Federal banking regulators (the Prudential Regulators)1 have re-proposed regulations
to require certain dealers and major participants in the swap and
security-based swap markets to collect initial and variation margin for noncleared
swaps (the 2014 Proposal).2 In April 2011, the Prudential Regulators first
issued proposed rules addressing non-cleared swaps margin (the 2011 Proposal).3
Following the 2011 Proposal, the Basel Committee on Banking Supervision and the
International Organization of Securities Commissions released a global framework
for margin requirements on non-centrally cleared derivatives (the International
Framework).4 As a result, the Prudential Regulators released the 2014 Proposal to
incorporate the International Framework and to address comments received on the
2011 Proposal. The CFTC this week voted to issue a similar re-proposal.
The 2014 Proposal would apply to all “swap entities” that are regulated by a Prudential
The 2014 Proposal makes several significant changes to the 2011 Proposal by:
1. requiring CSEs to post margin in addition to collecting margin;
2. restricting the acceptable collateral for variation margin to cash while expanding
the collateral that can be used as initial margin; and
3. adopting a substituted compliance approach that would allow certain CSEs
to comply with a foreign regulatory framework in lieu of the Prudential
The 2014 Proposal retains many of the requirements from the earlier proposal, and
continues to require significantly larger amounts of margin than for cleared contracts.
This client alert answers some of the basic questions about the re-proposal, summa-
1 The Prudential Regulators are the Federal Deposit Insurance Corporation, the Board of Governors of
the Federal Reserve System, the Office of the Comptroller of the Currency, the Farm Credit Administration
(FCA) and the Federal Housing Finance Agency (FHFA).
2 In this client alert, the term “swaps” refers both to swaps and securities-based swaps.
3 See Margin and Capital Requirements for Covered Swap Entities, Proposed Rule, 76 Fed. Reg.
27564 (May 11, 2011). In 2011, the Commodity Futures Trading Commission (CFTC) also released
proposed non-cleared swaps margin requirements for swap dealers and major swap participants, and
the Securities and Exchange Commission (SEC) proposed non-cleared swaps margin requirements
for security-based swap dealers and major security-based swap participants. See CFTC Margin Requirements
for Uncleared Swaps for Swap Dealers and Major Swap Participants, Notice of Proposed
Rulemaking, 76 Fed. Reg. 23,732 (Apr. 28, 2011); Capital, Margin, and Segregation Requirements
for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital Requirements
for Broker-Dealers, Proposed Rule, 77 Fed. Reg. 70213 (Nov. 23, 2012).
4 See BCBS and IOSCO “Consultative Document — Margin requirements for non-centrally cleared
derivatives” (July 2012), available at http://www.bis.org/publ/bcbs226.pdf; “Second consultative document
— Margin requirements for non-centrally cleared derivatives” (February 2013), available at
5 The term “swap entity” would mean a securities-based swap dealer, major securities-based participant,
swap dealer or major swap participant.
If you have any questions regarding
the matters discussed in this
memorandum, please contact the
following attorneys or call your
regular Skadden contact.
Mark D. Young
Maureen A. Donley
Elizabeth A. Mastrogiacomo
* * *
This memorandum is provided by
Skadden, Arps, Slate, Meagher
& Flom LLP and its affiliates for
educational and informational
purposes only and is not intended
and should not be construed as
legal advice. This memorandum
is considered advertising under
applicable state laws.
September 19, 2014
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Skadden, Arps, Slate, Meagher & Flom LLP
Prudential Regulators and CFTC Re-Propose
Margin Requirements for Non-Cleared Swaps
1440 New York Avenue, NW,
Washington, D.C. 20005
Four Times Square, New York, NY 10036
rizes the proposed margin counterparty categories and gives an overview of how margin calculations
would be made. Attached is a chart of the significant proposed requirements depending on counterparty
A. Basic Questions About Uncleared Margin
1. What will be considered a “non-cleared swap”? The 2014 Proposal would apply to swaps
that are not cleared by a CFTC-registered derivatives clearing organization (DCO) or a
clearing agency registered with the SEC. Margin would not be required for physically
settled foreign exchange forwards or swaps6 or foreign swaps (which would include swaps
where neither the counterparty nor the guarantor is a U.S. entity) of foreign CSEs.
2. Will the kind of counterparty matter? Yes. Margin requirements would vary based on
whether the counterparty is a swap entity, financial end user7 with material swaps exposure,
financial end user without material swaps exposure or another kind of counterparty.
3. How will initial margin be calculated? Like in the 2011 Proposal, a CSE will be able to
use a standardized table compiled by the Prudential Regulators. Alternatively, a CSE can
use an initial margin model approved by the relevant Prudential Regulator.
4. What is an initial margin threshold? The 2014 Proposal would permit a CSE to adopt a
threshold amount of up to $65 million, below which it would not need to collect or post
initial margin on swaps with swap entities and financial end users with material swaps
5. Is there a threshold for variation margin? The 2014 Proposal would not permit a CSE to
adopt a threshold amount below which it would not need to collect or post variation margin
on swaps with swap entities and financial end users (regardless of whether the financial
end user has material swaps exposure).
6. What kinds of collateral can be posted? For initial margin, eligible collateral would be
cash, debt securities issued or guaranteed by the U.S. Department of the Treasury or
another U.S. government agency, the Bank for International Settlements, the International
Monetary Fund, the European Central Bank, multilateral development banks, certain U.S.
government-sponsored enterprises’ debt securities, certain foreign government debt securities,
certain corporate debt securities, certain listed equities and gold. Noncash collateral
and cash collateral that is not USD or the currency in which payment obligations under the
swap are required to be settled would be subject to certain specified discounts (commonly
known as “haircuts”). For variation margin, eligible collateral would be cash only; cash
must be denominated in USD or in the currency in which payment obligations under the
swap are required to be settled.
