On September 3, 2014, the Federal Reserve Board, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, Farm Credit Administration, and Federal Housing Finance Agency (collectively the Prudential Regulators) adopted a proposed rule on margin requirements for uncleared swaps.
The margin rule is one piece of the regulatory overhaul of derivatives markets under the Dodd-Frank Wall Street Reform and Consumer Protection Act. This proposal marks the Prudential Regulators second attempt at drafting a margin rule after their first and highly criticized proposal in April 2011.
As newly drafted, the proposed rule is being hailed as a win for commercial end users because it does not require swap dealing banks to collect initial and variation margin from commercial end users that are not “systemically important.” The proposal requires only that banks collect initial and variation margin “at such times and in such forms and amounts (if any) as the covered swap entity determines would appropriately address the credit risk posed by swaps entered into with ‘other counterparties.’” Under the proposed rule, commercial end users such as utilities and other electric or natural gas companies would likely not be required to post margin on their swap transactions.
Margin calls would significantly increase the cost of swaps to commercial end users by requiring the commitment of cash the commercial end users could otherwise spend on their core business needs. The proposed rule thus favors commercial end users because it generally exempts them from margin calls. The end user community will likely show significant support for the proposal and encourage the Commodity Futures Trading Commission to take a similar approach it its own proposed margin rule, expected before the end of the year. There will be a 60-day comment period starting once the Prudential Regulators’ proposed margin rule is published in the Federal Register.