these entities differently from those of
U.S. CSEs would lead to unwarranted competitive distortions. That is,
the non-U.S. CSE that enters into a swap with a direct recourse
guarantee from a U.S. person would be positioned to benefit from more
competitive pricing when dealing with non-U.S. counterparties (as
compared to U.S. CSEs) to the extent
[[Page 41387]]
that either substituted compliance or the Exclusion would be available.
The Commission believes that requiring U.S. CSEs and non-U.S. CSEs
whose obligations under the relevant swap are guaranteed by a U.S.
person to comply with its margin requirements, with only limited
substituted compliance for margin posted to (but not collected from)
any non-U.S. counterparty (including a non-U.S. CSE) whose obligations
under the uncleared swap are not guaranteed by a U.S. person, would
help ensure their safety and soundness and support the stability of the
U.S. financial markets, reducing the likelihood of another financial
crisis affecting the U.S. economy.
Request for Comment. The Commission requests comments on all
aspects of the proposed treatment of uncleared swaps of U.S. CSEs and/
or non-U.S. CSEs whose obligations under the relevant swap are
guaranteed by a U.S. person, including:
1. Is the Proposed Rule's treatment of U.S. CSEs and non-U.S. CSEs
whose obligations under the swap are guaranteed by a U.S. person
appropriate? If not, please explain. If a different treatment should
apply to U.S. CSEs or non-U.S. CSEs whose obligations under the swap
are guaranteed by a U.S. person, please describe the alternative
treatment that should apply and explain why.
2. What are the competitive implications of the proposed treatment
of uncleared swaps of non-U.S. CSEs whose obligations under the swap
are guaranteed by a U.S. person?
3. Does the proposed treatment of non-U.S. CSEs whose obligations
under the swap are guaranteed by a U.S. person appropriately take into
account the supervisory interest of a non-U.S. CSE's home jurisdiction?
2. Uncleared Swaps of Non-U.S. CSEs (Including Foreign Consolidated
Subsidiaries) Whose Obligations Under the Relevant Swap Are Not
Guaranteed by a U.S. Person
Under the Proposed Rule, non-U.S. CSEs (including Foreign
Consolidated Subsidiaries) whose obligations under the relevant
uncleared swap are not guaranteed by a U.S. person may avail themselves
of substituted compliance to a greater extent than if their obligations
under the swap were guaranteed by a U.S. person. The Commission
believes that this approach is appropriate since a non-U.S. CSE whose
swap obligations are not guaranteed by a U.S. person (including a
Foreign Consolidated Subsidiary), on balance, may implicate equal or
greater supervisory concerns on the part of a foreign regulator
relative to the supervisory interest of the Commission (in comparison
to U.S. CSEs or non-U.S. CSEs whose obligations under the relevant swap
are guaranteed by a U.S. person, because the Commission has a
significant regulatory interest in uncleared swaps of these CSEs).
Under the Proposed Rule, where the obligations of a non-U.S. CSE
(including a Foreign Consolidated Subsidiary) under the relevant swap
are not guaranteed by a U.S. person, substituted compliance would be
available with respect to its uncleared swaps with any counterparty,
except where the counterparty is a U.S. CSE or a non-U.S. CSE whose
obligations under the relevant swap are guaranteed by a U.S.
person.\65\
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\65\ With respect to uncleared swaps with a U.S. CSE or a non-
U.S. CSE whose obligations under the relevant swap are guaranteed by
a U.S. person, substituted compliance would only be available for
initial margin collected by the non-U.S. CSE whose obligations under
the relevant swap are not guaranteed by a U.S. person, as discussed
in section II.C.1.
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Further, uncleared swaps entered into by Foreign Consolidated
Subsidiaries would not be eligible for the Exclusion under the Proposed
Rule. As described above, the financial position, operating results,
and statement of cash flows of a Foreign Consolidated Subsidiary are
incorporated into the financial statements of the U.S. ultimate parent
entity and therefore, likely have a direct impact on the consolidated
entity's financial position, risk profile, and market value. Under
these circumstances, and given the importance of margin in mitigating
counterparty credit risk, the Commission has greater supervisory
concerns with respect to the uncleared swaps of a Foreign Consolidated
Subsidiary than other non-U.S. CSEs. Therefore, the Commission believes
that extending the Exclusion to a Foreign Consolidated Subsidiary would
not further the goal of ensuring the safety and soundness of a CSE and
the stability of U.S. financial markets. The Commission is also
concerned that extending the Exclusion to Foreign Consolidated
Subsidiaries would encourage a U.S. entity to use their non-U.S.
subsidiaries to conduct their swap activities with non-U.S.
counterparties, possibly bifurcating the U.S. entity's U.S. and non-
U.S.-facing businesses, and potentially resulting in separate pools of
liquidity.
Request for Comment. The Commission requests comments on all
aspects of the proposed treatment of uncleared swaps of non-U.S. CSEs
(including Foreign Consolidated Subsidiaries) whose obligations under
the relevant swap are not guaranteed by a U.S. person, including:
1. The Proposed Rule makes substituted compliance more broadly
available to a Foreign Consolidated Subsidiary whose obligations under
the relevant swap are not guaranteed by a U.S. person than a non-U.S.
CSE (including a Foreign Consolidated Subsidiary) whose obligations
under the relevant swap are guaranteed by a U.S. person. Should Foreign
Consolidated Subsidiaries be treated the same as non-U.S. CSEs that are
guaranteed by a U.S. person and if not, what treatment is appropriate?
2. What are the competitive implications of the proposed treatment
of Foreign Consolidated Subsidiaries (relative to other non-U.S. CSEs)?
Does the proposed treatment appropriately take into account the
supervisory interest of a non-U.S. CSE's home jurisdiction?
3. Exclusion for Uncleared Swaps of Non-U.S. CSEs Where Neither
Counterparty's Obligations Under the Relevant Swap Are Guaranteed by a
U.S. Person and Neither Counterparty Is a Foreign Consolidated
Subsidiary Nor a U.S. Branch of a Non-U.S. CSE
Under the Proposed Rule, an uncleared swap entered into by a non-
U.S. CSE with a non-U.S. person counterparty (including a non-U.S. CSE)
would be excluded from the Commission's margin rules, provided that
neither counterparty's obligations under the relevant swap are
guaranteed by a U.S. person and neither counterparty is a Foreign
Consolidated Subsidiary nor a U.S. branch of a non-U.S. CSE.\66\
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\66\ See Sec. 23.160(b)(2)(ii) of the Proposed Rule.
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As discussed above, the Commission believes that, given the
importance of margin to the safety and soundness of a CSE, as a general
matter, margin requirements should apply to the uncleared swaps of a
CSE, without regard to the domicile of the counterparty or where the
trade is executed. At the same time, the Commission believes that it is
appropriate to make a limited exception to this principle of firm-wide
application of margin requirements in the cross-border context,
consistent with section 4s(e) of the CEA \67\ and comity principles, so
as to exclude a narrow class of uncleared swaps involving a
[[Page 41388]]
non-U.S. CSE and a non-U.S. counterparty.
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\67\ Section 4s(e)(3)(A) of the CEA, 7 U.S.C. 6s(e)(3)(A). The
section calls for, among other things, that margin requirements ``be
appropriate for the risks associated with the non-cleared swaps held
as a swap dealer or major market participant.''
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The Commission notes that a non-U.S. CSE that can avail itself of
the Exclusion would still be subject to the Commission's margin rules
with respect to all uncleared swaps not meeting the criteria for the
Exclusion, albeit with the possibility of substituted compliance. The
non-US CSE would also be subject to the Commission's capital
requirements, which, as proposed, would impose a capital charge for
uncollateralized exposures.\68\ Additionally, any excluded swaps would
most likely be covered by the margin requirements of another
jurisdiction that adheres to the BCBS-IOSCO framework.\69\
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\68\ See Capital Requirements of Swap Dealers and Major Swap
Participants, Notice of proposed rulemaking, 76 FR 27802 (May 12,
2011).
\69\ The non-U.S. CSE that qualifies for the exclusion would be
eligible for substituted compliance, with respect to all margin
requirements, if its counterparty to the uncleared swap is a U.S.
person that is not a CSE. If the uncleared swap is with a U.S. CSE,
substituted compliance would only be available with respect to
initial margin posed by the U.S. CSE counterparty.
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The Commission also recognizes that the supervisory interest of
foreign regulators in the uncleared swaps of non-U.S. CSEs (and their
non-U.S. counterparties) that are eligible for the Exclusion may equal
or exceed the supervisory interest of the United States in such
uncleared swaps. Both counterparties are domiciled outside the United
States and likely would be subject to the supervision of a foreign
regulator. As discussed above, the Commission believes that a workable
cross-border framework must take into account the interests of other
jurisdictions and balance those interests with the supervisory
interests of the United States in order to calibrate the application of
margin rules to non-U.S. CSEs' swaps with non-U.S. counterparties. Such
an approach would help mitigate the potential for conflicts with other
jurisdictions and ultimately promote global harmonization. For all of
the foregoing reasons, the Commission believes that it would be
appropriate to not apply the Commission's margin rules to uncleared
swaps meeting the criteria for the Exclusion.
The Commission acknowledges that similar mitigating factors and
comity considerations may apply to Foreign Consolidated Subsidiaries,
but as discussed above, a Foreign Consolidated Subsidiary's financial
position, operating results, and statement of cash flows are directly
reflected in its U.S. Ultimate Parent entity's financial statements,
which implicates greater supervisory concerns. Therefore, the
Commission believes that it has a greater regulatory interest in
Foreign Consolidated Subsidiaries than other non-U.S. CSEs (that are
not guaranteed by a U.S. person), and that the uncleared swaps of
Foreign Consolidated subsidiaries should not be excluded from the
margin requirements.
Further, the Commission believes that the uncleared swaps of a U.S.
branch of a non-U.S. CSE should not be excluded from the margin
requirements for the reasons discussed in the next section.
Request for Comment. The Commission is requesting comments on all
aspects of the proposed Exclusion, including:
1. In light of the mitigating factors cited above and the
Commission's supervisory interest in the safety and soundness of all
CSEs and the critical role that margin plays in helping ensure the
safety and soundness of CSEs, is the proposed Exclusion appropriate,
and if not, please explain why not? Is the scope of the Exclusion
appropriate, or should it be broader or narrower, and if so, why?
2. Under the Proposed Rule, uncleared swaps with a Foreign
Consolidated Subsidiary would not be eligible for the Exclusion from
the Commission's margin requirements. Should Foreign Consolidated
Subsidiaries be eligible for the Exclusion and if so, why?
4. U.S. Branches of Non-U.S. CSEs
The Proposed Rule treats uncleared swaps executed through or by a
U.S. branch of a non-U.S. CSE the same as those swaps of a non-U.S.
CSE, except that the Exclusion from the margin rules would not be
available to a U.S. branch of a non-U.S. CSE.
Generally speaking, because the risks posed by uncleared swaps are
borne by a CSE as a whole, it should not matter if the transaction is
entered by or through a U.S. branch or office within the United States.
Nevertheless, the Commission believes that extending the Exclusion (to
the extent than the Exclusion might otherwise apply to the non-U.S.
CSE, as discussed above) would not be appropriate in the case of
uncleared swaps executed by or through a U.S. branch of a non-U.S. CSE.
The Commission notes that non-U.S. CSEs can conduct their swap
dealing business within the United States utilizing a number of
different legal structures, including a U.S. subsidiary or a U.S.
branch or office. Excluding uncleared swaps conducted by or through
U.S. branches of non-U.S. CSEs would give these non-U.S. CSEs an unfair
advantage when dealing with non-U.S. clients relative to U.S. CSEs
(including those CSEs that are subsidiaries of foreign entities). That
is, a U.S. branch of a non-U.S. CSE that is permitted to operate
outside of the Commission's margin requirements would be able to offer
a more competitive price to non-U.S. clients than a U.S. CSE. The
Commission believes that when a non-U.S. CSE is conducting its swap
activities within the United States through a branch or office located
in the United States, it should be subject to U.S. margin laws.
However, the Commission also believes that, consistent with comity
principles, substituted compliance should be available for uncleared
swaps executed by or through a U.S. branch of a non-U.S. CSE whose
obligations under the relevant swap are not guaranteed by a U.S. person
with any counterparty (except where the counterparty is a U.S. CSE or a
non-U.S. CSE whose obligations under the relevant swap are guaranteed
by a U.S. person).\70\
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\70\ With respect to uncleared swaps with a U.S. CSE or a non-
U.S. CSE whose obligations under the relevant swap are guaranteed by
a U.S. person, substituted compliance would only be available for
initial margin collected by the U.S. branch of a non-U.S. CSE whose
obligations under the relevant swap are not guaranteed by a U.S.
person. See section II.C.1.
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Request for Comment. The Commission seeks comment on the Proposed
Rule's treatment of uncleared swaps conducted by or through a ``U.S.
branch of a non-U.S. CSE.'' In particular, the Commission requests
comment on the following questions:
1. How should the Commission determine whether a swap is executed
through or by a U.S. branch of a non-U.S. CSE for purposes of applying
the Commission's margin rules on a cross-border basis? Should the
Commission base the determination of whether the swap activity is
conducted at a U.S. branch of a non-U.S. CSE for purposes of applying
the Commission's margin rules on a cross-border basis on the same
analysis as is used in the Volcker rule? \71\
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\71\ Under the Volcker rule, personnel that arrange, negotiate,
or execute a purchase or sale conducted under the exemption for
trading activity of a foreign banking entity must be located outside
of the United States. See Prohibitions and Restrictions on
Proprietary Trading and Certain Interests in, and Relationships
With, Hedge Funds and Private Equity Funds; Final Rule, 79 FR 5808
(Jan. 31, 2014). Thus, for example, personnel in the United States
cannot solicit or sell to or arrange for trades conducted under this
exemption. Personnel in the United States also cannot serve as
decision makers in transactions conducted under this exemption.
Personnel that engage in back-office functions, such as clearing and
settlement of trades, would not be considered to arrange, negotiate,
or execute a purchase or sale for purposes of this provision. Id. at
5927, n.1526.
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2. The Commission seeks comment on the proposed treatment of U.S.
branches
[[Page 41389]]
of non-U.S. CSEs, including whether these branches should be eligible
for the Exclusion in light of the policy objectives outlined above. If
the Exclusion should be available, please explain why. The Commission
also seeks comment regarding whether the scope of substituted
compliance for U.S. branches of non-U.S. CSEs under the Proposed Rule
is appropriate. If not, please explain why.
D. Substituted Compliance
As noted above, consistent with CEA section 2(i) and comity
principles, the Commission would allow CSEs to comply with comparable
margin requirements in a foreign jurisdiction under certain
circumstances. In this release, we are proposing to establish a
standard of review that will apply to Commission determinations
regarding whether some or all of the relevant foreign jurisdiction's
margin requirements are comparable to the Commission's corresponding
margin requirements, as well as procedures for requests for
comparability determinations, including eligibility requirements and
submission requirements.
Specifically, the Commission would permit a U.S. CSE or a non-U.S.
CSE, as applicable, to avail itself of substituted compliance (to the
extent applicable under the Proposed Rule) by complying with the margin
requirements of the relevant foreign jurisdiction in lieu of compliance
with the Commission's margin requirements, provided that the Commission
finds that such jurisdiction's margin requirements are comparable to
the Commission's margin requirements. Failure to comply with the
applicable foreign margin requirements could result in a violation of
the Commission's margin requirements. Further, all CSEs, regardless of
whether they rely on a comparability determination, would remain
subject to the Commission's examination and enforcement authority.\72\
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\72\ Under Commission regulations 23.203 and 23.606, all records
required by the CEA and the Commission's regulations to be
maintained by a registered swap dealer or MSP shall be maintained in
accordance with Commission regulation 1.31 and shall be open for
inspection by representatives of the Commission, the United States
Department of Justice, or any applicable prudential regulator. The
Commission believes that, before a non-U.S. CSE should be permitted
to rely on substituted compliance, it should assure the Commission
that it can provide the Commission with prompt access to books and
records and submit to onsite inspection and examination. The
Commission further expects that access to books and records and the
ability to inspect and examine a non-U.S. CSE will be a condition to
any comparability determination.
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The Commission is proposing a comparability standard that is
outcome-based with a focus on whether the margin requirements in the
foreign jurisdiction achieve the same regulatory objectives as the
CEA's margin requirements. Under this outcome-based approach, the
Commission would not look to whether a foreign jurisdiction has
implemented specific rules and regulations that are identical to rules
and regulations adopted by the Commission. Rather, the Commission would
evaluate whether a foreign jurisdiction has rules and regulations that
achieve comparable outcomes. If it does, the Commission believes that a
comparability determination may be appropriate, even if there may be
differences in the specific elements of a particular regulatory
provision.\73\
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\73\ As noted below, because the Commission would make
comparability determinations on an element-by-element basis, it is
possible that a foreign jurisdiction's margin requirements would be
comparable with respect to some, but not all, elements of the margin
requirements.
