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Start Preamble Start Printed Page 74840 AGENCY: Office of the Comptroller of the Currency, Treasury (“OCC”); Board of Governors of the Federal Reserve System (“Board”); Federal Deposit Insurance Corporation (“FDIC”); Farm Credit Administration (“FCA”); and the Federal Housing Finance Agency (“FHFA”). ACTION: Final rule. SUMMARY: The OCC, Board, FDIC, FCA, and FHFA (each an “Agency” and, collectively, the “Agencies”) are adopting a joint rule to establish minimum margin and capital requirements for registered swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants for which one of the Agencies is the prudential regulator.
This final rule implements sections 731 and 764 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, as amended by the Terrorism Risk Insurance Program Reauthorization Act of 2015 (“TRIPRA”). Sections 731 and 764 require the Agencies to adopt rules jointly to establish capital requirements and initial and variation margin requirements for such entities on all non-cleared swaps and non-cleared security-based swaps in order to offset the greater risk to such entities and the financial system arising from the use of swaps and security-based swaps that are not cleared. DATES: The final rule is effective April 1, 2016. Start Further Info FOR FURTHER INFORMATION CONTACT: OCC: Kurt Wilhelm, Director, Financial Markets Group, (202) 649-6437, or Carl Kaminski, Special Counsel, Legislative and Regulatory Activities Division, (202) 649-5490, for persons who are deaf or hard of hearing, TTY (202) 649-5597, Office of the Comptroller of the Currency, 400 7th Street SW., Washington, DC 20219.
Board: Sean D. Campbell, Associate Director, (202) 452-3760, or Elizabeth MacDonald, Manager, Division of Banking Supervision and Regulation, (202) 475-6316; Anna M. Harrington, Counsel, Legal Division, (202) 452-6406, or Victoria M. Szybillo, Counsel, Legal Division, (202) 475-6325, Board of Governors of the Federal Reserve System, 20th and C Streets NW., Washington, DC 20551. FDIC: Bobby R. Bean, Associate Director, Capital Markets Branch, Jacob Doyle, Capital Markets Policy Analyst, Division of Risk Management Supervision, (202) 898-6888; Thomas F. Hearn, Counsel, or Catherine Topping, Counsel, Legal Division, Federal Deposit Insurance Corporation, 550 17th Street NW., Washington, DC 20429.
Floyd, Associate Director, Finance & Capital Markets Team, Timothy T. Nerdahl, Senior Policy Analyst—Capital Markets, Jeremy R.
Edelstein, Senior Policy Analyst, Office of Regulatory Policy, (703) 883-4414, TTY (703) 883-4056, or Richard A. Katz, Senior Counsel, Office of General Counsel, (703) 883-4020, TTY (703) 883-4056, Farm Credit Administration, 1501 Farm Credit Drive, McLean, VA.
FHFA: Robert Collender, Principal Policy Analyst, Office of Policy Analysis and Research, (202) 649-3196, or Peggy K. Balsawer, Associate General Counsel, Office of General Counsel, (202) 649-3060, Federal Housing Finance Agency, Constitution Center, 400 7th St. SW., Washington, DC 20219. The telephone number for the Telecommunications Device for the Hearing Impaired is (800) 877-8339. End Further Info End Preamble Start Supplemental Information SUPPLEMENTARY INFORMATION: I. Background A.
The Dodd-Frank Act The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act” or “Dodd-Frank Act”) was enacted on July 21, 2010. Title VII of the Dodd-Frank Act established a comprehensive new regulatory framework for derivatives, which the Act generally characterizes as “swaps” (which are defined in section 721 of the Dodd-Frank Act to include interest rate swaps, commodity swaps, equity swaps, and credit default swaps) and “security-based swaps” (which are defined in section 761 of the Dodd-Frank Act to include a swap based on a single security or loan or on a narrow-based security index). For the remainder of this preamble, the term “swaps” refers to swaps and security-based swaps unless the context requires otherwise. As part of this new regulatory framework, sections 731 and 764 of the Dodd-Frank Act add a new section, section 4s, to the Commodity Exchange Act of 1936, as amended (“Commodity Exchange Act”) and a new section, section 15F, to the Securities Exchange Act of 1934, as amended (“Securities Exchange Act”), respectively, which require registration with the U.S.
