Prudential Regulators Adopt Margin Requirements for Uncleared Swaps

In October 2015, the five U.S. prudential banking regulators adopted their final rules setting forth margin requirements for uncleared swaps transactions for entities subject to their regulation.  The final rules will apply to any SD, security-based SD, MSP and major security-swap participant (“MSSP”) regulated by the prudential banking regulators.  The final rules do not apply to CFTC-registered SDs and MSPs who are not otherwise subject to the supervision of the prudential banking regulators (collectively, “Covered Swap Entities” or “CSEs”).  Additionally, the margin requirements will not apply to swaps of commercial end-users and financial institutions with $10 billion or less in total assets that enter into swaps transactions for hedging purposes. 

Entities subject to the supervision of prudential regulators, including bank holding companies and insured depository institutions, that enter into swaps transactions with registered SDs, MSPs, security-based SDs, MSSPs  or “Financial End-Users” with “Material Swap Exposure” will be required to collect and post initial margin and variable margin on a daily basis.  A Financial End-User is an entity that falls within one of 13 enumerated categories of entities engaged primarily in financial activities, and includes state-registered credit or lending entities, broker-dealers, private funds, commodity pools, certain employee benefit plans, insurance companies and foreign entities that would constitute Financial End-Users if they were organized in the U.S. 

“Material Swap Exposure” is defined as an average daily aggregate notional amount of $8 billion (an increase from the proposed $3 billion) or more in uncleared swaps, uncleared security-based swaps, FX forwards and swaps during June, July and August of the previous calendar year.  However, for swaps transactions entered into with Financial End-Users that do not have Material Swaps Exposure, entities subject to the supervision of the prudential regulators will be required to collect and post daily variable margin, but not initial margin.  Margin requirements for uncleared swaps of entities subject to the supervision of prudential regulators will be phased in beginning in September 2016.

The CFTC proposed similar rules in October 2014, which would cover CSEs.  The CFTC’s proposed rules are still under consideration.

CFTC Proposes Rule on the Cross-Border Application of Margin Requirements with Respect to Uncleared Swaps

In July 2015, the CFTC issued a proposed rule (the “Proposed Rule”) on the cross-border application of the margin requirements with respect to uncleared swaps.  The Proposed Rule supplements the CFTC’s proposal from October 2014.  The Proposed Rule excludes uncleared swap transactions from compliance with CFTC margin requirements if they are entered into between two non-U.S. persons: (1) whose obligations are not guaranteed by a U.S. person; (2) that are not “Foreign Consolidated Subsidiaries” of a U.S. person; and (3) that are not acting through or by a U.S. branch.

Under the Proposed Rule, the term “U.S. person” is consistent with the CFTC’s prior definition of a U.S. person in its Cross Border Guidance and includes entities organized or incorporated in the U.S., entities with a principal place of business in the U.S., natural persons residing in the U.S. and accounts beneficially owned by any such persons.  The CFTC will permit a party to reasonably rely on its counterparty’s written representation in determining whether or not such counterparty is a U.S. person, absent any indications to the contrary.

In regards to swaps that may be guaranteed by a U.S. person, the proposed definition of guarantee under the Proposed Rule is an arrangement pursuant to which a party to an uncleared swap transaction with a counterparty that is a non-U.S. person has a legally enforceable right of recourse against at least one U.S. person (irrespective of any affiliation with the counterparty) with respect to the counterparty’s obligations under the uncleared swap transaction.

The term “Foreign Consolidated Subsidiary” referenced in (2) above captures any SD or MSP that is not a U.S. person in which an ultimate parent entity that is a U.S. person has a controlling interest, in accordance with U.S. GAAP, such that the ultimate parent entity includes the non-U.S. SD or MSP’s operating results, financial position and statement of cash flows in its consolidated financial statements.

If substituted compliance is granted by the CFTC with respect to some or all of a foreign jurisdiction’s uncleared margin requirements, then SDs and MSPs will be entitled to comply with the foreign jurisdiction’s uncleared swap margin requirements in order to satisfy the CFTC’s requirements.