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In evaluating whether a foreign jurisdiction's margin requirements
are comparable to the Commission's margin requirements, the Commission
would consider whether the foreign jurisdiction's margin rules are
consistent with international standards.\74\ That is, the Commission
would determine, considering all relevant facts and circumstances,
whether a foreign jurisdiction has adopted margin rules that adequately
address the BCBS-IOSCO framework. The Commission believes that
considering this factor is appropriate because BCBS and IOSCO
established this framework to ensure globally harmonized margin rules
for uncleared derivative transactions. Individual regulatory
authorities across major jurisdictions (including the EU, Japan, and
the United States) have started to develop their own margin rules
consistent with the final BCBS-IOSCO framework for non-centrally
cleared, bilateral derivatives.\75\ If the foreign jurisdiction's
margin rules are not consistent with international standards, then the
Commission may not find the rules comparable. In providing information
to the Commission for a determination, applicants should include, among
other things, information describing any difference between the foreign
jurisdiction's margin requirements and international standards.\76\
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\74\ Under the Proposed Rule, the term ``international
standards'' means the margin policy framework for non-cleared,
bilateral derivatives issued by the Basel Committee on Banking
Supervision and the International Organization of Securities
Commissions in September 2013, as subsequently updated, revised, or
otherwise amended, or any other international standards, principles
or guidance relating to margin requirements for non-cleared,
bilateral derivatives that the Commission may in the future
recognize, to the extent that they are consistent with United States
law (including the margin requirements in the Commodity Exchange
Act). See Sec. 23.160(a)(3) of the Proposed Rule. For further
information regarding the margin policy framework for non-cleared,
bilateral derivatives issued by the Basel Committee on Banking
Supervision and the International Organization of Securities in
September 2013, see note 12, supra.
\75\ See note 13, supra.
\76\ See Sec. 23.160(c)(2)(iii) of the Proposed Rule.
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Under the proposal, once the Commission has determined that a
foreign jurisdiction's margin requirements adhere to the BCBS-IOSCO
framework, the Commission would evaluate the various elements of the
foreign jurisdiction's margin requirements.\77\ Because the Commission
is not proposing to make a binary determination of comparability (i.e.,
all or nothing), but instead would make comparability determinations on
an element-by-element basis, it is possible that a foreign margin
system would be comparable with respect to some, but not all, elements
of the margin requirements. For instance, a foreign jurisdiction may
impose variation margin requirements on a non-U.S. CSE's uncleared
swaps with financial end-users that achieve outcomes comparable to the
Commission's margin requirements, but the same foreign jurisdiction may
not achieve comparable regulatory outcomes with respect to segregation
and rehypothecation requirements. By assessing each of the relevant
elements separately, the Commission would have the flexibility to
determine, with respect to one element of the requirements, that the
outcomes are comparable, but not another. The elements that the
Commission would be analyzing, among others, would include, but not be
limited to: (i) The transactions subject to the foreign jurisdiction's
margin requirements; (ii) the entities subject to the foreign
jurisdiction's margin requirements; (iii) the methodologies for
calculating the amounts of initial and variation margin; (iv) the
process and standards for approving models for calculating initial and
variation margin models; (v) the timing and manner in which initial and
variation margin must be collected and/or paid; (vi) any threshold
levels or amounts; (vii) risk management controls for the calculation
of initial and variation margin; (viii) eligible collateral for initial
and variation margin; (ix) the requirements of custodial arrangements,
including
[[Page 41390]]
rehypothecation and the segregation of margin; (x) documentation
requirements relating to margin; and (xi) the cross-border application
of the foreign jurisdiction's margin regime.
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\77\ See Sec. 23.160(c)(2) of the Proposed Rule.
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Moreover, the Commission would expect that the applicant, at a
minimum, describe how the foreign jurisdiction's margin requirements
addresses each of the above-referenced elements, and identify the
specific legal and regulatory provisions that correspond to each
element (and, if necessary, whether the foreign jurisdiction's margin
requirements do not address a particular element), and describe the
objectives of the foreign jurisdiction's margin requirements. Further,
the applicant would be required to furnish copies of the foreign
jurisdiction's margin requirements (including an English translation of
any foreign language document) and any other information or
documentation that the Commission deems appropriate.
In addition, in paragraph (c)(3) of the Proposed Rule,\78\ the
Commission sets out its standard of review that would take into
consideration all other relevant factors, including but not limited to,
the scope and objectives of the foreign jurisdiction's margin
requirement(s) for uncleared swaps; how the foreign jurisdiction's
margin requirements compare to international standards; whether the
foreign jurisdiction's margin requirements achieve comparable outcomes
to the Commission's corresponding margin requirements; the ability of
the relevant regulatory authority or authorities to supervise and
enforce compliance with the foreign jurisdiction's margin requirements;
and any other facts and circumstances the Commission deems
relevant.\79\
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\78\ See Sec. 23.160(c)(3) of the Proposed Rule.
\79\ The submission should include a description of the ability
of the relevant foreign regulatory authority or authorities to
supervise and enforce compliance with the foreign jurisdiction's
margin requirements, including the powers of the foreign regulatory
authority or authorities to supervise, investigate, and discipline
entities for compliance with the margin requirements and the ongoing
efforts of the regulatory authority or authorities to detect, deter,
and ensure compliance with the margin requirements. See Sec.
23.160(c)(2)(iv) of the Proposed Rule.
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The Proposed Rule provides that any CSE that is eligible for
substituted compliance may apply, either individually or collectively.
In addition, the Proposed Rule provides that a foreign regulatory
authority that has direct supervisory authority over one or more
covered swap entities and that is responsible for administering the
relevant foreign jurisdiction's margin requirements may submit a
request for a comparability determination with respect to some or all
of the Commission's margin requirements. Persons requesting a
comparability determination may want to coordinate their application
with other market participants and their home regulators to simplify
and streamline the process. Once a comparability determination is made
for a jurisdiction, it will apply for all entities or transactions in
that jurisdiction to the extent provided in the Proposed Rule and the
determination, subject to any conditions specified by the Commission.
The Commission expects that the comparability determination process
would require close consultation, cooperation, and coordination with
other appropriate U.S. regulators and relevant foreign regulators.
Further, the Commission expects that, in connection with a
comparability determination, the foreign regulator(s) would enter into,
or would have entered into, an appropriate memorandum of understanding
(``MOU'') or similar arrangement with the Commission.
In issuing a Comparability Determination, the Commission may impose
any terms and conditions it deems appropriate.\80\ Further, the
Proposed Rule would provide that the Commission may, on its own
initiative, further condition, modify, suspend, terminate, or otherwise
restrict a comparability determination in the Commission's discretion.
This could result, for example, from a situation where, after the
Commission issues a comparability determination, the basis of that
determination ceases to be true. In this regard, the Commission would
require an applicant to notify the Commission of any material changes
to information submitted in support of a comparability determination
(including, but not limited to, changes in the relevant foreign
jurisdiction's supervisory or regulatory regime) as the Commission's
comparability determination may no longer be valid.\81\
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\80\ The violation of such terms and conditions may constitute a
violation of the Commission's margin requirements and/or result in
the modification or revocation of the comparability determination.
\81\ The Commission expects to impose this obligation as one of
the conditions to the issuance of a comparability determination.
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Request for Comment. The Commission is seeking comments on all
aspects of the proposed standard of review that will apply to
Commission determinations regarding whether some or all of the relevant
foreign jurisdiction's margin requirements are comparable to the
Commission's corresponding margin requirements, as well as proposed
procedures for requests for comparability determinations, including
eligibility requirements and submission requirements. Among other
things, commenters may wish to submit comments on the following
questions:
1. Please provide comments on the appropriate standard of review
for comparability determinations and the degree of comparability and
comprehensiveness that should be applied to comparability
determinations.
2. Are the proposed procedures, including eligibility requirements
and submission requirements, for comparability determinations
appropriate?
3. Many foreign jurisdictions are in the process of implementing
margin reform. Should the Commission develop an interim process that
takes into account a different implementation timeline? Please provide
details and address competitive implications for U.S. CSEs and non-U.S.
CSEs that are required to comply with the Commission's margin
regulations.
4. In the Guidance, the Commission discussed ``a de minimis''
exemption with respect to transaction-level requirements for foreign
branches of U.S. swap dealers located in ``emerging markets'' that, in
the aggregate, constitute less than 5 percent of the firm's notional
swaps.\82\ The Proposed Rule does not contain an exemption for CSEs
operating in ``emerging markets.'' Should the Commission develop an
exemption for emerging markets? If so, what should be the eligibility
criteria or conditions? For example, should the Commission provide an
exemption where a non-U.S. CSE is operating in a jurisdiction that does
not permit the related collateral to be held outside that jurisdiction
and/or that lacks legal or operational infrastructure relating to
proper segregation of initial margin? Should the Commission require the
CSE to collect initial and variation margin from its counterparty in
eligible emerging market jurisdictions, but only require the CSE to
post variation margin? Should the Commission limit the type of eligible
collateral that could be used in eligible emerging market
jurisdictions? Which jurisdictions, if any, should qualify as
``emerging markets'' for purposes of the exemption? What should be the
process for determining that the qualifying criteria are met? Please
provide quantitative data, to the extent practical.
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\82\ See the Guidance, 78 FR 45351.
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5. As some emerging market jurisdictions' laws may not support
legally enforceable netting
[[Page 41391]]
arrangements, which would then, under the Proposed Margin Rules and
under certain circumstances, require that a CSE and its counterparty
post and collect gross margin, should the Commission, if it does not
provide for an emerging markets exception, permit the CSE and its
counterparty to collect/post variation margin on a net basis? If so,
what conditions, if any, should the Commission place on this
requirement to ensure that CSEs and the U.S. financial system are
adequately protected?
6. Is the scope of substituted compliance under the Proposed Rule
appropriate? Should additional or fewer transactions be eligible for
substituted compliance, and if so, how should the Proposed Rule be
modified?
E. General Request for Comments
In addition to the specific requests for comments included above,
the Commission seeks comment on all aspects of the Proposed Rule.
Commenters are encouraged to address, among other things, the scope and
application of the Proposed Rule, costs and benefits of the Proposed
Rule, alternatives to the Proposed Rule, practical implications for
CSEs and other market participants and the market generally related to
the Proposed Rule, whether the Proposed Rule sufficiently supports the
statutory goals of ensuring the safety and soundness of the CSE and
protecting the financial system against the risks associated with
uncleared swaps, and whether the Proposed Rule sufficiently takes into
account principles of international comity. In particular, the
Commission requests comment on the following:
1. Does the Proposed Rule's approach to the cross-border
application of margin requirements satisfy the Commission's statutory
requirements, including the requirement to help ensure the safety and
soundness of CSEs, and the requirement that the Commission, the
Prudential Regulators, and the SEC, to the maximum extent practicable,
establish and maintain comparable minimum initial and variation margin
requirements?
2. Would it be more appropriate to apply the margin requirements at
the entity-level, without any exclusion? If yes, please explain.
3. Would it be more appropriate to apply the margin requirements at
a transaction-level? If yes, please explain.
4. Is the scope of the Proposed Rule appropriate, or should it be
changed, and if so, how?
5. Would an alternative approach to the Proposed Rule better
achieve the Commission's statutory requirements or otherwise be
preferable or more appropriate? If yes, please explain.
6. Does the Commission's Proposed Rule strike the right balance
between the Commission's supervisory interest in offsetting the risk to
CSEs and the financial system arising from the use of uncleared swaps
and international comity principles? If not, please explain.
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires that agencies
consider whether the regulations they propose will have a significant
economic impact on a substantial number of small entities.\83\ The
Commission previously has established certain definitions of ``small
entities'' to be used in evaluating the impact of its regulations on
small entities in accordance with the RFA.\84\ The proposed regulation
establishes a mechanism for CSEs \85\ to satisfy margin requirements by
complying with comparable margin requirements in the relevant foreign
jurisdiction as described in paragraph (c) of the Proposed Rule,\86\
but only to the extent that the Commission makes a determination that
complying with the laws of such foreign jurisdiction is comparable to
complying with the corresponding margin requirement(s) for which the
determination is sought.
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\83\ 5 U.S.C. 601 et seq.
\84\ 47 FR 18618 (Apr. 30, 1982).
\85\ Section 23.151 of the Proposed Margin Rules defines CSEs as
a SD or MSP for which there is no prudential regulator.
\86\ See Sec. 23.160(c) of the Proposed Rule.
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The Commission previously has determined that SDs and MSPs are not
small entities for purposes of the RFA.\87\ Thus, the Commission is of
the view that there will not be any small entities directly impacted by
this rule.
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\87\ See 77 FR 30596, 30701 (May 23, 2012).
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The Commission notes that under the Proposed Margin Rules, SDs and
MSPs would only be required to collect and post margin on uncleared
swaps when the counterparties to the uncleared swaps are either other
SDs and MSPs or financial end users. As noted above, SDs and MSPs are
not small entities for RFA purposes. Furthermore, any financial end
users that may be indirectly \88\ impacted by the Proposed Rule would
be similar to eligible contract participants (``ECPs''), and, as such,
they would not be small entities.\89\ Further, to the extent that there
are any foreign financial entities that would not be considered ECPs,
the Commission expects that there would not be a substantial number of
these entities significantly impacted by the Proposed Rule. As noted
above, most foreign financial entities would likely be ECPs to the
extent they would trade in uncleared swaps. The Commission expects that
only a small number of foreign financial entities that are not ECPs, if
any, would trade in uncleared swaps.
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\88\ The RFA focuses on direct impact to small entities and not
on indirect impacts on these businesses, which may be tenuous and
difficult to discern. See Mid-Tex Elec. Coop., Inc. v. FERC, 773
F.2d 327, 340 (D.C. Cir. 1985); Am. Trucking Assns. v. EPA, 175 F.3d
1027, 1043 (D.C. Cir. 1985).
\89\ As noted in paragraph (1)(xii) of the definition of
``financial end user'' in Sec. 23.151 of the Proposed Margin Rules,
a financial end-user includes a person that would be a financial
entity described in paragraphs (1)(i)-(xi) of that definition, if it
were organized under the laws of the United States or any State
thereof. The Commission believes that this prong of the definition
of financial end-user would capture the same type of U.S. financial
end-users that are ECPs, but for them being foreign financial
entities. Therefore, for purposes of the Commission's RFA analysis,
these foreign financial end-users will be considered ECPs and
therefore, like ECPs in the U.S., not small entities.
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Accordingly, the Commission finds that there will not be a
substantial number of small entities impacted by the Proposed Rule.
Therefore, the Chairman, on behalf of the Commission, hereby certifies
pursuant to 5 U.S.C. 605(b) that the proposed regulations will not have
a significant economic impact on a substantial number of small
entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') imposes certain
requirements on Federal agencies, including the Commission, in
connection with their conducting or sponsoring any collection of
information, as defined by the PRA. This proposed rulemaking would
result in the collection of information requirements within the meaning
of the PRA, as discussed below. The proposed rulemaking contains
collections of information for which the Commission has not previously
received control numbers from the Office of Management and Budget
(``OMB''). If adopted, responses to this collection of information
would be required to obtain or retain benefits. An agency may not
conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a currently valid control
number. The Commission has submitted to OMB an information collection
request to obtain an OMB control number for the collections contained
in this proposal.
Section 731 of the Dodd-Frank Act, amended the CEA,\90\ to add, as
section
[[Page 41392]]
4s(e) thereof, provisions concerning the setting of initial and
variation margin requirements for SDs and MSPs. Each SD and MSP for
which there is a Prudential Regulator, as defined in section 1a(39) of
the CEA, must meet margin requirements established by the applicable
Prudential Regulator, and each CSE must comply with the Commission's
regulations governing margin. With regard to the cross-border
application of the swap provisions enacted by Title VII of the Dodd-
Frank Act, section 2(i) of the CEA provides the Commission with express
authority over activities outside the United States relating to swaps
when certain conditions are met. Section 2(i) of the CEA provides that
the provisions of the CEA relating to swaps enacted by Title VII of the
Dodd-Frank Act (including Commission rules and regulations promulgated
thereunder) shall not apply to activities outside the United States
unless those activities (1) have a direct and significant connection
with activities in, or effect on, commerce of the United States or (2)
contravene such rules or regulations as the Commission may prescribe or
promulgate as are necessary or appropriate to prevent the evasion of
any provision of Title VII.\91\ Because margin requirements are
critical to ensuring the safety and soundness of a CSE and supporting
the stability of the U.S. financial markets, the Commission believes
that its margin rules should apply on a cross-border basis in a manner
that effectively addresses risks to the registered CSE and the U.S.
financial system.
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\90\ 7 U.S.C. 1 et seq.
\91\ 7 U.S.C. 2(i).
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As noted above, the Proposed Rule would establish margin
requirements for uncleared swaps of CSEs on a firm-wide, entity-level
basis (with substituted compliance available in certain circumstances),
except as to a narrow class of uncleared swaps between a non-U.S. CSE
and a non-U.S. counterparty that fall within the Exclusion. The
Proposed Rule would establish a procedural framework in which the
Commission would consider permitting compliance with comparable margin
requirements in a foreign jurisdiction to substitute for compliance
with the Commission's margin requirements in certain circumstances. The
Commission would consider whether the requirements of such foreign
jurisdiction with respect to margin of uncleared swaps are comparable
to the Commission's margin requirements.