Commodity Futures Trading Commission (the “CFTC”) of swap dealers and major swap participants and the U.S. Securities and Exchange Commission (the “SEC”) of security-based swap dealers and major security-based swap participants (each a “swap entity” and, collectively, “swap entities”). For swap entities that are prudentially regulated by one of the Agenciessections 731 and 764 of the Start Printed Page 74841Dodd-Frank Act require the Agencies to adopt rules jointly for swap entities under their respective jurisdictions imposing (i) capital requirements and (ii) initial and variation margin requirements on all swaps not cleared by a registered derivatives clearing organization or a registered clearing agency.
Swap entities that are prudentially regulated by one of the Agencies and therefore subject to this final rule are referred to herein as “covered swap entities.” Sections 731 and 764 of the Dodd-Frank Act also require the CFTC and SEC separately to adopt rules imposing capital and margin requirements to their applicable swap entities for which there is no prudential regulator. The Dodd-Frank Act requires the CFTC, SEC, and the Agencies to establish and maintain, to the maximum extent practicable, capital and margin requirements that are comparable, and to consult with each other periodically (but no less than annually) regarding these requirements.
The capital and margin standards for swap entities imposed under sections 731 and 764 of the Dodd-Frank Act are intended to offset the greater risk to the swap entity and the financial system arising from non-cleared swaps. Sections 731 and 764 of the Dodd-Frank Act require that the capital and margin requirements imposed on swap entities must, to offset such risk, (1) help ensure the safety and soundness of the swap entity and (2) be appropriate for the greater risk associated with non-cleared swaps. In addition, sections 731 and 764 of the Dodd-Frank Act require the Agencies, in establishing capital requirements for entities designated as covered swap entities for a single type or single class or category of swap or activities, to take into account the risks associated with other types, classes, or categories of swaps engaged in, and the other activities conducted by swap entities that are not otherwise subject to regulation. In addition to the Dodd-Frank Act authorities mentioned above, the Agencies also have safety and soundness authority over the entities they supervise. The Dodd-Frank Act specified that the provisions of its Title VII shall not be construed as divesting any Agency of its authority to establish or enforce prudential or other standards under other law.
The capital and margin requirements for non-cleared swaps under sections 731 and 764 of the Dodd-Frank Act complement other Dodd-Frank Act provisions that require all sufficiently standardized swaps to be cleared through a registered derivatives clearing organization or clearing agency. This requirement is consistent with the consensus of the G-20 leaders to clear derivatives through central counterparties (“CCPs”) where appropriate. In the derivatives clearing process, CCPs manage credit risk through a range of controls and methods, including a margining regime that imposes both initial margin and variation margin requirements on parties to cleared Start Printed Page 74842transactions. Thus, the mandatory clearing requirement established by the Dodd-Frank Act for swaps effectively will require any party to any transaction subject to the clearing mandate to post initial and variation margin in connection with that transaction. However, a particular swap may not be cleared either because it is not subject to the mandatory clearing requirement, or because one of the parties to a particular swap is eligible for, and uses, an exception or exemption from the mandatory clearing requirement. Such a swap is a “non-cleared” swap that may be subject to the capital and margin requirements for such transactions established under sections 731 and 764 of the Dodd-Frank Act.
The swaps-related provisions of Title VII of the Dodd-Frank Act, including sections 731 and 764, are intended in general to reduce risk, increase transparency, promote market integrity within the financial system, and, in particular, address a number of weaknesses in the regulation and structure of the swaps markets that were revealed during the financial crisis of 2008 and 2009. During the financial crisis, the opacity of swap transactions among dealers and between dealers and their counterparties created uncertainty about whether market participants were significantly exposed to the risk of a default by a swap counterparty. By imposing a regulatory margin requirement on non-cleared swaps, the Dodd-Frank Act reduces the uncertainty around the possible exposures arising from non-cleared swaps.
