Last week two prudential regulators – the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation – announced their approved of a final rule governing margin requirements for so-called “covered swap entities” in connection with their uncleared swaps.
In general, the final rule addresses (1) when, in connection with uncleared swaps, CSEs must collect from and post with their counterparties initial and variation margin; (2) initial margin calculation methodologies; (3) eligible collateral that may be used to meet margin requirements; and (4) the treatment of collateral posted as margin. Non-financial end users are expected to be exempted from mandatory margin requirements under a related rule, but CSEs will be authorized to collect margin from such counterparties consistent with their overall credit risk management.
The Board of Governors of the Federal Reserve System, the Farm Credit Administration and the Federal Housing Finance Agency will also formally approve the new rule, which is mostly consistent with a proposed rule governing margin requirements for uncleared swaps issued by the five prudential regulators in September 2014. (Click here for details regarding the proposed rule in the article “FRB and Four Other Federal Agencies Propose Minimum Margin Rules for Uncleared Swaps” in the September 7, 2014 edition of Bridging the Week.)
Highlights of the final rule are that:
- CSEs transacting with other swap entities and with financial end users are required to post and collect minimum margin amounts in connection with uncleared swap transactions, subject to certain exceptions;
- CSEs are required to calculate initial margin requirements using a standardized margin schedule or an internal margin model approved by the relevant prudential regulator;
- eligible collateral for both initial and variation margin requirements must be certain designated high-quality liquid assets that are expected to retain their value and remain liquid, although eligible collateral for variation margin will depend on the type of counterparty the CSE faces. All non-cash collateral is subject to a haircut; and
- a CSE must require that any collateral it posts with a counterparty for initial margin is segregated at certain third-party custodians. A similar requirement exists for collateral received by a CSE from a swap entity or a financial end user with material swaps exposure (e.g., swaps exposure in excess of US $8 billion) – such collateral must also be segregated by the CSE at an independent third-party custodian.
In addition, the final rule addresses margin requirements for cross-border swap transactions involving CSEs and transactions between affiliates. For purposes of the final rule, affiliates will be determined on financial statement consolidation principles rather than securities-law control concepts.
The Commodity Futures Trading Commission and the Securities and Exchange Commission are required by law to separately adopt rules imposing margin and capital requirements on registered swap entities where there is no separate prudential regulator. Each has previously proposed margin rules for uncleared swaps. (Click here for background on the CFTC's proposal in the article, "CFTC Proposes Margin Rules for Uncleared Swaps and Approves Special Treatment for Operations-Related Swaps With Certain Government-Owned Natural Gas and Electric Utilities" in the September 21, 2014 edition of Bridging the Week. Click here to access a copy of the SEC's proposal.)
The final rule is consistent with the international framework developed in 2013 (and subsequently revised in 2015) by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions (click here to access). It becomes effective April 1, 2016, but the compliance dates roll in at various times afterwards depending on the nature of the counterparties. The first compliance date, for example, is September 1, 2016, for the largest firms.
CSEs are entities prudentially regulated by one of the five agencies adopting the final rule and required to be registered as a swap dealer or a major swap participant with the CFTC or as a security-based swap dealer or a major security-based swap participant with the SEC.