Specifically, the Proposed Rule would provide that a CSE who is
eligible for substituted compliance may submit a request, individually
or collectively, for a comparability determination.\92\ Persons
requesting a comparability determination may coordinate their
application with other market participants and their home regulators to
simplify and streamline the process. Once a comparability determination
is made for a jurisdiction, it would apply for all entities or
transactions in that jurisdiction to the extent provided in the
determination, as approved by the Commission. In providing information
to the Commission for a comparability determination, applicants must
include, at a minimum, information describing any differences between
the relevant foreign jurisdiction's margin requirements and
international standards,\93\ and the specific provisions of the foreign
jurisdiction that govern: (i) The transactions subject to the foreign
jurisdiction's margin requirements; (ii) the entities subject to the
foreign jurisdiction's margin requirements; (iii) the methodologies for
calculating the amounts of initial and variation margin; (iv) the
process and standards for approving models for calculating initial and
variation margin models; (v) the timing and manner in which initial and
variation margin must be collected and/or paid; (vi) any threshold
levels or amounts; (vii) risk management controls for the calculation
of initial and variation margin; (viii) eligible collateral for initial
and variation margin; (ix) the requirements of custodial arrangements,
including rehypothecation and the segregation of margin; (x)
documentation requirements relating to margin; and (xi) the cross-
border application of the foreign jurisdiction's margin regime.\94\
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\92\ A CSE may apply for a comparability determination only if
the uncleared swap activities of the CSE are directly supervised by
the authorities administering the foreign regulatory framework for
uncleared swaps. Also, a foreign regulatory agency may make a
request for a comparability determination only if that agency has
direct supervisory authority to administer the foreign regulatory
framework for uncleared swaps in the requested foreign jurisdiction.
\93\ See note 74, supra, for a discussion of the definition of
``international standards'' under the Proposed Rule. See also Sec.
23.160(a)(3) of the Proposed Rule.
\94\ See Sec. 23.160(c)(2) of the Proposed Rule for submission
requirements.
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In addition, the Commission would expect the applicant, at a
minimum, to describe how the foreign jurisdiction's margin requirements
addresses each of the above-referenced elements, and identify the
specific legal and regulatory provisions that correspond to each
element (and, if necessary, whether the relevant foreign jurisdiction's
margin requirements do not address a particular element). Further, the
applicant must describe the objectives of the foreign jurisdiction's
margin requirements, the ability of the relevant regulatory authority
or authorities to supervise and enforce compliance with the foreign
jurisdiction's margin requirements, including the powers of the foreign
regulatory authority or authorities to supervise, investigate, and
discipline entities for compliance with the margin requirements and the
ongoing efforts of the regulatory authority or authorities to detect,
deter, and ensure compliance with the margin requirements. Finally, the
applicant must furnish copies of the foreign jurisdiction's margin
requirements (including an English translation of any foreign language
document) and any other information and documentation that the
Commission deems appropriate.\95\
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\95\ See Sec. 23.160(c)(2)(v) and (vi) of the Proposed Rule.
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In issuing a Comparability Determination, the Commission may impose
any terms and conditions it deems appropriate.\96\ In addition, the
Proposed Rule would provide that the Commission may, on its own
initiative, further condition, modify, suspend, terminate, or otherwise
restrict a comparability determination in the Commission's discretion.
This could result, for example, from a situation where, after the
Commission issues a comparability determination, the basis of that
determination ceases to be true. In this regard, the Commission would
require an applicant to notify the Commission of any material changes
to information submitted in support of a comparability determination
(including, but not limited to, changes in the foreign jurisdiction's
supervisory or regulatory regime) as the Commission's comparability
determination may no longer be valid.\97\
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\96\ The violation of such terms and conditions may constitute a
violation of the Commission's margin requirements and/or result in
the modification or revocation of the comparability determination.
\97\ The Commission expects to impose this obligation as one of
the conditions to the issuance of a comparability determination.
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The collection of information that is proposed by this rulemaking
is necessary to implement sections 4s(e) of the CEA, which mandates
that the Commission adopt rules establishing minimum initial and
variation margin requirements for CSEs on all swaps that are not
cleared by a registered derivatives clearing organization, and section
2(i) of the CEA, which provides that the provisions of the CEA relating
to swaps that were enacted by Title VII of the Dodd-Frank Act
(including any rule prescribed or regulation promulgated thereunder)
apply to
[[Page 41393]]
activities outside the United States that have a direct and significant
connection with activities in, or effect on, commerce of the United
States.\98\ The information collection would be necessary for the
Commission to consider whether the requirements of the foreign rules
are comparable to the applicable requirements of the Commission's
rules.
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\98\ Section 2(i) of the CEA provides that the provisions of the
CEA relating to swaps that were enacted by Title VII of the Dodd-
Frank Act (including any rule prescribed or regulation promulgated
thereunder), shall not apply to activities outside the United States
unless those activities (1) have a direct and significant connection
with activities in, or effect on, commerce of the United States or
(2) contravene such rules or regulations as the Commission may
prescribe or promulgate as are necessary or appropriate to prevent
the evasion of any provision of Title VII of the CEA.
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As noted above, any CSE who is eligible for substituted compliance
may make a request for a comparability determination. Currently, there
are approximately 102 CSEs provisionally registered with the
Commission. The Commission further estimates that of the approximately
102 CSEs, approximately 61 CSEs would be subject to the Commission's
margin rules as they are not subject to a Prudential Regulator.
However, the Commission notes that any foreign regulatory agency that
has direct supervisory authority over one or more CSEs and that is
responsible to administer the relevant foreign jurisdiction's margin
requirements may apply for a comparability determination. Further, once
a comparability determination is made for a jurisdiction, it would
apply for all entities or transactions in that jurisdiction to the
extent provided in the determination, as approved by the Commission.
The Commission estimates that it will receive requests for a
comparability determination from 17 jurisdictions, consisting of the 16
jurisdictions within the G20, plus Switzerland,\99\ and that each
request would impose an average of 10 burden hours.
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\99\ Because the Commission's proposed margin requirements are
based on the BCBS-IOSCO framework and one of the factors that the
Commission will consider in making its determination is the
comparability to these international standards, the Commission
estimates that in all likelihood, it will receive applications from
all 16 jurisdictions within the G20, plus Switzerland.
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Based upon the above, the estimated hour burden for collection is
calculated as follows:
Number of respondents: 17.
Frequency of collection: Once.
Estimated annual responses per registrant: 1.
Estimated aggregate number of annual responses: 17.
Estimated annual hour burden per registrant: 10 hours.
Estimated aggregate annual hour burden: 170 hours (17 registrants x
10 hours per registrant).
Information Collection Comments. The Commission invites the public
and other Federal agencies to comment on any aspect of the reporting
burdens discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the
Commission solicits comments in order to: (1) Evaluate whether the
proposed collection of information is necessary for the proper
performance of the functions of the Commission, including whether the
information will have practical utility; (2) evaluate the accuracy of
the Commission's estimate of the burden of the proposed collection of
information; (3) determine whether there are ways to enhance the
quality, utility, and clarity of the information to be collected; and
(4) minimize the burden of the collection of information on those who
are to respond, including through the use of automated collection
techniques or other forms of information technology.
Comments may be submitted directly to the Office of Information and
Regulatory Affairs, by fax at (202) 395-6566 or by email at
[email protected]. Please provide the Commission with a copy
of submitted comments so that all comments can be summarized and
addressed in the final rule preamble. Refer to the ADDRESSES section of
this notice of proposed rulemaking for comment submission instructions
to the Commission. A copy of the supporting statements for the
collections of information discussed above may be obtained by visiting
RegInfo.gov. OMB is required to make a decision concerning the
collection of information between 30 and 60 days after publication of
this document in the Federal Register. Therefore, a comment is best
assured of having its full effect if OMB receives it within 30 days of
publication.
C. Cost-Benefit Considerations
1. Introduction
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders.\100\ Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
five broad areas of market and public concern: (1) Protection of market
participants and the public; (2) efficiency, competitiveness, and
financial integrity of futures markets; (3) price discovery; (4) sound
risk management practices; and (5) other public interest
considerations. The Commission considers the costs and benefits
resulting from its discretionary determinations with respect to the
section 15(a) factors.
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\100\ 7 U.S.C. 19(a).
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In promulgating the Proposed Margin Rules,\101\ the Commission
considered the costs and benefits associated with its choices regarding
the scope and extent to which it would apply its proposed margin
requirements to uncleared swaps of a CSE, including those related to
the setting of the material swap exposure for financial entities, and
related substantive requirements, such as the determination of eligible
collateral and acceptable custodial arrangements. In addition, in light
of the fact that section 4s(e), by its terms, applies to uncleared
swaps of all CSEs, regardless of the domicile of the CSE (or its
counterparties), the costs and benefits discussed in the Proposed
Margin Rules' Federal Register release relate both to the domestic and
cross-border application of the margin rule.\102\ The cost and benefit
considerations (``CBC'') set out in this proposal are intended to
augment the CBC set forth in the Proposed Margin Rules' Federal
Register release and address cost and benefit considerations related to
the Commission's choices regarding the extent to which it would
recognize compliance with comparable foreign requirements as an
alternative means of compliance with the Commission's margin rules
(``substituted compliance'') and the extent to which it would exclude
uncleared swaps from the Commission's margin rules. Further, in
considering the relevant costs and benefits of the Proposed Margin
Rules, the Commission used as its baseline the swaps market as it
existed at the time of the Proposed Margin Rules' Federal Register
release; because this Proposed Rule addresses the cross-border
application of the Proposed Margin Rules, the Commission is using as
its baseline the swaps market as it would operate once the Proposed
Margin Rules were fully implemented.
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\101\ The Commission's Proposed Margin Rules are set forth in
proposed Sec. Sec. 23.150 through 23.159 of part 23 of the
Commission's regulations, proposed as 17 CFR 23.150 through 23.159.
See Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants, 79 FR 59898 (Oct. 3, 2014).
\102\ See Margin Requirements for Uncleared Swaps for Swap
Dealers and Major Swap Participants, 79 FR 59920-59926 (Oct. 3,
2014).
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As discussed in section I.B. above, in developing the proposed
cross-border framework in the Proposed Rule, the
[[Page 41394]]
Commission is mindful of the global and highly interconnected nature of
the swaps market--and that risk exposures overseas can quickly manifest
in the United States and pose substantial threat to the U.S. financial
system. At the same time, the Commission also recognizes that
competitive distortions and market inefficiencies can result--and the
benefits of the BCBS-IOSCO framework lost--if due consideration is not
given to comity principles. The Commission has also carefully
considered the impact of its choices in determining whether (and, if
so, under what circumstances) substituted compliance would be available
or whether (and, if so, under what circumstances) swaps would be deemed
excluded, including the effect of its choices on efficiency,
competition, market integrity and transparency.
The Commission is aware of the potentially significant trade-offs
inherent in its policy decisions. For instance, the Commission's choice
not to exclude from its margin requirements certain foreign-facing
swaps involving U.S. CSEs and non-U.S. CSEs whose obligations under the
relevant swap are guaranteed by a U.S. person may make it more costly
for such firms to conduct their swaps business, particularly in foreign
jurisdictions, and put them at a competitive disadvantage relative to
non-U.S. CSEs whose obligations under the relevant swap are not
guaranteed by a U.S. person. It could also make foreign counterparties
less willing to deal with U.S. CSEs and non-U.S. CSEs whose obligations
under the relevant swap are guaranteed by a U.S. person. On the other
hand, full application of the margin requirements to these CSEs may
enhance the safety and soundness of these CSEs and consequently, the
U.S. financial system. In addition, the extent, if any, to which either
of the aforementioned disadvantages would arise depends on whether
competitors of such CSEs must comply with comparable margin
requirements. In developing the proposed cross-border framework in the
Proposed Rule, the Commission has attempted to appropriately consider
competing concerns in seeking to effectively address the risk posed to
the safety and soundness of CSEs, while creating a workable framework
that mitigates the potential for undue market distortions and that
promotes global harmonization.
The Commission's consideration of the costs and benefits associated
with the proposed framework is complicated by the fact that other
jurisdictions may adopt requirements with different scope or on
different timelines. Currently, no foreign jurisdiction has finalized
rules for margin of uncleared swaps. However, the EU \103\ and Japan
\104\ have proposed such rules, each of which are based on the BCBS-
IOSCO framework.\105\ The extent to which, if at all, foreign
jurisdictions will follow the BCBS-IOSCO framework and the differences
between the requirements implemented overseas and the Commission's
margin requirements will affect the costs and benefits related to the
Proposed Rule. Thus, for example, if a margin rule in a particular
foreign jurisdiction is less rigorous than the Commission's margin
rule, those CSEs (U.S. and non-U.S. CSEs) that are subject to the
Commission's margin rule may be competitively disadvantaged relative to
those dealers that are eligible for Exclusion from the Commission's
margin rule for certain swaps or are outside the Commission's
jurisdiction.\106\
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\103\ See European Banking Authority, European Securities and
Markets Authority, and European Insurance and Occupational Pensions
Authority, Consultation Paper on draft regulatory technical
standards on risk-mitigation techniques for OTC-derivative contracts
not cleared by a CCP under Article 11(15) of Regulation (EU) No 648/
2012 (for the European Market Infrastructure Regulation) (April 14,
2014), available at https://www.eba.europa.eu/documents/10180/655149/JC+CP+2014+03+%28CP+on+risk+mitigation+for+OTC+derivatives%29.pdf, and Second Consultation Paper on draft regulatory technical
standards on risk-mitigation techniques for OTC-derivative contracts
not cleared by a CCP under Article 11(15) of Regulation (EU) No 648/
2012 (for the European Market Infrastructure Regulation) (Jun. 10,
2015), available at https://www.eba.europa.eu/documents/10180/1106136/JC-CP-2015-002+JC+CP+on+Risk+Management+Techniques+for+OTC+derivatives+.pdf.
\104\ See Financial Services Agency of Japan, draft amendments
to the ``Cabinet Office Ordinance on Financial Instruments
Business'' and ``Comprehensive Guidelines for Supervision'' with
regard to margin requirements for non-centrally cleared derivatives
(July 3, 2014). Available in Japanese at http://www.fsa.go.jp/news/26/syouken/20140703-3.html.
\105\ See Margin Requirements for Non-centrally Cleared
Derivatives, Sept. 2013, available at http://www.bis.org/publ/bcbs261.pdf. The Commission is not incorporating the details of the
EU and Japanese proposals in this CBC, because they have not been
adopted and would be subject to change upon adoption.
\106\ As discussed in section I.B. above, in the interest of
promoting global harmonization, the Commission has consulted and
coordinated with the Prudential Regulators and foreign regulatory
authorities. In addition, the Commission staff has participated in
numerous bilateral and multilateral discussions with foreign
regulatory authorities discussing national efforts to implement
margin reform and the possibility of conflicts and overlaps between
U.S. and foreign regulatory regimes. Although at this time foreign
jurisdictions do not yet have their margin regimes in place, the
Commission has participated in ongoing, collaborative discussions
with regulatory authorities in the EU and Japan regarding their
cross-border approaches to the margin rules, including the
anticipated scope of application of margin requirements in their
jurisdiction to cross-border swaps, their plans for recognizing
foreign margin regimes, and their anticipated timelines. The
Commission expects that these discussions will continue as it
finalizes and then implements its margin rules, and as other
jurisdictions develop their own margin rules and approaches to
cross-border applications.
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In sum, given that foreign jurisdictions do not yet have in place
their margin rules, it is not possible to fully evaluate the costs and
benefits associated with the Proposed Rule, and in particular, the
implications for the safety and soundness of CSEs and competition.
However, to the extent that a foreign regime's margin requirements are
comparable, any differences between the Commission's margin
requirements and foreign margin requirements would be insignificant
and, therefore, mitigate the potential for undue risk to the CSE and
competitive distortions. However, if a foreign regime's margin
requirements are not deemed comparable, this may put a CSE at a
competitive disadvantage when competing with non-U.S. firms that are
not registered with the Commission because these non-CFTC registered
dealers would have a cost advantage that could affect their pricing
terms to clients.
In the sections that follow, the Commission considers: (i) Costs
and benefits associated with the proposed definition of U.S. person;
(ii) the proposed framework for substituted compliance; (iii) the
proposed exclusion from the margin rule; (iv) the submission of
requests for a comparability determination; and (v) alternatives
considered and the cost and benefit of such alternatives. Wherever
reasonably feasible, the Commission has endeavored to quantify the
costs and benefits of this proposed rulemaking. In a number of
instances, the Commission currently lacks the data and information
required to precisely estimate costs and benefits. Where it was not
feasible to quantify (e.g., because of the lack of accurate data or
appropriate metrics), the Commission has endeavored to consider the
costs and benefits of these rules in qualitative terms.
2. Proposed Rule
The Proposed Rule sets forth a definition of ``U.S. person,''
describing the circumstances under which substituted compliance or the
exclusion would be available, and would establish a process for the
submission of requests for a comparability determination. In addition
to issues related to financial integrity of markets, competition and
market distortions noted above, the U.S. person definition and
comparability determination process entail monetary costs for CSEs and
market participants because a market participant may have
[[Page 41395]]
to expend resources to determine whether it (or its counterparty) is a
U.S. person. A CSE seeking to rely on substituted compliance could
incur costs in connection with the submission of a request for a
comparability determination, although this would not be the case in
circumstances where the relevant jurisdiction has itself attained a
comparability finding from the Commission. In this section, we describe
the most significant considerations that we have taken into account in
formulating the Proposed Rule.
a. U.S. Person
Under the Proposed Rule, the term ``U.S. person'' would be defined
so as to identify activities having a substantial nexus to the U.S.
market because they are undertaken by individuals or entities organized
or domiciled in the United States or because of other connections to
the U.S. market. The definition is intended to identify those
individuals and entities whose swap activities have a substantial nexus
to U.S. markets even when they transact in swaps with a non-U.S. CSE.