Further, the financial crisis revealed that a number of significant participants in the swaps markets had taken on excessive risk through the use of swaps without sufficient financial resources to make good on their contracts. By imposing an initial and variation margin requirement on non-cleared swaps, sections 731 and 764 of the Dodd-Frank Act will reduce the ability of firms to take on excessive risks through swaps without sufficient financial resources. Additionally, the minimum margin requirement will reduce the amount by which firms can leverage the underlying risk associated with the swap contract. The Agencies originally published proposed rules to implement sections 731 and 764 of the Act in May 2011 (the “2011 proposal”).
Over 100 comments were received in response to the 2011 proposal from a variety of commenters, including banks, asset managers, commercial end users, and various trade associations. Following the release of the Agencies' 2011 proposal, the Basel Committee on Banking Supervision (“BCBS”) and the Board of the International Organization of Securities Commissions (“IOSCO”) proposed an international framework for margin requirements on non-cleared derivatives with the goal of creating an international standard for non-cleared derivatives.
Following the issuance of the international framework proposal, the Agencies re-opened the comment period on the Agencies' 2011 proposal to allow for additional comments in relation to the proposed international framework. The proposed international framework was also subject to extensive public comment before being finalized in September 2013 (the “2013 international framework”). Following the publication of the 2013 international framework the Agencies published a re-proposal of the Agencies' rule in September 2014 (the “proposal,” “2014 proposal” or “proposed rule”). The Agencies received over 55 comments in response to the proposal. The Agencies subsequently met with several commenters at their request to discuss their concerns with the proposal and summaries of these meetings may be found on each Agency's respective public Web site. Other Dodd-Frank Act Provisions Affecting the Margin and Capital Rule The applicability of the Agencies' margin requirements rely in part on regulatory action taken by the CFTC, the SEC, and the Secretary of the Treasury.
The margin requirements will apply to any prudentially-regulated entity that: (1) Is registered as a swap dealer or major swap participant with the CFTC, or as a security-based swap dealer, major security-based swap participant with the SEC; and (2) enters into a non-cleared swap. In addition, as a means of ensuring the safety and soundness of the covered swap entity's non-cleared swap activities under the final rule, the requirements would apply to all of a covered swap entity's swap and security-based swap activities without regard to whether the entity has registered as both a swap entity and a security-based swap entity. Thus, for example, for an entity that is a swap dealer but not a security-based swap dealer or major security-based swap participant, the final rule's requirements would apply to all of that swap dealer's non-cleared swaps and non-cleared security-based swaps. On May 23, 2012, the CFTC and SEC adopted a final joint rule defining “swap dealer,” “major swap participant,” “security-based swap dealer,” and “major security-based swap dealer.” These definitions include quantitative thresholds in the relevant activity that affect whether an entity subject to the “prudential regulator” definition also will be subject to the margin regulations.
On August 13, 2012, the CFTC and SEC adopted a final joint rule defining “swap” and “security-based swap.” On November 16, 2012, the Secretary of the Treasury made a determination pursuant to sections 1a(47)(E) and 1(b) of the Commodity Exchange Act to exempt foreign exchange swaps and foreign exchange forwards from certain swap requirements, including the Title VII margin requirements. The CFTC has adopted a final rule requiring registration by entities meeting the substantive definition of Start Printed Page 74843swap dealer or major swap participant and engaging in relevant activities above the applicable quantitative thresholds. As of September 24, 2015, 104 entities have registered as swap dealersand two entities have registered as major swap participants.
The SEC has also adopted rules for registering entities that meet the definition of “security-based swap dealer,” or “major security-based swap participant,” however, the compliance dates for registration have yet to occur. The CFTC has adopted guidance addressing how the Commodity Exchange Act's swap requirements, will apply to “cross-border swaps.” Similarly, the SEC published a final rule and interpretative guidance that addresses the application of the definitions of “security-based swap dealer” and “major security-based swap participant” in the cross-border context. The SEC also recently proposed amendments and a re-proposed rule to address the application of certain provisions of the Securities Exchange Act to cross-border security-based swap activities. On January 12, 2015, the President signed into law TRIPRA. Title III of TRIPRA amends sections 731 and 764 of the Dodd-Frank Act to exempt certain transactions of certain counterparties from the Agencies' margin requirements as set out in this final rule. Compliance date Initial margin requirements September 1, 2016 Initial margin where both the covered swap entity combined with all its affiliates and its counterparty combined with all its affiliates have an average daily aggregate notional amount of covered swaps for March, April and May of 2016 that exceeds $3 trillion. September 1, 2017 Initial margin where both the covered swap entity combined with all its affiliates and its counterparty combined with all its affiliates have an average daily aggregate notional amount of covered swaps for March, April and May of 2017 that exceeds $2.25 trillion.
