A few weeks after the Federal Reserve Bank and four other federal regulatory agencies proposed margin rules for uncleared swaps involving swap dealers and other similar entities subject to their oversight (so-called “covered swap entities” or “CSEs”), the Commodity Futures Trading Commission followed suit and proposed its own margin rules for uncleared swaps for swaps dealers (SD) and major swap participants (MSP) that are subject to its oversight but not the oversight of a prudential regulator.
The CFTC also finalized a rule that carves out many utility operations-related swaps with certain government-owned natural gas and electric utilities from calculations of thresholds that might otherwise cause counterparties to have to register with the CFTC as swap dealers.
Although the CFTC’s proposed margin rules appear likely to be similar to the rules proposed by the Fed and other federal regulators—as well as certain international regulators—they apparently will not be identical. (Actual proposed rules have not yet been made publicly available; only summaries and comments related to the rules are currently posted to the CFTC’s website as of the date of this blog.)
The CFTC rules will require margin on uncleared swaps between CSEs and SDs or MSPs and swaps between CSEs and financial end users. The rules will not obligate commercial end users to post margin, but parties may contractually agree to this requirement.
Initial margin obligations will be two-way on uncleared swaps between a CSE and a SD or MSP, as well as between a CSE and any financial end user with over US $3 billion exposure in uncleared swaps.
Calculation of initial margin could be based on a model or standardized methodology, and payment of initial margin would have to be in the form of cash or approved high-quality financial instruments. Initial margin would have to be held at an independent custodian and could not be rehypothecated. A model involving initial margin would have to presume it would take 10 days to liquidate an open position.
The CFTC rules will also require daily variation margin settlements between CSEs and SDs or MSPs and between SDs or MSPs and financial end users for all uncleared swaps. A variation margin payment would have to be made in cash.
Obligations regarding initial margin would kick in for the largest entities on December 1, 2015, and be phased in through December 1, 2019, for all entities. Variation margin obligations would commence December 1, 2015.
The CFTC apparently will seek comment on the cross-border application of its proposed margin rules.
Separately, the CFTC also unanimously passed a rule that carves out many utility operations-related swaps with utility special entities from calculations of thresholds that might otherwise cause counterparties to have to register with the CFTC as a swap dealer. Under current CFTC rule, persons must register as swap dealers if they transact in excess of US $25 million of swaps with certain federal and local government agencies, operated companies (including certain electric or natural gas utilities), or pension systems (together, so-called “special entities”).
Under the CFTC’s new rule, persons entering into utility operations-related swaps with certain government-operated electric or natural gas utilities will not have to include such swaps in the calculation of their US $25 million threshold against special entities. However, they will have to include such swaps in the calculation of their ordinary overall US $8 billion threshold to assess whether they need to be registered as a swap dealer.
All four commissioners issued comments related to the proposed margin rules and new rule regarding utility operations-related swaps. Commissioners J. Christopher Giancarlo and Mark Wetjen both questioned the proposal to subject financial entities to initial margin requirements if they have uncleared swaps exposure of US $3 billion as opposed to the international standard of US $11 billion. Mr. Giancarlo expressed his concern that this could detrimentally impact certain US mid-level financial institutions “that will not be borne by similar firms overseas.”
Mr. Giancarlo also questioned the rationale for an across-the-board 10-day liquidation standard for initial margin models, questioning whether the risk of all types of swaps is so similar as to justify the same treatment.
Mr. Wetjen likewise raised a number of nuanced questions, including whether the definition of uncleared swap in the proposed rule comports with prior CFTC guidance. This is because the definition seems to include swaps cleared by a non-US clearing house that comply with certain international standards—which the commissioner suggests should be considered a cleared swap.
In his comments, Chairman Timothy Massad expressed his optimism that by December 15, 2014, either the CFTC and the European Commission will resolve open issues that appear to preclude the EC from recognizing US clearing houses as so-called “qualified CCPs,” or the December 15 date will be postponed. Currently, if agreement is not reached by December 15, European-based banks will incur high capital charges to transact through US clearing houses. (Click here to see the article below entitled "Financial Stability Board Assesses Jurisdictions’ Deference to Other Jurisdictions’ Regulatory Regimes in the Oversight of OTC Derivatives Markets" for another perspective on international regulators' cooperation.)