As noted in section II.B.1. above, this proposed definition generally
follows the traditional, territorial approach to defining a U.S.
person. The chief benefit of this territorial approach is that it is
objective and clear--and the Commission believes that the industry has
largely followed a similar definition of ``U.S. person'' included in
the Guidance.
The Commission considered including the U.S. majority-ownership
prong that was included in the Guidance (50% U.S. person ownership of a
fund or other collective investment vehicle), but has determined not to
propose it.\107\ The Commission understands that unlike other corporate
structures, certain types of funds, specifically fund-of-funds and
master-feeder structures, would require an adviser or administrator to
look through to other fund entities in the fund structure, in
ascertaining whether a beneficial owner of the fund is a U.S. person.
The Commission further understands that this may be difficult to
determine in some cases. In addition, the Commission believes that
other elements of the U.S. person definition would in many
circumstances cover these funds as a ``U.S. person.''
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\107\ The Commission's definition of the term ``U.S. person'' as
used in the Guidance included a prong (iv) which covered ``any
commodity pool, pooled account, or collective investment vehicle
(whether or not it is organized or incorporated in the United
States) of which a majority ownership is held, directly or
indirectly, by a U.S. person(s).''
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Even if a non-U.S. fund with U.S. majority-ownership is treated as
a non-U.S. person, such fund would be excluded from the Commission's
margin rules only in limited circumstances (namely, when the fund
trades with a non-U.S. CSE that is not a consolidated subsidiary of a
U.S. entity or a U.S. branch of a non-U.S. CSE). Additionally, any
excluded swaps would most likely be covered by another jurisdiction
that adheres to the BCBS-IOSCO standards. The Commission anticipates
that non-U.S. CSEs will generally be required, in their home
jurisdiction, to collect margin from these non-U.S. funds.\108\
Therefore, non-U.S. CSEs would generally be protected in the event of a
default by a non-U.S. fund even if the uncleared swap with the non-U.S.
fund falls within the Exclusion.\109\ Accordingly, the Commission
believes that treatment of non-U.S. funds with U.S. majority-ownership
as non-U.S. persons will not have a substantial impact on the safety
and soundness of CSEs or the stability of the U.S. financial system; at
the same time, the Commission believes that excluding the majority-
ownership prong would alleviate any burden associated with determining
whether a fund qualifies as a U.S. person under this criterion.
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\108\ At this time, we do not have information as to what
portion of the funds that would have been covered by the U.S.
majority-ownership prong are hedge funds.
\109\ Further, as noted earlier, a non-U.S. CSE that can avail
itself of the Exclusion would still be subject to the Commission's
margin rules with respect to all uncleared swaps not meeting the
criteria for the Exclusion, albeit with the possibility of
substituted compliance. The Commission further believes that the
possibility of a cascading event affecting U.S. counterparties and
the U.S. market more broadly as a result of a default by the non-
U.S. CSE would also be mitigated because the non-U.S. CSE would be
subject to U.S. margin requirements (with the possibility of
substituted compliance to the extent applicable) when entering into
a swap with U.S. counterparties.
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As noted in section II.B.1. above, prong (6) (Proposed Rule Sec.
23.160(a)(10)(vi)) of the proposed ``U.S. person'' definition would
capture certain legal entities owned by one or more U.S. person(s) and
for which such person(s) bear unlimited responsibility for the
obligations and liabilities of the legal entity. In the case of the
Guidance, the ``U.S. person'' definition would generally characterize a
legal entity as a U.S. person if the entity were ``directly or
indirectly majority-owned'' by one or more persons falling within the
term ``U.S. person'' and such U.S. person(s) bears unlimited
responsibility for the obligations and liabilities of the legal entity.
Because this prong of the proposed definition of ``U.S. person'' is
broader in scope, the Commission believes that this may result in more
legal entities meeting the U.S. person definition. In addition, to the
extent that this prong of the proposed definition of ``U.S. person''
expands the number of market participants that would be deemed to be a
``U.S. person,'' the Commission believes that the benefits that would
have been provided to otherwise non-U.S. CSEs from being able to avail
themselves of substituted compliance and the Exclusion would not be
realized.
The proposed ``U.S. person'' definition does not include the
prefatory phrase ``includes, but is not limited to'' that was included
in the Guidance. The Commission believes that this prefatory phrase
should not be included in the Proposed Rule in order to provide legal
certainty regarding the application of U.S. margin requirements to
cross-border swaps.
Finally, the Commission believes that the definition of ``U.S.
person'' provides a clear and objective basis upon which to identify a
U.S. person, and that identifying whether a counterparty is a ``U.S.
person'' should be relatively straightforward because, as noted above,
the Commission believes that a swap counterparty generally should be
permitted to reasonably rely on its counterparty's written
representation in determining whether the counterparty is within the
definition of the term ``U.S. person.''
b. Availability of Substituted Compliance and Exclusion
i. Uncleared Swaps of U.S. CSEs or of Non-U.S. CSEs Whose Obligations
Under the Relevant Swap Are Guaranteed by a U.S. Person
As set out in Table A to this release, under the Proposed Rule, the
Commission's margin rules would generally apply to all uncleared swaps
of U.S. CSEs. For U.S. CSEs, substituted compliance would only be
available with respect to the requirement to post initial margin and
only if the counterparty is a non-U.S. person (including a non-U.S.
CSE) whose obligations under the uncleared swap are not guaranteed by a
U.S. person. Uncleared swaps with U.S. CSEs would never qualify for the
Exclusion. Under the Proposed Rule, non-U.S. CSEs whose obligations
under the relevant swap are guaranteed by a U.S. person would receive
the same treatment as U.S. CSEs.\110\ The Commission believes
[[Page 41396]]
that this result is appropriate because a swap of an entity guaranteed
by that U.S. person will have economic and financial implications that
are likely to be very similar to the economic and financial
implications of a swap entered into directly by the U.S. guarantor, as
discussed in section II.B.2. above.
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\110\ As discussed in section II.B.2, under the Proposed Rule
the Commission is defining a guarantee narrower than in the
Guidance, and in doing so, the Commission has broadened the
availability of substituted compliance and the Exclusion to certain
non-U.S. CSEs that would not have the ability to avail themselves of
these if the broader definition of guarantee used in the Guidance
were used in the Proposed Rule instead of the narrower definition.
However, the Commission believes that as a result of its decision to
define certain non-U.S. CSEs as Foreign Consolidated Subsidiaries,
some of these same non-U.S. CSEs that would have been able to avail
themselves of substituted compliance and the Exclusion, as a result
of the narrow definition of a guarantee, would not be eligible for
the Exclusion (but would benefit from the full application of
substituted compliance instead of a limited application). The costs
and benefits related to substituted compliance and the Exclusion are
set out in this section and below.
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The Commission understands that the Proposed Rule may place U.S.
CSEs and non-U.S. CSEs whose obligations under the relevant swap are
guaranteed by a U.S. person at a disadvantage when competing with
either non-U.S. CSEs that are able to rely on the Exclusion or with
non-CFTC registered dealers for foreign clients, though whether such a
disadvantage exists would depend on whether these competitors are
subject to comparable margin rules in other jurisdictions. For example,
the ability of a non-U.S. CSE that is not guaranteed by a U.S. person
(and that is not a Foreign Consolidated Subsidiary or a U.S. branch of
a non-U.S. CSE) to rely on the Exclusion could allow it to gain a cost
advantage over a U.S. CSE or a non-U.S. CSE that is guaranteed by a
U.S. person and thus offer better pricing terms to foreign clients,
unless it is subject to another jurisdiction's margin rules that are
comparable. U.S. CSEs and non-U.S. CSEs whose obligations under the
relevant swap are guaranteed by a U.S. person may also be at a
disadvantage when competing for clients with non-U.S. CSEs that are
able to rely on substituted compliance more broadly if the clients
believe complying with the foreign jurisdiction's margin requirements
would be less burdensome or costly than when transacting with a U.S.
CSE under the Proposed Rule, as the amount posted by the non-U.S.
counterparty would need to comply with U.S. margin requirements.
However, the Commission believes that the requirement that the relevant
foreign jurisdiction's margin requirements have comparable outcomes
should operate to narrow any competitive disadvantage, thereby
diminishing opportunities for regulatory arbitrage.\111\
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\111\ The Commission notes that of the approximately 61 CSEs
that would be subject to the Commission's margin rules, 21 are non-
U.S. CSEs. Of those 21 non-U.S. CSEs, 20 are domiciled in
jurisdictions that participated in the development of the BCBS-IOSCO
framework. Although harmonization among these jurisdictions may
mitigate some competitive disadvantages, the associated costs and
benefits cannot be reasonably determined as no jurisdictions have
finalized their margin rules.
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In addition, because the Proposed Rule provides for limited
substituted compliance for U.S. CSEs and non-U.S. CSEs whose
obligations under the relevant swap are guaranteed by a U.S. person
(relative to other CSEs), those CSEs may be subject to conflicting or
duplicative regulations, and consequently, would incur costs associated
with developing multiple sets of policies and procedures and
operational infrastructures. The Commission recognizes that such costs
would vary for firms depending on the nature and scope of the
individual firm's business, and costs relative to other competitors
would depend on whether the competitors are subject to other
jurisdictions' margin rules. The Commission requests data from
commenters to assist the Commission in considering the quantitative
effect of the limited substituted compliance for U.S. CSEs and non-U.S.
CSEs whose obligations under the relevant swap are guaranteed by a U.S.
person.
On the other hand, the Commission believes that requiring U.S. CSEs
and non-U.S. CSEs whose obligations under the relevant swap are
guaranteed by a U.S. person to comply with its margin requirements
would foster the stability of the U.S. financial markets. By their
nature, U.S. CSEs and non-U.S. CSEs whose swap obligations are
guaranteed by a U.S. person have a significant impact on the U.S.
financial markets, and the Commission therefore has a strong interest
in ensuring their viability. As discussed in section II.C.1. above, the
Commission believes that requiring U.S. CSEs and non-U.S. CSEs whose
swap obligations are guaranteed by a U.S. person to comply with the
Commission's margin requirements, with only limited substituted
compliance, is important to maintaining well-functioning U.S. financial
markets and ensuring the sound risk management practices of key market
participants in the U.S. swaps market.
ii. Uncleared Swaps of Non-U.S. CSEs Whose Obligations Under the
Relevant Swap Are Not Guaranteed by a U.S. Person
As set out in Table A to this release, under the Proposed Rule,
non-U.S. CSEs whose obligations under the relevant uncleared swap are
not guaranteed by a U.S. person, including Foreign Consolidated
Subsidiaries, are eligible for substituted compliance to a greater
extent relative to U.S. CSEs or non-U.S. CSEs whose obligations under
the relevant uncleared swap are guaranteed by a U.S. person. A subset
of these non-U.S. CSEs may qualify for the Exclusion, as described in
section II.C.3. above. As noted in section II.C.2., the Commission
believes that the proposed approach is appropriate since a non-U.S. CSE
whose swap obligations are not guaranteed by a U.S. person (including a
Foreign Consolidated Subsidiary), may implicate equal or greater
supervisory concerns on the part of a foreign regulator relative to the
Commission's supervisory interests (in comparison to U.S. CSEs or non-
U.S. CSEs whose obligations under the relevant swap are guaranteed by a
U.S. person, because the Commission has a significant regulatory
interest in uncleared swaps of these CSEs).
Substituted compliance would benefit such non-U.S. CSEs by allowing
them to avoid conflicting or duplicative regulations and choose the
most appropriate set of rules when transacting with each other.
Furthermore, eligible non-U.S. CSEs could further benefit from
developing one enterprise-wide set of compliance and operational
infrastructures.\112\ And
[[Page 41397]]
because substituted compliance is contingent on the Commission's
determination that the relevant jurisdiction's margin rules are
comparable, the potential for undue risk to the CSE and competitive
distortions between those registrants that are eligible for substituted
compliance and those that are not would be mitigated. However, if the
foreign jurisdiction's margin requirements are not deemed comparable,
these CSEs will be at a disadvantage to non-CFTC registered dealers
when competing for client business.
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\112\ The Commission notes that the costs of developing the
margin infrastructure needed to comply with Commission margin
requirements in the context of cross-border transactions, as well as
the costs of complying with the Commission's margin requirements
more generally in the context of cross-border transactions, could
vary significantly for different CSEs based on factors specific to
each firm (e.g., organizational structure, status as a U.S. CSE or
non-U.S. CSE (including whether the firm is a Foreign Consolidated
Subsidiary or a U.S. branch of a non-U.S. CSE), jurisdictions in
which uncleared swaps activities are conducted, applicable margin
requirements in the U.S. and other jurisdictions, the location and
status of counterparties, existence of an appropriate MOU or similar
arrangement with the relevant jurisdictions, existence of
Comparability Determinations in the relevant jurisdictions and any
conditions in such determinations, and firm policies and procedures
for the posting and collection of margin). The Commission further
notes that currently no foreign jurisdiction has finalized rules for
margin of uncleared swaps. However, the EU and Japan have proposed
such rules, each of which are based on the BCBS-IOSCO framework.
Accordingly, the Commission lacks the data and information required
to reasonably estimate costs related to developing the appropriate
margin infrastructure or the costs of complying with the
Commission's margin requirements generally in the context of cross-
border transactions.
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iii. Exclusion for Uncleared Swaps of Non-U.S. CSEs Where Neither
Counterparty's Obligations Under the Relevant Swap Are Guaranteed by a
U.S. Person and Neither Counterparty Is a Foreign Consolidated
Subsidiary Nor a U.S. Branch of a Non-U.S. CSE
As discussed in section II.C.3., under the Proposed Rule, the
Commission would exclude from its margin rules uncleared swaps entered
into by a non-U.S. CSE with a non-U.S. person counterparty (including a
non-U.S. CSE), provided that neither counterparty's obligations under
the relevant swap are guaranteed by a U.S. person and neither
counterparty is a Foreign Consolidated Subsidiary nor a U.S. branch of
a non-U.S. CSE. As discussed in section II.C.3. above, the Commission
believes that it would be appropriate to tailor the application of
margin requirements in the cross-border context, consistent with
section 4s(e) of the CEA \113\ and comity principles, so as to exclude
this narrow class of uncleared swaps involving a non-U.S. CSE and a
non-U.S. counterparty.
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\113\ Section 4s(e)(3)(A) of the CEA, 7 U.S.C. 6s(e)(3)(A). The
section provides, among other things, that margin requirements ``be
appropriate for the risks associated with the non-cleared swaps held
as a swap dealer or major market participant.''
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The Commission believes that such non-U.S. CSEs may benefit from
the Exclusion because it allows them to avoid conflicting or
duplicative regulations where a transaction would be subject to more
than one uncleared swap margin regime. On the other hand, to the extent
a non-U.S. CSE would be able to rely on the margin requirements of a
foreign jurisdiction, as opposed to the Commission's margin
requirements, and such other margin requirements are not comparable,
the Exclusion could result in a less rigorous margin regime for such
CSE. This, in turn, could create competitive disparities between non-
U.S. CSEs relying on the Exclusion and other CSEs that are not eligible
for the Exclusion. That is, the Exclusion could allow these non-U.S.
CSEs to offer better pricing to their non-U.S. clients, which would
give them a competitive advantage relative to those CSEs that are not
eligible for the Exclusion (e.g., U.S. CSEs, non-U.S. CSEs whose
obligations under the relevant swap are not guaranteed by a U.S.
person, or Foreign Consolidated Subsidiaries). However, whether these
competitive effects occur will also depend on whether the relevant
foreign jurisdiction has comparable margin rules. In addition, non-U.S.
CSEs that are eligible for the Exclusion could be in a better position
to compete with non-CFTC registered dealers in the relevant foreign
jurisdiction for foreign clients.
As noted above, at this time, given that foreign jurisdictions do
not yet have in place their margin regimes, it is not possible to fully
evaluate the Proposed Rule's eventual implications for the safety and
soundness of CSEs and competition. Assuming, however, for the sake of
analysis that the relevant foreign jurisdiction does not have
comparable margin requirements, the Commission preliminarily believes
that the Exclusion would not result in a significant diminution in the
safety and soundness of the non-U.S. CSE, as discussed in section
II.C.3. above. This is based on several considerations. First, the
potential adverse effect on a non-U.S. CSE would be substantially
mitigated by the Commission's capital requirements.\114\ Additionally,
any excluded swaps would most likely be covered by another jurisdiction
that adheres to the BCBS-IOSCO standards because the Commission
believes that most swaps are currently undertaken in jurisdictions that
already have agreed to adhere to the BCBS-IOSCO margin standards.
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\114\ See section II.A.1.