September 1, 2018 Initial margin where both the covered swap entity combined with all its affiliates and its counterparty combined with all its affiliates have an average daily aggregate notional amount of covered swaps for March, April and May of 2018 that exceeds $1.5 trillion. September 1, 2019 Initial margin where both the covered swap entity combined with all its affiliates and its counterparty combined with all its affiliates have an average daily aggregate notional amount of covered swaps for March, April and May of 2019 that that exceeds $0.75 trillion. September 1, 2020 Initial margin for any other covered swap entity with respect to covered swaps with any other counterparty. In calculating the amount of covered swaps as set forth in the table above, the final rule provides that a covered swap entity shall count the average daily aggregate notional amount of a non-cleared swap, a non-cleared security- Start Printed Page 74850based swap, a foreign exchange forward or a foreign exchange swap between the entity and an affiliate only one time, and shall not count a swap or security-based swap that is exempt from the Agencies' margin requirements under §.1(d), as added by the interim final rule. These provisions were not included in the proposed rule. The purpose of the first provision in the final rule is to prevent double counting of covered swaps between affiliates, a concern raised by a number of commenters, which could artificially increase a covered swap entity's average daily aggregate notional amount.
The purpose of the second provision is to ensure that swaps that have been exempted from the margin requirements are fully exempted and do not influence other aspects of the rule such as whether an entity maintains a material swaps exposure. The Agencies expect that covered swap entities likely will need to make a number of operational and legal changes to their current swaps business operations in order to achieve compliance with the provisions of the final rule relating to the initial margin requirements, including potential changes to internal risk management and other systems, trading documentation, collateral arrangements, and operational technology and infrastructure. In addition, the Agencies expect that covered swap entities that wish to calculate initial margin using an initial margin model will need sufficient time to develop such models and obtain regulatory approval for their use. Accordingly, the compliance dates have been structured to ensure that the largest and most sophisticated covered swap entities and counterparties that present the greatest potential risk to the financial system comply with the requirements first.
These swap market participants should be able to make the required operational and legal changes more rapidly and easily than smaller entities that engage in swaps less frequently and pose less risk to the financial system. Compliance Date Schedule for Variation Margin. For purposes of variation margin, the compliance dates are September 1, 2016 and March 1, 2017. As set out in the table below, these compliance dates also depend on the average daily aggregate notional amount of covered swaps of the covered swap entity combined with its affiliates and each of its counterparties (combined with that counterparty's affiliates) for each business day in March, April and May of that year (the “calculation period”). Thus, a given covered swap entity may have multiple compliance dates depending on both the combined average daily aggregate notional amount of covered swaps of the covered swap entity and its affiliates during the calculation period as well as the combined average daily notional amount of covered swaps of each of its counterparties and that counterparty's affiliates during the calculation period.
Compliance date Variation margin requirements September 1, 2016 Variation margin where both the covered swap entity combined with all its affiliates and its counterparty combined with all its affiliates have an average daily aggregate notional amount of covered swaps for March, April and May of 2016 that exceeds $3 trillion. March 1, 2017 Variation margin for any other covered swap entity with respect to covered swaps with any other counterparty.
Calculating the amount of covered swaps set forth in the table above for the purposes of determining variation margin is done in the same manner as calculating the amount of covered swaps for purposes of determining initial margin. A covered swap entity shall count the average daily aggregate notional amount of a non-cleared swap, a non-cleared security-based swap, a foreign exchange forward or a foreign exchange swap between the entity and an affiliate only one time, and shall not count a swap or security-based swap that is exempt from the Agencies' margin requirements under §.1(d), as added by the interim final rule.