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Further, a non-U.S. CSE that can avail itself of the Exclusion
would still be subject to the Commission's margin rules with respect to
all uncleared swaps not meeting the criteria for the Exclusion, albeit
with the possibility of substituted compliance. The Commission further
believes that the possibility of a cascading event affecting U.S.
counterparties and the U.S. financial markets more broadly as a result
of a default by the non-U.S. CSE would also be mitigated because the
non-U.S. CSE would be subject to U.S. margin requirements (with the
possibility of substituted compliance to the extent applicable) when
entering into a swap with U.S. counterparties.
iv. Foreign Consolidated Subsidiaries
Under the Proposed Rule, substituted compliance is more broadly
available to a Foreign Consolidated Subsidiary whose obligations under
the relevant swap are not guaranteed by a U.S. person than a U.S. CSE
or a non-U.S. CSE whose obligations under the relevant swap are
guaranteed by a U.S. person. Further, a Foreign Consolidated Subsidiary
would be able to avail itself of substituted compliance to the same
extent as other non-U.S. CSEs, but would not be eligible for the
Exclusion. A Foreign Consolidated Subsidiary's financial position,
operating results, and statement of cash flows are directly reflected
in its ultimate U.S. parent entity's financial statements. Given the
nature of a Foreign Consolidated Subsidiary's direct relationship to a
U.S. person, the Commission believes that the uncleared swaps of
Foreign Consolidated Subsidiaries should not be excluded from the
margin requirements, as discussed in section II.C.3. above.
The unavailability of the Exclusion could disadvantage Foreign
Consolidated Subsidiaries relative to other non-U.S. CSEs that would be
eligible for the Exclusion (i.e., non-U.S. CSEs where neither
counterparty's obligations under the relevant swap are guaranteed by a
U.S. person and neither counterparty is a Foreign Consolidated
Subsidiary nor a U.S. branch of a non-U.S. CSE) or non-CFTC registered
dealers within a foreign jurisdiction. Non-U.S. CSEs that rely on the
Exclusion or non-CFTC registered dealers could realize a cost advantage
over Foreign Consolidated Subsidiaries and thus have the potential to
offer better pricing terms to foreign clients. The competitive
disparity between non-U.S. CSEs that rely on the Exclusion and Foreign
Consolidated Subsidiaries, however, may be somewhat mitigated to the
extent that the relevant foreign jurisdiction implements the BCBS-IOSCO
framework.
v. U.S. Branch of a Non-U.S. CSE
Under the Proposed Rule, the Exclusion from the margin rules would
not be available to a U.S. branch of a non-U.S. CSE. The Commission
believes that when a non-U.S. CSE conducts its swap activities within
the United States through a branch or office located in the United
States, it should be subject to U.S. margin requirements, but with the
possibility of substituted compliance, consistent with comity
principles. The Commission believes that the Proposed Rule's Exclusion
should not be available in this case, because U.S. branches of non-U.S.
CSEs are operating within the
[[Page 41398]]
U.S. market and competing with U.S. CSEs for business, including from
non-U.S. counterparties.
If a U.S. branch of a non-U.S. CSE were permitted to use the
Exclusion it could be able to offer more competitive terms to non-U.S.
clients than U.S. CSEs, and thereby gain an unwarranted advantage when
dealing with non-U.S. clients relative to other CSEs operating within
the United States (i.e., U.S. CSEs). On the other hand, for the same
reason, the Proposed Rule could put non-U.S. CSEs that conduct swaps
business through their U.S. branches at a disadvantage relative to
either non-U.S. CSEs that are eligible for the Exclusion or non-CFTC
registered dealers that conduct swaps business overseas. However, to
the extent that the U.S. branch of a non-U.S. CSE is able to rely on
substituted compliance, the competitive disparities relative to those
non-U.S. CSEs that are eligible for the Exclusion should be reduced to
the extent that the relevant foreign jurisdiction implements BCBS-IOSCO
framework standards.\115\
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\115\ Non-U.S. CSEs are also likely to conduct swaps business
with U.S. clients from locations outside the United States;
nevertheless, U.S. branches are likely to have greater U.S. client-
orientation relative to such foreign operations.
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The unavailability of the Exclusion could also result in the U.S.
branch of a non-U.S. CSE being subject to conflicting or duplicative
margin requirements. However, the Commission believes that overall any
resulting costs may not be significant to the extent that the U.S.
branch is able to avail itself of substituted compliance in that
jurisdiction.
c. Alternatives
The Commission believes that the Proposed Rule effectively
addresses the risk posed to the safety and soundness of CSEs, while
creating a workable framework that reduces the potential for undue
market disruptions and promotes global harmonization by taking into
account the interests of other jurisdictions and balancing those
interests with the supervisory interests of the United States.
The Commission has determined not to propose the Guidance Approach
because it believes that if the Guidance Approach were adopted, too
many swaps would be excluded from the margin rules to ensure the safety
and soundness of CSEs and the U.S. financial system. In particular,
under the Guidance Approach, uncleared swaps between a non-U.S. CSE and
a non-U.S. person whose uncleared swap obligations are not guaranteed
by a U.S. person would be excluded from the Commission's margin rules
without regard to whether the non-U.S CSE is guaranteed or its
financial statements are consolidated with a U.S. parent entity under
U.S. generally accepted accounting principles.
The Commission has also determined not to propose the Entity-Level
Approach. On the one hand, the Entity-Level Approach (where the margin
requirements would apply to all uncleared swaps of a CSE, with no
possibility of any exclusion) is arguably appropriate because margin
requirements are critical in ensuring the safety and soundness of a CSE
and in supporting the stability of the U.S. financial markets. As a
result of CSEs engaging in a level of uncleared swap activity that is
significant enough to warrant U.S. registration, their uncleared swaps
have a direct and significant nexus to the U.S. financial system,
irrespective of whether their counterparty is a U.S. or non-U.S.
entity. However, the Commission believes that the Entity-Level Approach
does not adequately consider the relative supervisory interests of U.S.
and foreign regulators.
d. Comparability Determinations
As noted in section II.D. above, any CSE who is eligible for
substituted compliance may make a request for a comparability
determination. Currently, there are approximately 102 CSEs
provisionally registered with the Commission. The Commission further
estimates that of the 102 CSEs that are registered, approximately 61
CSEs would be subject to the Commission's margin rules, as they are not
supervised by a Prudential Regulator. However, the Commission notes
that any foreign regulatory agency that has direct supervisory
authority to administer the foreign regulatory framework for margin of
uncleared swaps in the requested foreign jurisdiction may apply for a
comparability determination. Further, once a comparability
determination is made for a jurisdiction, it would apply for all
entities or transactions in that jurisdiction to the extent provided in
the determination, as approved by the Commission.
The Commission assumes that a CSE or foreign regulatory agency will
apply for a comparability determination only if the anticipated
benefits warrant the costs attendant to submission of a request for a
comparability determination. Although there is uncertainty regarding
the number of requests that would be made under the Proposed Rule, the
Commission estimates that it would receive applications for
comparability determinations from 17 jurisdictions representing 61
separate registrants, and that each request would impose an average of
10 burden hours per registrant.\116\
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\116\ See note 99, supra.
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Based upon the above, the Commission estimates that the preparation
and filing of submission requests for comparability determinations
should take no more than 170 hours annually in the aggregate (17
registrants x 10 hours). The Commission further estimates that the
total aggregate cost of preparing such submission requests would be
$64,600, based on an estimated cost of $380 per hour for an in-house
attorney.\117\
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\117\ Although different registrants may choose to staff
preparation of the comparability determination request with
different personnel, Commission staff estimates that, on average, an
initial request could be prepared and submitted with 10 hours of an
in-house attorney's time. To estimate the hourly cost of an in-house
attorney's attorney time, Commission staff reviewed data in SIFMA's
Report on Management and Professional Earnings in the Securities
Industry 2013, modified by Commission staff to account for an 1800-
hour work-year and multiplied by a factor of 5.35 to account for
firm size, employee benefits and overhead. Commission staff believes
that use of a 5.35 multiplier here is appropriate because some
persons may retain outside advisors to assist in making the
determinations under the rules.
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3. Section 15(a) Factors
As discussed above, the Proposed Rule is intended to apply the
Proposed Margin Rules on a cross-border basis in a manner that
effectively addresses risks to U.S. persons and the U.S. financial
system, while mitigating the potential for conflicts and duplications
that could lead to market distortions and undue competitive
disparities. The discussion that follows supplements the related cost
and benefit considerations addressed in the preceding section and
addresses the overall effect of the Proposed Rule in terms of the
factors set forth in section 15(a) of the CEA.
a. Protection of Market Participants and the Public
CEA section 15(a)(2)(A) requires the Commission to evaluate the
costs and benefits of a proposed regulation in light of considerations
of protection of market participants and the public. CEA section
4s(e)(2)(A) requires the Commission to develop rules designed to ensure
the safety and soundness of CSEs and the U.S. financial system. In
developing the Proposed Rule, the Commission's primary focus was on the
relationship or trade-offs between the benefits associated with
applying the Commission's margin requirement and the costs associated
with extending substituted compliance or the
[[Page 41399]]
Exclusion. On the one hand, full application of the Commission's margin
requirements would help to ensure the safety and soundness of CSEs and
the U.S. financial system by reducing counterparty credit risk and the
threat of contagion; on the other hand, extending substituted
compliance or the Exclusion to CSEs would reduce the potential for
conflicting or duplicative requirements, which would, in turn, reduce
market distortions and promote global harmonization. Substituted
compliance in particular should not reduce the safety and soundness
benefit of the Proposed Rule because substituted compliance will not be
available unless the Commission determines that foreign margin
regulations are comparable to the Commission's margin regulations.
Granting the Exclusion to certain CSEs should not significantly
undermine these purposes, because other requirements and circumstances
discussed above should mitigate the risk those CSEs pose to the U.S.
financial system.
b. Efficiency, Competitiveness, and Financial Integrity
CEA section 15(a)(2)(B) requires the Commission to evaluate the
costs and benefits of a proposed regulation in light of efficiency,
competitiveness and financial integrity considerations.
i. Efficiency
The availability of substituted compliance to CSEs following
comparable margin requirements in a foreign jurisdiction may
incentivize global implementation of the BCBS-IOSCO framework. Greater
harmonization across markets lessens the potential for conflicting or
duplicative requirements, which, in turn, would promote greater
operational efficiencies as a CSE would be able to avoid creating
individualized compliance and operational infrastructures to account
for the unique requirements of each jurisdiction in which it conducts
swaps business. Also, to the extent that margin regimes across
jurisdictions are comparable, substituted compliance should help to
mitigate regulatory arbitrage.
ii. Competitiveness
Under the Proposed Rule, the availability of substituted compliance
would turn primarily on the nature of the non-U.S. CSE's relationship
to a U.S. person and the national status of the non-U.S. CSE's
counterparty. For example, in the case of a non-U.S. CSE whose swap
obligations are not guaranteed by a U.S. person, substituted compliance
would be available for any swap with a counterparty that is not a U.S.
CSE or a non-U.S. CSE whose swap obligations are guaranteed by a U.S.
person. Further, under the Proposed Rule, an uncleared swap entered
into by a non-U.S. CSE with a non-U.S. person counterparty (including a
non-U.S. CSE) would be excluded from the Commission's margin rules,
provided that neither counterparty's obligations under the relevant
swap are guaranteed by a U.S. person and neither counterparty is a
Foreign Consolidated Subsidiary nor a U.S. branch of a non-U.S. CSE.
The availability of substituted compliance and/or the Exclusion
could create competitive disparities between those CSEs that are
eligible for substituted compliance and/or the Exclusion relative to
those that are not eligible. In addition, as the Exclusion is not
provided to all CSEs, those that are not permitted to use the Exclusion
may be at a competitive disadvantage when competing in foreign
jurisdictions that do not have comparable margin rules to that of the
Commission relative to non-CFTC registered dealers for foreign
clients.\118\ Because the Proposed Rule offers to U.S. CSEs (and non-
U.S. CSEs with respect to swaps whose obligations are guaranteed by a
U.S. person) only a minimal degree of substituted compliance and no
Exclusion, these CSEs may be particularly impacted. As discussed in
section II.C.1., however, the Commission believes that the Proposed
Margin Rules should apply to the maximum degree to such CSEs in order
to ensure the safety and soundness of U.S. CSEs (and U.S. guarantor)
and the U.S. financial system. Furthermore, to the extent that that a
relevant foreign jurisdiction's margin rules are comparable to that of
the Commission's margin rules, such competitive disparities could be
reduced.
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\118\ The Commission notes, however, that of the approximately
61 CSEs that would be subject to the Commission's margin rules, 21
are non-U.S. CSEs. Of those 21 non-U.S. CSEs, 20 are domiciled in
jurisdictions that participated in the development of the BCBS-IOSCO
framework, which may mitigate possible regulatory arbitrage between
these dealers.
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iii. Financial Integrity of Markets
The safety and soundness of CSEs are critical to the financial
integrity of markets. Further, as discussed in section II.A. above,
margin serves as a first line of defense to protect a CSE as a whole in
the event of a default by a counterparty. Together with capital, margin
represents a key element in a CSE's overall risk management program,
which ultimately mitigates the possibility of a systemic event.
At the same time, the Commission recognizes that a CSE's uncleared
swaps with a particular counterparty may implicate the supervisory
interests of foreign regulators, and it is important to calibrate the
cross-border application of the margin requirements to mitigate, to the
extent possible, consistent with the Commission's regulatory interests,
the potential for conflict or duplication with other jurisdictions.
Therefore, the Proposed Rule also allows for substituted compliance and
an Exclusion in certain circumstances.
The Commission believes that the Proposed Rule strikes the right
balance between the two competing considerations to ensure that
substituted compliance and the Exclusion are not extended in a way that
could pose substantial risk to the integrity of the U.S. financial
system. Substituted compliance is predicated on the Commission's
determination that the relevant foreign jurisdiction has comparable
margin rules; if the Commission does not find a foreign jurisdiction's
rules comparable, the CSE would then need to comply with the
Commission's rules. Even in instances where the Exclusion would be
available, the Commission has taken into account that the risk to the
integrity of the financial markets would be mitigated by the
Commission's expectation that: (1) The Proposed Margin Rules would
cover many of the swaps of the non-U.S. CSEs (eligible for the
Exclusion) with other counterparties, namely, all U.S. counterparties;
(2) the Exclusion would be limited to a narrow set of swaps by non-U.S.
CSEs; (3) the capital requirements would apply on an entity-level basis
to all CSEs; and (4) the excluded swaps will most likely be covered by
another foreign regulator's margin rules that are based on the BCBS-
IOSCO framework.
c. Price Discovery
CEA section 15(a)(2)(C) requires the Commission to evaluate the
costs and benefits of a proposed regulation in light of price discovery
considerations. The Commission generally believes that substituted
compliance, by reducing the potential for conflicting or duplicative
regulations, could reduce impediments to transact uncleared swaps on a
cross-border basis. This, in turn, may enhance liquidity as more market
participants would be willing to enter into uncleared swaps, thereby
possibly improving price discovery--and ultimately reducing market
fragmentation. Alternatively, if substituted compliance or the
Exclusion were not made available, it would
[[Page 41400]]
incentivize CSEs to consider setting up their swap operations outside
the Commission's jurisdiction, and as a result, increase the potential
for market fragmentation.
d. Sound Risk Management Practices
CEA section 15(a)(2)(D) requires the Commission to evaluate the
costs and benefits of a proposed regulation in light of sound risk
management practices. Margin is a critical element of a firm's sound
risk management program that, among other things, can prevent the
accumulation of counterparty credit risk. As international regulators
and the Commission harmonize their margin regulations for uncleared
swaps, market participants may be able to manage their risk more
effectively on an enterprise-wide basis. On the other hand, to the
extent that a CSE relies on the Exclusion for eligible swaps and the
relevant foreign jurisdiction does not have comparable margin
requirements, the Proposed Rule could lead to weaker risk management
practices.
e. Other Public Interest Considerations
CEA section 15(a)(2)(E) requires the Commission to evaluate the
costs and benefits of a proposed regulation in light of other public
interest considerations. The Commission has not identified any
additional public interest considerations related to the costs and
benefits of the Proposed Rule.
4. General Request for Comment
The Commission requests comment on all aspects of the costs and
benefits relating to the cross-border application of the Proposed Rule,
including the nature and extent of the costs and benefits discussed
above and any other costs and benefits that could result from adoption
of the Proposed Rule. Commenters are encouraged to discuss the costs
and benefits to U.S. CSEs and non-U.S. CSEs covered by the Proposed
Rule, as well as any costs and benefits to other market participants,
the swap markets, or the general public, and to the extent such costs
and benefits can be quantified, monetary and other estimates thereof.
The Commission requests that commenters provide any data or other
information that would be useful in estimating the quantifiable costs
and benefits of this rulemaking. Among other things, commenters may
wish to submit comments on the following questions:
1. Are the Commission's assumptions about the costs and benefits of
the Proposed Rule accurate? If not, please explain and provide any data
or other information that you have quantifying or qualifying the costs
and benefits of the Proposed Rule.
2. Did the Commission consider all of the appropriate costs and
benefits related to the Proposed Rule? If not, what additional costs
and benefits should the Commission consider? Please explain why these
additional costs and benefits should be considered and provide any data
or other information that you have quantifying or qualifying the costs
and benefits of these additional costs of the Proposed Rule.
3. Please provide any data or other information relating to costs
associated with the definition of ``U.S. person'' in the Proposed Rule,
and in particular, as the proposed definition relates to the definition
of ``U.S. person'' that was included in the Guidance.
4. Will allowing substituted compliance or the Exclusion for swaps
between certain categories of non-U.S. persons lead to fragmentation
(e.g., creating separate or multiple swap markets) of the liquidity in
swaps markets for uncleared swaps to the detriment of price discovery?
Is swap market fragmentation detrimental to various market participants
when there is post-trade price transparency of swaps? Commenters are
encouraged to quantify when practicable. Does the Proposed Rule have
any significant effects on price discovery? Indeed, to what extent are
the impacts on price discovery the result of other requirements, such
as the margin for uncleared swaps or the trade execution mandate, and
not the Proposed Rule per se?
List of Subjects in 17 CFR Part 23
Swaps, Swap dealers, Major swap participants, Capital and margin
requirements.
For the reasons discussed in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR chapter I as set forth
below:
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
0
1. The authority citation for part 23 is revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.
Section 23.160 also issued under 7 U.S.C. 2(i); Sec. 721(b),
Pub. L. 111-203, 124 Stat. 1641 (2010).
0
2. Add subpart E to part 23 to read as follows:
Subpart E--Capital and Margin Requirements for Swap Dealers and Major
Swap Participants
Sec.
23.100-23.149 [Reserved]
23.150-23.159 [Reserved]
23.160 Cross-border application.
23.161-23.199 [Reserved]
Subpart E--Capital and Margin Requirements for Swap Dealers and
Major Swap Participants
Sec. Sec. 23.100-23.149 [Reserved]
Sec. Sec. 23.150-23.159 [Reserved]
Sec. 23.160 Cross-border application.
(a) Definitions. For purposes of this section only:
(1) Foreign Consolidated Subsidiary means a non-U.S. CSE in which
an ultimate parent entity that is a U.S. person has a controlling
financial interest, in accordance with U.S. GAAP, such that the U.S.
ultimate parent entity includes the non-U.S. CSE's operating results,
financial position and statement of cash flows in the U.S. ultimate
parent entity's consolidated financial statements, in accordance with
U.S. GAAP.
(2) Guarantee means an arrangement pursuant to which one party to a
swap transaction with a non-U.S. person counterparty has rights of
recourse against a U.S. person, with respect to the non-U.S. person
counterparty's obligations under the swap transaction. For these
purposes, a party to a swap transaction has rights of recourse against
a U.S. person if the party has a conditional or unconditional legally
enforceable right to receive or otherwise collect, in whole or in part,
payments from the U.S. person in connection with the non-U.S. person
counterparty's obligations under the swap.
(3) International standards means the margin policy framework for
non-cleared, bilateral derivatives issued by the Basel Committee on
Banking Supervision and the International Organization of Securities in
September 2013, as subsequently updated, revised, or otherwise amended,
or any other international standards, principles or guidance relating
to margin requirements for non-cleared, bilateral derivatives that the
Commission may in the future recognize, to the extent that they are
consistent with United States law (including the margin requirements in
the Commodity Exchange Act).
(4) Non-U.S. CSE means a covered swap entity that is not a U.S.
person. The term ``non-U.S. CSE'' includes a ``Foreign Consolidated
Subsidiary'' or a U.S. branch of a non-U.S. CSE.
(5) Non-U.S. person means any person that is not a U.S. person.
(6) Ultimate parent entity means the parent entity in a
consolidated group in which none of the other entities in the
[[Page 41401]]
consolidated group has a controlling interest, in accordance with U.S.
GAAP.
(7) United States means the United States of America, its
territories and possessions, any State of the United States, and the
District of Columbia.
(8) U.S. CSE means a covered swap entity that is a U.S. person.
(9) U.S. GAAP means U.S. generally accepted accounting principles.
(10) U.S. person means:
(i) A natural person who is a resident of the United States;
(ii) An estate of a decedent who was a resident of the United
States at the time of death;
(iii) A corporation, partnership, limited liability company,
business or other trust, association, joint-stock company, fund or any
form of entity similar to any of the foregoing (other than an entity
described in paragraph (a)(10)(iv) or (v) of this section) (a ``legal
entity''), in each case that is organized or incorporated under the
laws of the United States or having its principal place of business in
the United States, including any branch of such legal entity;
(iv) A pension plan for the employees, officers or principals of a
legal entity described in paragraph (a)(10)(iii) of this section,
unless the pension plan is primarily for foreign employees of such
entity;
(v) A trust governed by the laws of a state or other jurisdiction
in the United States, if a court within the United States is able to
exercise primary supervision over the administration of the trust;
(vi) A legal entity (other than a limited liability company,
limited liability partnership or similar entity where all of the owners
of the entity have limited liability) that is owned by one or more
persons described in paragraphs (a)(10)(i) through (v) of this section
and for which such person(s) bears unlimited responsibility for the
obligations and liabilities of the legal entity, including any branch
of the legal entity; or
(vii) An individual account or joint account (discretionary or not)
where the beneficial owner (or one of the beneficial owners in the case
of a joint account) is a person described in paragraphs (a)(10)(i)
through (vi) of this section.
(b) Applicability of margin requirements--(1) Uncleared swaps of
U.S. CSEs or Non-U.S. CSEs whose obligations under the relevant swap
are guaranteed by a U.S. person--(i) Applicability of U.S. margin
requirements; availability of substituted compliance for requirement to
post initial margin. With respect to each uncleared swap entered into
by a U.S. CSE or a non-U.S. CSE whose obligations under the swap are
guaranteed by a U.S. person, the U.S. CSE or non-U.S. CSE whose
obligations under the swap are guaranteed by a U.S. person shall comply
with the requirements of Sec. Sec. 23.150 through 23.159, provided
that the U.S. CSE or non-U.S. CSE whose obligations under the swap are
guaranteed by a U.S. person may satisfy its requirement to post initial
margin to certain counterparties to the extent provided in paragraph
(b)(1)(ii) of this section.
(ii) Compliance with foreign initial margin collection requirement.
A covered swap entity that is covered by paragraph (b)(1)(i) of this
section may satisfy its requirement to post initial margin under this
part by posting initial margin in the form and amount, and at such
times, that its counterparty is required to collect initial margin
pursuant to a foreign jurisdiction's margin requirements, but only to
the extent that:
(A) The counterparty is neither a U.S. person nor a non-U.S. person
whose obligations under the relevant swap are guaranteed by a U.S.
person;
(B) The counterparty is subject to such foreign jurisdiction's
margin requirements; and
(C) The Commission has issued a comparability determination under
paragraph (c) of this section (``Comparability Determination'') with
respect to such foreign jurisdiction's requirements regarding the
posting of initial margin by the covered swap entity (that is covered
in paragraph (b)(1) of this section).
(2) Uncleared swaps of Non-U.S. CSEs whose obligations under the
relevant swap are not guaranteed by a U.S. person--(i) Applicability of
U.S. margin requirements except where an exclusion applies;
Availability of substituted compliance. With respect to each uncleared
swap entered into by a non-U.S. CSE whose obligations under the
relevant swap are not guaranteed by a U.S. person, the non-U.S. CSE
shall comply with the requirements of Sec. Sec. 23.150 through 23.159
except to the extent that an exclusion is available under paragraph
(b)(2)(ii) of this section, provided that a non-U.S. CSE whose
obligations under the relevant swap are not guaranteed by a U.S. person
may satisfy its margin requirements under this part to the extent
provided in paragraphs (b)(2)(iii) and (iv) of this section.
(ii) Exclusion. A non-U.S. CSE shall not be required to comply with
the requirements of Sec. Sec. 23.150 through 23.159 with respect to
each uncleared swap it enters into to the extent:
(A) The non-U.S. CSE's obligations under the relevant swap are not
guaranteed by a U.S. person;
(B) The non-U.S. CSE is not a U.S. branch of a non-U.S. CSE; and
(C) The non-U.S. CSE is not a Foreign Consolidated Subsidiary with
a non-U.S. person counterparty (excluding a Foreign Consolidated
Subsidiary or the U.S. branch of a non-U.S. CSE), whose obligations
under the relevant swap are not guaranteed by a U.S. person.
(iii) Availability of substituted compliance where the counterparty
is not a U.S. CSE or a non-U.S. CSE whose obligations under the
relevant swap are guaranteed by a U.S. person. Except to the extent
that an exclusion is available under paragraph (b)(2)(ii) of this
section, with respect to each uncleared swap entered into by a non-U.S.
CSE whose obligations under the relevant swap are not guaranteed by a
U.S. person with a counterparty (except where the counterparty is
either a U.S. CSE or a non-U.S. CSE whose obligations under the
relevant swap are guaranteed by a U.S. person), the non-U.S. CSE whose
obligations under the relevant swap are not guaranteed by a U.S. person
may satisfy margin requirements under this part by complying with the
margin requirements of a foreign jurisdiction to which such non-U.S.
CSE (whose obligations under the relevant swap are not guaranteed by a
U.S. person) is subject, but only to the extent that the Commission has
issued a Comparability Determination under paragraph (c) of this
section for such foreign jurisdiction.
(iv) Availability of substituted compliance where the counterparty
is a U.S. CSE or a non-U.S. CSE whose obligations under the relevant
swap are guaranteed by a U.S. person. With respect to each uncleared
swap entered into by a non-U.S. CSE whose obligations under the
relevant swap are not guaranteed by a U.S. person with a counterparty
that is a U.S. CSE or a non-U.S. CSE whose obligations under the
relevant swap are guaranteed by a U.S. person, the non-U.S. CSE (whose
obligations under the relevant swap are not guaranteed by a U.S.
person) may satisfy its requirement to collect initial margin under
this part by collecting initial margin in the form and amount, and at
such times and under such arrangements, that the non-U.S. CSE (whose
obligations under the relevant swap are not guaranteed by a U.S.
Person) is required to collect initial margin pursuant to a foreign
jurisdiction's margin requirements, provided that:
[[Page 41402]]
(A) The non-U.S. CSE (whose obligations under the relevant swap are
not guaranteed by a U.S. person) is subject to the foreign
jurisdiction's regulatory requirements; and
(B) The Commission has issued a Comparability Determination with
respect to such foreign jurisdiction's margin requirements.
(c) Comparability determinations--(1) Eligibility requirements. The
following persons may, either individually or collectively, request a
Comparability Determination with respect to some or all of the
Commission's margin requirements:
(i) A covered swap entity that is eligible for substituted
compliance under this section; or
(ii) A foreign regulatory authority that has direct supervisory
authority over one or more covered swap entities and that is
responsible for administering the relevant foreign jurisdiction's
margin requirements.
(2) Submission requirements. Persons requesting a Comparability
Determination should provide the Commission (either by hard copy or
electronically):
(i) A description of the objectives of the relevant foreign
jurisdiction's margin requirements;
(ii) A description of how the relevant foreign jurisdiction's
margin requirements address, at minimum, each of the following elements
of the Commission's margin requirements. Such description should
identify the specific legal and regulatory provisions that correspond
to each element and, if necessary, whether the relevant foreign
jurisdiction's margin requirements do not address a particular element:
(A) The transactions subject to the foreign jurisdiction's margin
requirements;
(B) The entities subject to the foreign jurisdiction's margin
requirements;
(C) The methodologies for calculating the amounts of initial and
variation margin;
(D) The process and standards for approving models for calculating
initial and variation margin models;
(E) The timing and manner in which initial and variation margin
must be collected and/or paid;
(F) Any threshold levels or amounts;
(G) Risk management controls for the calculation of initial and
variation margin;
(H) Eligible collateral for initial and variation margin;
(I) The requirements of custodial arrangements, including
rehypothecation and the segregation of margin;
(J) Documentation requirements relating to margin; and
(K) The cross-border application of the foreign jurisdiction's
margin regime.
(iii) A description of the differences between the relevant foreign
jurisdiction's margin requirements and the International Standards;
(iv) A description of the ability of the relevant foreign
regulatory authority or authorities to supervise and enforce compliance
with the relevant foreign jurisdiction's margin requirements. Such
description should discuss the powers of the foreign regulatory
authority or authorities to supervise, investigate, and discipline
entities for compliance with the margin requirements and the ongoing
efforts of the regulatory authority or authorities to detect, deter,
and ensure compliance with the margin requirements; and
(v) Copies of the foreign jurisdiction's margin requirements
(including an English translation of any foreign language document);
(vi) Any other information and documentation that the Commission
deems appropriate.
(3) Standard of review. The Commission will issue a Comparability
Determination to the extent that it determines that some or all of the
relevant foreign jurisdiction's margin requirements are comparable to
the Commission's corresponding margin requirements. In determining
whether the requirements are comparable, the Commission will consider
all relevant factors, including:
(i) The scope and objectives of the relevant foreign jurisdiction's
margin requirements;
(ii) How the relevant foreign jurisdiction's margin requirements
compare to the International Standards;
(iii) Whether the relevant foreign jurisdiction's margin
requirements achieve comparable outcomes to the Commission's
corresponding margin requirements;
(iv) The ability of the relevant regulatory authority or
authorities to supervise and enforce compliance with the relevant
foreign jurisdiction's margin requirements; and
(v) Any other facts and circumstances the Commission deems
relevant.
(4) Reliance. Any covered swap entity that, in accordance with a
Comparability Determination, complies with a foreign jurisdiction's
margin requirements would be deemed to be in compliance with the
Commission's corresponding margin requirements. Accordingly, the
failure of such a covered swap entity to comply with the foreign
jurisdiction's margin requirements may constitute a violation of the
Commission's margin requirements. All covered swap entities, regardless
of whether they rely on a Comparability Determination, remain subject
to the Commission's examination and enforcement authority.
(5) Conditions. In issuing a Comparability Determination, the
Commission may impose any terms and conditions it deems appropriate.
The violation of such terms and conditions may constitute a violation
of the Commission's margin requirements and/or result in the
modification or revocation of the Comparability Determination.
(6) Modifications. The Commission reserves the right to further
condition, modify, suspend, terminate or otherwise restrict a
Comparability Determination in the Commission's discretion.
(7) Delegation of authority. The Commission hereby delegates to the
Director of the Division of Swap Dealer and Intermediary Oversight, or
such other employee or employees as the Director may designate from
time to time, the authority to request information and/or documentation
in connection with the Commission's issuance of a Comparability
Determination.
Sec. Sec. 23.161--23.199 [Reserved]
Note: The following table will not appear in the Code of Federal
Regulations.
Table A--Application of the Proposed Rule \1\ \2\ \3\
----------------------------------------------------------------------------------------------------------------
CSE Counterparty Proposed approach
----------------------------------------------------------------------------------------------------------------
U.S. CSE or Non-U.S. CSE (including U.S. person (including U.S. CSE). U.S. (All).
U.S. branch of a non-U.S. CSE and a Non-U.S. person (including non-
Foreign Consolidated Subsidiary U.S. CSE, FCS, and U.S. branch of a non-
(``FCS'')) whose obligations under U.S. CSE) whose obligations under the
the relevant swap are guaranteed by relevant swap are guaranteed by a U.S.
a U.S. person. person.
[[Page 41403]]
Non-U.S. person (including non- U.S. (Initial Margin
U.S. CSE, FCS and U.S. branch of a non- collected by CSE in column
U.S. CSE) whose obligations under the 1).
relevant swap are not guaranteed by a Substituted Compliance
U.S. person. (Initial Margin posted by
CSE in column 1).
U.S. (Variation Margin).
FCS whose obligations under the U.S. CSE. U.S. (Initial Margin posted
relevant swap are not guaranteed by Non-U.S. CSE (including U.S. by CSE in column 1).
a U.S. person or U.S. branch of a branch of a non-U.S. CSE and FCS) whose Substituted Compliance
non-U.S. CSE whose obligations under obligations under the relevant swap are (Initial Margin collected by
the relevant swap are not guaranteed guaranteed by a U.S. person. CSE in column 1).
by a U.S. person. U.S. (Variation Margin).
U.S. person (except as noted Substituted Compliance (All).
above for a CSE).
Non-U.S. person whose obligations
under the swap are guaranteed by a U.S.
person (except a non-U.S. CSE, U.S.
branch of a non-U.S. CSE, and FCS whose
obligations are guaranteed, as noted
above).
Non-U.S. person (including non-
U.S. CSE, U.S. branch of a non-U.S. CSE,
and a FCS) whose obligations under the
relevant swap are not guaranteed by a
U.S. person.
Non-U.S. CSE (that is not a FCS or a U.S. CSE. U.S. (Initial Margin posted
U.S. branch of a non-U.S. CSE) whose Non-U.S. CSE (including U.S. by CSE in column 1).
obligations under the relevant swap branch of a non-U.S. CSE and FCS) whose Substituted Compliance
are not guaranteed by a U.S. person. obligations under the swap are guaranteed (Initial Margin collected by
by a U.S. person. CSE in column 1).
U.S. (Variation Margin).
U.S. person (except as noted Substituted Compliance (All).
above for a CSE).
Non-U.S. person whose obligations
under the swap are guaranteed by a U.S.
person (except a non-U.S. CSE whose
obligations are guaranteed, as noted
above).
U.S. branch of a Non-U.S. CSE or
FCS, in each case whose obligations under
the relevant swap are not guaranteed by a
U.S. person.
Non-U.S. person (including a non- Excluded.
U.S. CSE, but not a FCS or a U.S. branch
of a non-U.S. CSE) whose obligations
under the relevant swap are not
guaranteed by a U.S. person.
----------------------------------------------------------------------------------------------------------------
\1\ This table should be read in conjunction with the rest of the preamble and the text of the Proposed Rule.
\2\ The term ``U.S. person'' is defined in Sec. 23.160(a)(10) of the Proposed Rule. A ``non-U.S. person'' is
any person that is not a ``U.S. person.'' The term swap means an uncleared swap and is defined in Sec.