The final rule adopts a phase-in arrangement for variation margin requirements that is different from the 2014 proposal. Several commenters urged that the compliance date for variation margin requirements be phased in, in a manner similar to the compliance dates for the initial margin requirements. These commenters argued, among other things, that the phase-in of the variation margin requirements would allow covered swap entities the time to re-document all necessary swap contracts at one time. One commenter stated that variation margin requirements should be phased in based on decreasing notional amount thresholds over a two-year period commencing upon the latter of the publication of the margin rules for OTC derivatives in the United States, the EU and Japan or the publication of the Agencies' comparability determinations with respect to the EU and Japan. In response to these comments, the Agencies believe that a phase-in of variation margin requirements similar to the phase-in of initial margin requirements is not necessary because the collection of daily variation margin is currently an industry best practice and will not require many changes in current swaps business operations for covered swaps entities. However, the Agencies have revised the 2014 proposal to include the phase-in of compliance dates for variation margin as set forth above to align with the dates suggested by the BCBS and IOSCO on March 18, 2015. The meaning of Swaps Entered Into After the Compliance Date The rule's margin requirements apply to non-cleared swaps entered into on or after the applicable compliance date.
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Certain commenters also requested that the Agencies consider the following swaps as entered into prior to the compliance date: (1) swaps entered into prior to the applicable compliance date (legacy swaps) that are amended in a non-material manner; (2) novations; and (3) new derivatives that result from portfolio compression of legacy Start Printed Page 74851derivatives. These commenters urged that if a general exclusion for novated legacy swaps is not provided, there should be an exclusion for novated swaps between affiliates resulting from organizational restructuring or regulatory requirements such as the swaps push-out rule.
Notwithstanding these comments, the Agencies believe that classifying new swap transactions as “swaps entered into prior to the compliance date” could create significant incentives to engage in amendments and novations for the purpose of evading the margin requirements. Moreover, limiting the extension to “material” amendments or “legitimate” novations is difficult to effect within the final rule as the specific motivation for an amendment or novation is generally not observable. Finally, the Agencies believe that classifying some new swap transactions as transactions entered into prior to the compliance date would make the process of identifying those swaps to which the rule applies overly complex and non-transparent. Accordingly, the Agencies have elected not to extend the meaning of swaps entered into prior to the compliance date as was requested by some commenters. Ongoing Applicability and Implementation of the Margin Requirements.
Section.1(f) provides that once a covered swap entity and its counterparty must comply with the margin requirements for non-cleared swaps based on the compliance dates set forth in §.1(e), the covered swap entity and its counterparty shall remain subject to the margin requirements from that point forward. For example, September 1, 2017 is the relevant compliance date where both the covered swap entity combined with all its affiliates and its counterparty combined with all its affiliates have an average aggregate daily notional amount of covered swaps that exceed $2.25 trillion must comply with these margin requirements. If the notional amount of the swap activity for the covered swap entity or the counterparty drops below that threshold amount of covered swaps in subsequent years, their swaps would nonetheless remain subject to the margin requirements. On September 1, 2020, any covered swap entity/counterparty combination that did not have an earlier compliance date will become subject to the initial margin requirements with respect to any non-cleared swaps.
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One commenter urged that, during the phase-in period, only entities whose swap volume currently exceeds the applicable threshold should be subject to the margin requirements. The commenter stated that, if the swap activity of either party to a swap declines below the applicable threshold, that party should cease being subject to the initial margin requirements until such time as it exceeds the applicable threshold. The Agencies have declined to make this change to the final rule. The Agencies believe that allowing entities' coverage status to change over time results in additional complexity with little benefit since all entities will in any event be subject to the rule as of September 1, 2020. Accordingly, allowing an entity's coverage status to fluctuate would only be consequential for a limited period of time. One commenter asked how the margin requirements would apply in the event of a change in status of the counterparty.
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The Agencies have added §.1(g) to the final rule to clarify the applicability of the margin requirements in the event a covered swap entity's counterparty changes its status (for example, if the counterparty is a financial end user without material swaps exposure and becomes a financial end user with material swaps exposure). Under §.1(g)(1), in the event a counterparty changes its status such that a non-cleared swap or non-cleared security-based swap with that counterparty becomes subject to stricter margin requirements, then the covered swap entity shall comply with the stricter margin requirements for any non-cleared swap or non-cleared security-based swap entered into with that counterparty after the counterparty changes its status.