23.151 of the Proposed Margin Rules. See Margin Requirements for Uncleared Swaps for Swap Dealers and Major
Swap Participants, 79 FR 59898 (Oct. 3, 2014).
\3\ As used in this table, the term ``Foreign Consolidated Subsidiary'' or ``FCS'' refers to a non-U.S. CSE in
which an ultimate parent entity that is a U.S. person has a controlling financial interest, in accordance with
U.S. GAAP, such that the U.S. ultimate parent entity includes the non-U.S. CSE's operating results, financial
position and statement of cash flows in the U.S. ultimate parent entity's consolidated financial statements,
in accordance with U.S. GAAP. The term ``ultimate parent entity'' means the parent entity in a consolidated
group in which none of the other entities in the consolidated group has a controlling interest, in accordance
with U.S. GAAP.
Issued in Washington, DC, on July 2, 2015, by the Commission.
Christopher J. Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants--Cross-Border Application of the Margin
Requirements--Commission Voting Summary, Chairman's Statement, and
Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Massad and Commissioners Wetjen, Bowen,
and Giancarlo voted in the affirmative. No Commissioner voted in the
negative.
Appendix 2--Statement of Chairman Timothy G. Massad
Today the Commission voted unanimously to issue a proposal on
the cross-border application of our previously proposed rules on
margin for uncleared swaps. I thank my fellow Commissioners for
their work and input on this proposal, and I also want to thank our
staff for their hard work.
The proposed rule on margin for uncleared swaps, which we issued
last fall, is one of the most important rules for the regulation of
the over-the-counter swaps market.
That is because there will always be a large part of the swaps
market that is not cleared through central counterparties. Although
we are mandating clearing for certain swaps, we should not mandate
clearing for all swaps. Some products are not appropriate for such
[[Page 41404]]
a mandate because of their risk or liquidity characteristics.
Margin can be an effective tool for addressing counterparty
credit risk arising from uncleared swaps. Our rule will make sure
that registered swap dealers post and collect margin in their
transactions with other registered swap dealers and financial
institutions that are above certain thresholds. That helps lower the
risk to the financial system and the overall economy. I also note
that the requirements do not apply to commercial end users.
We saw what happened in 2008 when there was a build-up of
excessive risk in bilateral swaps. That risk intensified and
accelerated the financial crisis like gasoline poured on a fire. And
that crisis cost our economy eight million jobs and untold suffering
for American families.
Moreover, we saw how that risk could be created offshore,
outside our borders, but still jeopardize our financial stability
and our economy.
The excessive swap risk taken on by AIG was initiated from its
overseas operation. In order to prevent the failure of AIG, our
government had to commit over $180 billion.
We got all that money back, but that is a painful example of why
the cross-border application of the margin rule is important.
The proposal we are issuing today addresses the possibility that
risk created offshore can flow back into the U.S. And so it applies
to activities of non-U.S. swap dealers that are registered with us.
At the same time, our proposal recognizes the importance of
harmonizing rules with other jurisdictions.
If a transaction by an offshore swap dealer is guaranteed by a
U.S. person, such as the parent of the dealer, the risk of that
transaction can flow back into the U.S. But the same can occur even
if the transaction is not guaranteed by the U.S. parent. Our
proposal addresses that. By doing so, I believe our proposal is a
good way to address the risk that can arise from uncleared swaps in
that situation.
The proposal draws a line as to when we should take this
offshore risk into account that is both reasonable and clear. The
line we are proposing is this: If the financial results and position
of the non-U.S. swap dealer are consolidated in the financial
statements of the U.S. parent, then we should take that into
account, whether or not there is an explicit guarantee.
This is how the proposal works: U.S. swap dealers would be
required to comply with the rule in all their transactions, but in
their transactions with certain non-U.S. counterparties, they would
be entitled to substituted compliance with respect to margin they
post, but not the margin they collect. Non-U.S. swap dealers whose
swap obligations are guaranteed by a U.S. person would be treated
the same way. Substituted compliance would be available in the case
of the laws of those jurisdictions which we have deemed comparable.
For non-U.S. swap dealers registered with us, whose obligations
are not guaranteed by a U.S. person, they must still comply, but
they would be entitled to substituted compliance to a greater
extent. Generally, they could avail themselves of full substituted
compliance unless the counterparty was a U.S. swap dealer or a swap
dealer guaranteed by a U.S. person. And, transactions between a non-
U.S. swap dealer (but not conducted through its U.S. branch) and a
non-U.S. counterparty would be excluded from the margin rules, if
neither party's obligations under the relevant swap are guaranteed
by a U.S. person nor consolidated in the financial statements of its
U.S. parent.
Limiting the exclusion from our rule to only those transactions
where neither party is guaranteed or consolidated with a U.S. person
helps address the concern that there is risk to the U.S. even if
there is no explicit guarantee.
Lastly, when foreign banks conduct their swaps business within
the U.S. through their branches located in the U.S., in direct
competition with U.S. swap dealers, the exclusion would not apply.
However, U.S. branches would be eligible for substituted compliance,
which would reduce the potential for conflicts with foreign
jurisdictions.
The broad scope of substituted compliance recognizes that we
must work together with other jurisdictions to regulate this market,
and we should design our rules to avoid conflict and duplication as
much as possible. And the proposal may reduce competitive
disparities that would otherwise result from different sets of rules
applying to swap dealers engaged in essentially the same activity.
The proposal we are making today is very similar to the approach
proposed last fall by the prudential regulators. That is
appropriate, because the law requires us and the prudential
regulators to harmonize our margin rules as much as possible. It
also makes sense when you look at the composition of the registered
swap dealers. There are approximately 100 swap dealers registered
with us. Approximately 40 of those will be subject to the margin
rules of the prudential regulators, while approximately 60 will be
subject to our rules. About two thirds of those 60 swap dealers that
will be subject to our margin rule have affiliates who will be
subject to the margin rules of the prudential regulators. For
example, of the approximately 60 swap dealers subject to our margin
rules, over half are subsidiaries of just five major U.S. bank
holding companies. Each of those large bank holding companies has
other subsidiaries that are, subject to the margin rules of the
prudential regulators. Therefore, if our margin rules are
substantially different from the margin rules of the prudential
regulators, then we have created incentives for firms to move
activity from one entity to another solely to take advantage of
potential differences in the rules. That is an outcome we should try
very hard to avoid.
We also wish to coordinate our rules with the margin rules of
other jurisdictions. That is why our proposal today provides for
substituted compliance. In addition, at my direction, our staff is
actively engaged with their counterparts in other jurisdictions to
try to harmonize the rules as much as possible. Although much work
remains to be done, and the Commission must take final action, I am
hopeful that our final rules will be similar on many critical issues
to those currently being developed in other major jurisdictions.
I would also like to say a word about our Cross-Border Guidance,
which discussed how the Commission would generally apply Dodd-Frank
requirements to cross-border swap activities. In doing so, the
Commission recognized that the market is complex and dynamic and
that a flexible approach is necessary. As stated in the Guidance,
``the Commission will continue to follow developments as foreign
regulatory regimes and the global swaps market continue to evolve.
In this regard, the Commission will periodically review this
Guidance in light of future developments.'' That is essentially what
we are doing here. With each area of our rules, the implications of
cross-border transactions for our policy objectives may vary. Margin
for uncleared swaps is intended to protect the safety and soundness
of swap dealers and ultimately, to ensure the stability of the U.S.
financial system. Therefore, it is appropriate to take into account
whether that risk flows back into the United States by virtue of a
guarantee by a U.S. person, or financial consolidation with a U.S.
person. But the approach we are proposing today for margin may not
be appropriate with respect to other areas of regulation--such as
swaps reporting or trading.
In conclusion, I believe the approach we are proposing today
combines the best elements of the various approaches proposed last
fall. It strikes the right balance between the Commission's
supervisory interest in ensuring the safety and soundness of
registered swap dealers and the need to recognize principles of
international comity and reduce the potential for conflict with
foreign regulatory requirements.
Appendix 3--Statement of Commissioner Mark P. Wetjen
Today's release lays out a proposed framework for the
application of the Commission's margin rules to un-cleared swaps
(the ``Margin Rule'') in cross-border transactions. Interestingly,
the release states that there was no consensus among those who filed
comments in response to the Commission's Advance Notice of Proposed
Rulemaking (``ANPR'') last fall, which laid out three alternative,
cross-border approaches: The Guidance Approach, the Prudential
Regulators' Approach, and the Entity Approach. To the extent,
therefore, that the release was designed to identify a consensus
view concerning which of these three approaches was best, it failed.
The comment letters, however, provided a great deal of useful
discussion that has aided the Commission's thinking about the extra-
territorial application of its rules. Ultimately, the agency was
guided by those comments to propose today an approach that is
essentially an entity approach, but because of more availability of
substituted compliance, appears most similar to the Prudential
Regulators' Approach in terms of its practical implementation.
I am comfortable supporting today's release, but for the reasons
discussed below,
[[Page 41405]]
continue to harbor some doubts as to whether we have selected the
approach that best balances the Commission's interests in protecting
the financial system and U.S. taxpayers, meeting its statutory
mandate to preserve an appropriate competitive landscape for
participants in the global swaps market, and adopting policies whose
costs to those affected do not exceed their benefits.\1\
---------------------------------------------------------------------------
\1\ See 7 U.S.C. 19(a).
---------------------------------------------------------------------------
The Commission's Responsibilities Regarding the Margin Rule
To begin, it is important to understand the scope of the
Commission's responsibilities with respect to implementing and
enforcing the Margin Rule. As was made plain by the proposal seeking
comment on the Margin Rule released last fall, the rulemaking is one
of the most important component parts of the risk-focused
requirements under Title VII of Dodd-Frank. The statute divides up
responsibilities for implementing and enforcing the Margin Rule
among this Commission, the U.S. prudential regulators, and the
Securities and Exchange Commission. Those responsibilities are
weighty, requiring, among others, the review and approval of margin
methodologies submitted by the covered swap entities under each
authority's jurisdiction.
As of today, five U.S. bank holding companies regulated by the
Board of Governors of the Federal Reserve System (the ``Board'')
have 17 U.S. registered swap dealers that would fall exclusively
within the CFTC's jurisdiction for margin purposes. These same five
U.S. bank holding companies have 15 non-U.S. registered swap dealers
that would fall exclusively within the CFTC's jurisdiction for
margin purposes (the ``U.S. Foreign-Affiliate Dealers''). That is a
total of 32 registered swap dealers that the commission would have
to oversee, supervise, and enforce compliance with respect to the
Margin Rule.
There are another three non-U.S. parent entities regulated by
the Board, which altogether have four entities registered with the
Commission as swap dealers, due to the level of swap-dealing
activity they engage in with U.S. counterparties (``Non-U.S.
Dealers''). There are only three non-U.S. registered swap dealers
that do not have a parent entity regulated by the Board and that
would fall exclusively within the CFTC's jurisdiction for margin
purposes (the ``Truly Foreign Dealers''), or just a fraction of the
number of firms that are either based in the U.S. or controlled by a
U.S. regulated parent. This brings to 39 the total number of swap
dealers whose un-cleared swap activities would be subjected to the
Commission's Margin Rule.
The Commission's regulatory interests in each of these
categories of registered swap dealers is different, notwithstanding
the fact the Commission has responsibility over all of them. In most
respects, the Commission (and other U.S. policymakers and swap-
market stakeholders) should be primarily concerned about the U.S.
Foreign-Affiliate Dealers when thinking through and developing a
cross-border framework to determine when these entities should
follow U.S. law. This statement is based on the fact that concerns
about risk importation into the U.S. are much lower, relatively
speaking, when it comes to the activities of the Non-U.S. Dealers
and Truly Foreign Dealers (none of the Non-U.S. Dealers or Truly
Foreign Dealers would appear to meet the control test under the
prudential regulators' September 2014 margin rule proposal).
Instead, these latter categories of swap dealers raise different
issues related to the Commission's mandates to enhance market
integrity and promote fair competition.\2\
---------------------------------------------------------------------------
\2\ See section 3(b) of the Commodity Exchange Act (``CEA''), 7
U.S.C. 5(b).
---------------------------------------------------------------------------
Appropriately, when Non-U.S. Dealers and Truly Foreign Dealers
face other non-U.S. counterparties, they are excluded from having to
comply with the Margin Rule under the proposal, so long as neither
the registered swap dealer's nor its counterparty's obligations
benefit from a guarantee by a U.S. person. Under the Guidance
Approach, these Non-U.S. Dealers and Truly Foreign Dealers would be
excluded from the Margin Rule as well, so long as neither the swap
dealer's nor its counterparty's obligations benefit from a guarantee
by a U.S. person.
I review the scope and weight of these responsibilities here
because the context to deciding how much supervisory
responsibilities to assert over the cross-border swap activities of
entities located outside of the U.S. is important, both in
understanding the practical implications of claiming those
responsibilities as well as the potential effect on international
comity. The review of the different categories of swap-dealer
registrants also makes it clear to me that to pursue the Entity
Approach without allowing substituted compliance, as some commenters
suggested, is neither necessary for the Commission to meet its
statutory responsibilities nor advisable, not to mention
impractical.
When the Commission voted on the ANPR, I noted the potential
benefits of the proposal set forth by the Prudential Regulators'
Approach, which would effectively apply the margin rule as an
entity-level rule with certain exclusions for foreign swap
activities. At that time, however, I expressed my view that applying
the margin rule as a transaction-level requirement under the
Guidance Approach was the better option. In part, that view was
shaped by the practical reality that it would be difficult for the
Commission to meet its challenge to supervise U.S. swap dealers'
compliance with the margin rule, let alone the activities of the
U.S. Foreign-Affiliate Dealers and Truly Foreign Dealers.
Policy Advantages of Today's Proposal
As it relates to the Truly Foreign Dealers, compliance
obligations under today's proposal would be effectively the same as
under the cross-border guidance, so presumably no new burdens or
competitive considerations would be created here for those firms (as
discussed above). Additionally, as it relates to the U.S. Foreign-
Affiliate Dealers (some of which have affiliates not supervised by
the commission and engaged in swap activities), today's proposal
could dis-incentivize firms from moving swap activity transacted by
an affiliated entity regulated by a U.S. prudential regulator, into
the U.S. Foreign-Affiliate Dealer. Such a market response is
conceivable given the fact there could be different compliance
obligations under the proposal as compared to the Guidance Approach
depending on whether the U.S. Foreign-Affiliate Dealer is a Foreign
Consolidated Subsidiary, and whether the dealer's un-cleared swap is
supported by a guarantee. Presumably, there is swap activity of some
of these U.S. Foreign-Affiliate Dealers that would be required to
comply with the Margin Rule under today's proposal, that would not
have been subjected to the Margin Rule under the Guidance Approach.
U.S. domestic regulators should not knowingly create an
opportunity for affiliates within a U.S. bank holding company to
move swap activity from one affiliate to another for no other reason
than to avoid application of U.S. law (even if there are legitimate
policy reasons that U.S. law would not apply). Indeed, this is why
the Dodd-Frank Act requires the relevant agencies implementing the
Margin Rule to coordinate their efforts as closely as possible.
Knowingly allowing such a result also would be inconsistent with the
Commission's statutory duty to promote fair competition.\3\
---------------------------------------------------------------------------
\3\ See section 3(b) of the CEA, 7 U.S.C. 5(b).
---------------------------------------------------------------------------
Similarly, the Commission should be careful to avoid adopting a
significantly different cross-border approach from the U.S.
prudential regulators if it would incentivize affiliates of U.S.
Foreign-Affiliate Dealers to move their swap activity to the U.S.
Foreign-Affiliate Dealer in order to exploit the relative dearth of
resources available to the Commission for supervising and enforcing
compliance. The CFTC currently is under-staffed. Meeting the
challenge to monitor compliance with the complex and technical
requirements of the Margin Rule as it applies to the swap activity
conducted by U.S. Foreign-Affiliate Dealers today would be
difficult. A cross-border approach that is substantively similar to
the Prudential Regulators' Approach may facilitate the Commission in
meeting its supervisory challenge.
Relatedly, I am also cognizant of market efforts to develop a
standard initial-margin methodology for un-cleared swaps, which I
believe would be supported by the hybrid approach set forth in
today's proposal. I am in favor of these efforts because the use of
a standard initial margin methodology has the potential to reduce
dispute burdens by using a common approach for reconciliation,
promote the efficient use of limited market resources, and enhance
fairness and transparency in the global OTC derivatives markets. As
such, the Commission should, if possible, avoid adopting a cross-
border approach that would discourage the development of a standard
initial-margin methodology, or would otherwise encourage the
development of different margin methodologies across affiliated
entities and/or the broader marketplace. This outcome
[[Page 41406]]
would complicate the jobs of all supervisory authorities involved,
perhaps especially the U.S. prudential regulators.
Policy Advantages of the Guidance Approach
Generally speaking, the Commission in adopting its cross-border
guidance intended to strike a reasonable balance in assuring that
the swaps markets were brought under the new regulatory regime as
directed by Congress and consistent with section 2(i) of the CEA.\4\
We should not depart from those important policy judgments without a
compelling reason to do so.
---------------------------------------------------------------------------
\4\ See section 2(i) of the CEA, 7 U.S.C. 2(i).
---------------------------------------------------------------------------
One advantage of the Guidance Approach, therefore, is that it
would harmonize the Commission's own cross-border policies as they
related to both cleared and un-cleared swap activity. Because many
firms under the Commission's jurisdiction have incurred significant
costs by building systems and practices designed to follow the
Commission's cross-border guidance, overall costs to registered swap
dealers might be lower if the Guidance Approach were adopted, which
obviously is relevant to the Commission's mandate to consider the
benefits and costs of its policies. But of course, with harmony of
the Commission's cross-border policies comes disharmony with the
U.S. prudential regulators.
Another advantage to the Guidance Approach is that it provides a
more elegant way for U.S. Foreign-Affiliate Dealers, Non-U.S.
Dealers and Truly Foreign Dealers to comply with their regulatory
obligations when the Commission has made a substituted-compliance
determination regarding another jurisdiction's margin requirements.
Under the Guidance Approach, an affected swap dealer's obligations
to post margin and collect margin would follow the same law or
regulation of another jurisdiction if the Commission had made such a
substituted-compliance determination; which is to say, margin
payments going in both directions would follow the same set of
rules. This outcome has the added benefit of being consistent with
the Basel Committee on Banking Supervision's (``BCBS'') and the
Board of the International Organization of Securities Commissions'
(``IOSCO'') final margin policy framework for margin requirements
for non-centrally cleared derivatives (the ``BCBS-IOSCO
Framework''), which states that when a transaction is subject to two
sets of rules, the regulators should endeavor to harmonize their
rules to the extent possible.\5\
---------------------------------------------------------------------------
\5\ See BCBS and IOSCO, Margin requirements for non-centrally
cleared derivatives (Sept. 2013) at 22, available at http://www.bis.org/publ/bcbs261.pdf. The BCBS-IOSCO Framework also provides
that regulators should recognize the equivalence and comparability
of their respective rules and apply only one set of rules to the
transaction.
---------------------------------------------------------------------------
Given the relatively broad agreement among key jurisdictions
about how the global framework for margin requirements ought to be
structured, such a result should be an acceptable way to address any
remaining concerns about risk from overseas activity transferring
back to the U.S. Again, those concerns primarily would arise from
the un-cleared swap activities of the U.S. Foreign-Affiliate
Dealers. The proposal, on the other hand, would require a non-U.S.
covered swap entity guaranteed by a U.S. person to follow U.S.
initial margin rules, but only permit substituted compliance for the
posting of initial margin when such non-U.S. covered swap entity
trades with a non-U.S. counterparty.
In this scenario, it would be possible for two separate laws to
apply to the same transaction. Under this framework, I question
whether market participants engaging in un-cleared swaps would have
the necessary legal certainty as to which margin requirements they
would face. While this framework is proposed ostensibly to help
ensure the safety and soundness of covered swap entities and to
support the stability of the U.S. financial markets, these goals
arguably will be accomplished only if the framework is workable. The
Guidance Approach would arguably provide greater certainty as to the
law applicable to a particular transaction, and render the
Commission's policy more consistent with the BCBS-IOSCO
Framework.\6\
---------------------------------------------------------------------------
\6\ See id.
---------------------------------------------------------------------------
To that end, I look forward to hearing additional comments on
whether a swap between a non-U.S. covered swap entity and a non-U.S.
counterparty should receive substituted compliance for the entire
swap, rather than subject the swap to both U.S. and foreign margin
requirements. Ideally, such comments would give the Commission a
better understanding of the feasibility of designing systems to
assist the covered swap entity comply with two separate margin
requirements for the same transaction.
To the degree that the Commission should be concerned about
deferring to other regulators to supervise the posting and
collecting of margin for un-cleared swaps--as it would in the wake
of a substituted-compliance determination--context again is
important to remember here. As mentioned, there is relatively broad
agreement among key jurisdictions about how the global framework for
margin requirements should be structured, as a result of the
issuance of the BCBS-IOSCO Framework. It's equally important to
remember that the Commission's capital rule is treated as an entity-
level rule under the Commission's cross-border guidance.\7\ As I
stated when the Commission released its proposal for the Margin
Rule, credit risks not addressed through the Margin Rule could be
addressed, at least in part, through indirect capital requirements
at the holding company level, and direct capital requirements at the
registrant level for those swap dealers relying on substituted
compliance (or otherwise).
---------------------------------------------------------------------------
\7\ See Interpretive Guidance and Policy Statement Regarding
Compliance with Certain Swap Regulations, 78 FR 45292 (July 26,
2013).
---------------------------------------------------------------------------
Yet another advantage to the Guidance Approach is that it might
better avoid further diminishments to liquidity that the marketplace
has experienced recently, as well as better avoid regulatory market
fragmentation that materialized after the Commission's new swap-
execution framework went into effect. Several commenters expressed
strong concerns that the Entity Approach could further fragment the
swaps markets and impair liquidity, promote regulatory arbitrage,
and place the foreign affiliates of U.S. entities at a competitive
disadvantage beyond the circumstances they face in the cleared swap
environment under the Commission cross-border guidance. I have
recognized and spoken about market fragmentation for years, and so
do not take lightly such concerns being raised again in this
context.
Clarifications of the Commission's Definition of ``Guarantee'' and
``U.S. Person''
The proposal includes two important clarifications for market
participants that I would like to acknowledge. First, I am
supportive of the proposed removal of the U.S. majority-ownership
prong from the U.S. person definition. For certain types of funds,
it is extremely difficult for advisors or administrators to
accurately determine whether, and how many of, the beneficial owners
of fund entities within the fund structure are U.S. persons. Given
this complexity and the other elements of the U.S. person definition
that would capture those funds that have a substantial nexus to the
U.S. markets, I believe this exclusion is necessary and appropriate.
I also support the release's proposed definition of ``guarantee''.
This clearer definition will help market participants better
identify those transactions that raise or implicate greater
supervisory interest by the Commission.
Conclusion
The questions asked in this proposal are intended to solicit
comment in hopes of further clarifying the most appropriate way for
the Commission to meet its regulatory objectives as well as finding
more consensus on the important issues raised in the release. As
discussed above, I am open to the approach taken in this proposal
and recognize its merits. I look forward to seeing whether comments
filed in response to today's release can further build the case for
the Commission adopting the proposal, rather than the Guidance
Approach.
Appendix 4--Concurring Statement of Commissioner Sharon Y. Bowen
I'm pleased to support this new proposed rule on cross-border
application of uncleared margin requirements for swap dealers and
major swap participants. Margin requirements for uncleared swaps,
needless to say, are a core piece of the new regulatory regime we
are establishing as required by the Dodd-Frank Wall Street Reform
and Consumer Protection Act.
It is imperative that we get all aspects of our margin
requirements right, and that includes getting the cross-border
element of the requirements right. The swaps market is a global
one--the market has organically evolved to rely on the ability of
U.S. entities to trade with European entities as a matter of course.
It is incumbent on us that our rules not severely restrict this flow
of commerce, just as it is incumbent on us that our rules provide
rigorous regulations on this market for the protection of investors,
consumers, and the broader financial system.
[[Page 41407]]
To that end, I look forward to receiving comments on this
proposal from a wide swath of stakeholders, from market participants
to financial reform advocates. I hope we will receive comments on
whether this rule is workable, whether it is sufficiently robust,
and what changes would make the rule more effective on both of those
metrics.
Appendix 5--Statement of Commissioner J. Christopher Giancarlo
The Commission's proposal for the cross-border application of
margin requirements for uncleared swaps is a highly complicated
labyrinth. I look forward to the jolt to U.S. economic growth that
will occur in the 3rd quarter of 2015 as a result of the thousands
of billable hours that will be expended by lawyers and other
professionals, who will have to read, interpret and respond to this
tangled regulatory construct.
I have many concerns and questions regarding the proposal,
including:
1. The shift from the transaction-level approach set forth in
the July 2013 Cross-Border Interpretive Guidance and Policy
Statement \1\ (``Guidance'') to a hybrid approach and what this
means for the status of the Guidance moving forward;
---------------------------------------------------------------------------
\1\ Interpretive Guidance and Policy Statement Regarding
Compliance With Certain Swap Regulations, 78 FR 45292 (Jul. 26,
2013).
---------------------------------------------------------------------------
2. the revised definitions of ``U.S. person'' (defined for the
first time in an actual Commission rule) and ``guarantee'' and how
these new terms will be interpreted and applied by market
participants across their entire global operations;
3. the scope of when substituted compliance is allowed; and
4. the practical implications of permitting substituted
compliance, but disallowing the exclusion from CFTC margin
requirements (``Exclusion'') for non-U.S. covered swap entities
(``CSEs'') who qualify as Foreign Consolidated Subsidiaries.
My concerns extend to the standards set forth for determining
comparability. An appropriate framework for the cross-border
application of margin requirements for uncleared swaps is essential
if we are to preserve the global nature of the swaps market.
Congress recognized this when it instructed the CFTC, the SEC and
the prudential regulators to ``coordinate with foreign regulatory
authorities on the establishment of consistent international
standards with respect to the regulation . . . of swaps.'' \2\
Towards that end, representatives of more than 20 regulatory
authorities, including the CFTC, participated in consultations with
the Basel Committee on Banking Supervision (``BCBS'') and the Board
of the International Organization of Securities Commissions
(``IOSCO''), which resulted in the issuance of a final BCBS-IOSCO
framework in September 2013 that establishes minimum margin
standards for uncleared swaps (``BCBS-IOSCO framework'').\3\
---------------------------------------------------------------------------
\2\ 15 U.S.C. 8325(a) (added by section 752 of the Dodd-Frank
Act).
\3\ See Margin Requirements for Non-centrally Cleared
Derivatives (Sep. 2013), available at http://www.bis.org/publ/bcbs261.pdf, revised Mar. 2015, available at http://www.bis.org/bcbs/publ/d317.pdf.
---------------------------------------------------------------------------
Element seven of the BCBS-IOSCO framework discusses the cross-
border application of margin requirements and stresses the
importance of developing consistent requirements across
jurisdictions to ensure that implementation at a national
jurisdictional level is appropriately interactive:
that is, that each national jurisdiction's rule is territorially
complementary such that (i) regulatory arbitrage opportunities are
limited, (ii) a level playing field is maintained, (iii) there is no
application of duplicative or conflicting margin requirements to the
same transaction or activity, and (iv) there is substantial
certainty as to which national jurisdiction's rules apply. When a
transaction is subject to two sets of rules (duplicative
requirements), the home and the host regulators should endeavor to
(1) harmonize the rules to the extent possible or (2) apply only one
set of rules, by recognizing the equivalence and comparability of
their respective rules.\4\
---------------------------------------------------------------------------
\4\ Id. at 23.
---------------------------------------------------------------------------
Regulatory authorities in major financial centers continue to
collaborate in the development of their rules and I commend CFTC
staff for their continued dialogue with fellow domestic and foreign
regulators. Nevertheless, there are bound to be differences across
jurisdictions in the final rule sets that are ultimately adopted.
Comparability determinations allowing for substituted compliance
with the margin requirements of foreign jurisdictions will be
essential to achieving a workable cross-border framework. I am
concerned that the standards for making comparability determinations
outlined in the Commission's proposal may be too restrictive.
The Commission states that it will employ an outcome-based
comparability standard focusing on whether the margin requirements
in a foreign jurisdiction achieve the same regulatory objectives as
the CFTC's margin requirements and will not require specific rules
identical to the Commission's rules. The Commission states further,
however, that it will make its outcome-based determinations on an
element-by-element basis that will include, but not be limited to,
analyzing: (i) The transactions subject to the foreign
jurisdiction's margin requirements; (ii) the entities subject to the
foreign jurisdiction's margin requirements; (iii) the methodologies
for calculating the amounts of initial and variation margin; (iv)
the process and standards for approving models for calculating
initial and variation margin models; (v) the timing and manner in
which initial and variation margin must be collected and/or paid;
(vi) any threshold levels or amount; (vii) risk management controls
for the calculation of initial and variation margin; (viii) eligible
collateral for initial and variation margin; (ix) the requirements
of custodial arrangements, including rehypothecation and segregation
of margin; (x) documentation requirements relating to margin; and
(xi) the cross-border application of the foreign jurisdiction's
margin regime.
As proposed, the Commission will not be assessing whether the
foreign authority's margin regime as a whole meets the broad
regulatory objectives of requiring margin for uncleared swaps.\5\
Rather, in looking at each element (and any other factor not
included in the foregoing list) the Commission may determine that a
foreign regime is comparable as to some elements, but not others, in
which case substituted compliance might be allowed, for example,
with respect to the methodologies for calculating initial and
variation margin, but not for the eligible collateral.
---------------------------------------------------------------------------
\5\ The regulatory objectives of requiring margin for uncleared
swaps, as stated in the Dodd-Frank Act, are to help insure the
safety and soundness of the swap dealer or major swap participant,
the financial integrity of the markets and the stability of the U.S.
financial system. Section 4s(e)(3)(A), (C), 7 U.S.C. 6s(e)(3)(A),
(C).
---------------------------------------------------------------------------
Depending on how it is put into practice, this element-by-
element approach may be difficult to distinguish from the rule-by-
rule analysis the Commission claims to eschew. We have seen this
before when the Commission made its comparability determinations for
certain foreign countries regarding certain transaction-level
requirements for swap dealers and major swap participants.\6\ There,
the Commission made its determinations on a ``requirement-by-
requirement'' basis, rather than on the basis of the foreign regime
as a whole.\7\ Former Commissioner Scott O'Malia observed in that
instance that this was a ``rule-by-rule'' analysis, which was
contrary to the recommendations of the OTC Derivatives Regulators
Group and afforded only limited substituted compliance relief.\8\
Will our ``element-by-element'' analysis be any different than the
``requirement-by-requirement'' method the Commission employed then?
---------------------------------------------------------------------------
\6\ See, e.g., Comparability Determination for the European
Union: Certain Transaction-Level Requirements, 78 FR 78878 (Dec. 27,
2013).
\7\ Id. at 78881.
\8\ Id. at 78889.
---------------------------------------------------------------------------
I fear that the proposed element-by-element approach will be
outcome-based in name only. In a perfect world all G-20 countries
will adopt comparable margin requirements, but we cannot let the
perfect be the enemy of the good. For substituted compliance to
work, we must focus on broad objectives, not specific requirements.
I am also troubled by the provision of the proposed rule that
would not permit swaps executed ``through or by'' a U.S. branch of a
non-U.S. CSE to qualify for the Exclusion for non-U.S. CSEs who
qualify as Foreign Consolidated Subsidiaries. Under the proposal,
uncleared swaps entered into by a non-U.S. CSE with a non-U.S.
person counterparty (purely foreign-to-foreign swaps), where neither
counterparty is a Foreign Consolidated Subsidiary or guaranteed by a
U.S. person, would be excluded from the Commission's margin rules.
The Exclusion is not available, however, if the swap is executed
``through or by'' the U.S. branch of a non-U.S. CSE.\9\ The
[[Page 41408]]
request for comment following this discussion asks how the
Commission should determine whether a swap is executed ``through or
by'' a U.S. branch and suggests using the same analysis used in the
Commission's Volcker Rule, which required that personnel that
``arrange, negotiate, or execute'' a purchase or sale conducted
under the exemption for trading activity of a foreign banking entity
must be located outside the U.S.\10\
---------------------------------------------------------------------------
\9\ I note that the ``through or by'' language appears in the
preamble to the rule, not the rule text.
\10\ See Prohibitions and Restrictions on Proprietary Trading
and Certain Interests in, and Relationships With, Hedge Funds and
Private Equity Funds, 79 FR 5808, 5927 & n.1526 (Jan. 31, 2014).
---------------------------------------------------------------------------
Prior to its appearance in the Commission's final Volcker Rule
this concept appeared in a hastily issued, November 2013 Staff
Advisory 13-69 (sometimes referred to in the industry as the
``elevator rule'') that imposed swaps transaction rules on trades
between non-U.S. persons whenever anyone on U.S. soil ``arranged,
negotiated, or executed'' the trade.\11\ The effective date of this
Staff Advisory has been delayed four times.\12\ As I have stated
before, the elevator rule is causing many overseas trading firms to
consider cutting off all activity with U.S.-based trade support
personnel to avoid subjecting themselves to the CFTC's flawed swaps
trading rules. The Staff Advisory, if it goes into effect, will
jeopardize the role of bank sales personnel in U.S. financial
centers like Boston, Charlotte, Chicago, New Jersey and New York. It
will likely have a ripple effect on technology staff supporting U.S.
electronic trading systems, along with the thousands of jobs tied to
the vendors who provide food services, office support, custodial
services and transportation for the U.S. financial series industry.
With this proposal, rather than recognizing the myriad of
problematic issues arising from the Staff Advisory, the Commission
is proposing to expand its scope from trading rules to margin rules.
---------------------------------------------------------------------------
\11\ CFTC Staff Advisory No. 13-69 (Nov. 14, 2013), available at
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-69.pdf.
\12\ CFTC Letter No. 14-140, Extension of No-Action Relief:
Transaction-Level Requirements for Non-U.S. Swap Dealers (Nov. 14,
2014), available at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-140.pdf.
---------------------------------------------------------------------------
Despite my many questions and concerns, I support issuing the
proposed rule only so that the public may provide thorough analysis
and thoughtful comment. My vote to issue the proposal for public
comment should not signal, however, my agreement with it. I look
forward to reviewing public comment.
[FR Doc. 2015-16718 Filed 7-13-15; 8:45 am]
BILLING CODE 6351-01-P