7. What about third-party custodians? Like the 2011 Proposal, the 2014 Proposal would
require that any collateral (other than variation margin) that a CSE posts to its counterparty
(including collateral not required by the 2014 Proposal) would be required to be segregated
at one or more custodians that are not affiliates of the CSE or the counterparty (a
Third-Party Custodian). Furthermore, a CSE would be required to place the initial margin
6 In 2012, the Secretary of the Treasury made a determination that physically settled foreign exchange forwards and
swaps are not to be considered swaps under the Dodd-Frank Act. See Determination of Foreign Exchange Swaps and
Foreign Exchange Forwards Under the Commodity Exchange Act, 77 Fed. Reg. 69694 (Nov. 20, 2012). Although margin
would not be required for these kinds of swaps, foreign exchange forwards and foreign exchange swaps exposure
would be relevant for determining material swaps exposure.
7 See below for a list of entities that would be financial end users.
it collects from a swap entity or a financial end user with material swaps exposure at a
Third-Party Custodian.8 A CSE would not be required to segregate the initial margin it collects
from financial end users without material swaps exposures or Other Counterparties
(as defined below). There would be restrictions on rehypothecation, although substitutions
and reinvestments in eligible collateral would be permitted. There would be no segregation
requirements for variation margin.
B. Proposed Margin Counterparty Categories
1. Counterparty Category 1: CSE to Another Swap Entity
For swaps with other swap entities, CSEs would be required to post and collect initial margin at the
time they enter into a swap and to post and collect variation margin on a daily basis.
2. Counterparty Category 2: CSE to Financial End User With Material Swaps Exposure
The 2014 Proposal would define the term financial end user to include: bank holding companies,
savings and loan holding companies, nonbank financial institutions supervised by the Board of Governors
of the Federal Reserve System, depository institutions, foreign banks, state-licensed or registered
credit or lending entities, broker-dealers, registered investment companies, business development
companies, private funds, securitization vehicles, commodity pools, commodity pool operators,
employee benefit plans, insurance companies, cooperatives that are financial institutions, similar
foreign entities and any other entity that a Prudential Regulator determines should be treated as a
financial end user.9
A financial end user would have material swaps exposure when the entity and its affiliates have an average
daily aggregate notional amount of non-cleared swaps, non-cleared security-based swaps, foreign
exchange forwards and foreign exchange swaps with all counterparties that exceeds $3 billion.
A CSE would be required to post initial margin and daily variation margin to, and collect initial margin
and daily variation margin from, financial end users with material swaps exposures.
3. Counterparty Category 3: CSE to Other Counterparty
“Other Counterparties” are counterparties that are not CSEs or financial end users with material
swaps exposure. Other Counterparties include commercial end users that generally engage in swaps
to hedge commercial risk, sovereigns (which would have been financial end users in the 2011 Proposal),
multilateral development banks and financial end users without material swaps exposure.
When transacting with an Other Counterparty, the 2014 Proposal would only require a CSE to collect
initial margin at such times and in such forms and such amounts that the CSE determines appropriately
addresses the credit risk posed by the counterparty and the risk of the swap. This could result in
the CSE determining not to collect any initial margin from an Other Counterparty. There would be no
requirement that a CSE post initial margin to an Other Counterparty.
The Prudential Regulators consider financial end users without material swaps exposure to be Other
Counterparties for purposes of initial margin because they expect that in most instances, a financial
end user without material swaps exposure would have an initial margin requirement that is signifi-
8 A CSE would only be required to segregate the required minimum amount of initial margin that it collects from a swap
entity or a financial end user with a material swaps exposure.
9 This list of entities included within the definition of a financial end user was intended to eliminate potential uncertainties
with the 2011 Proposal definition, which would have included persons predominantly engaged in activities that are
in the business of banking or in activities that are financial in nature, as defined in Section 4(k) of the Bank Holding
cantly below the proposed $65 million threshold amount. A CSE would, however, be required to collect
and post variation margin on swaps with financial end users without material swaps exposures.
Thus, variation margin would be required for swaps with all financial end users.
When transacting with an Other Counterparty other than an Other Counterparty that is a financial end
user without material swaps exposure, the 2014 Proposal would not require a CSE to post variation
margin and would only require a CSE to collect variation margin at such times and in such forms and
in such amounts that the CSE determines appropriately addresses the credit risk posed by the counterparty
and the risk of the swap.
C. Proposed Margin Calculations
1. Initial Margin Calculation
The Prudential Regulators propose two alternative methods for calculating initial margin: (1) a standardized
margin schedule, expressed as a percentage of the notional amount of the swap that allows
for certain types of netting and offset exposure; or (2) an approved internal initial margin model.
There would be extensive requirements for initial margin models, such as basing potential future
exposure on a 99 percent confidence interval for a 10-day period (compared to the current practice
of using a one- to five-day period for cleared swaps) and calibrating the initial margin to a period of
financial stress. Initial margin models could consider portfolio offsets for swaps within the same asset
class — agricultural commodities, energy commodities, metal commodities, other commodities,
credit, equity or foreign exchange/interest rate — that are governed by the same netting agreement
(e.g., an ISDA). Internal margin models would need the approval of the relevant Prudential Regulator.
Initial margin requirements would not apply to Treasury-exempted foreign exchange (FX)
forwards and swaps or to the fixed physically settled FX component of cross-currency swaps.
The Prudential Regulators stressed that the decision to use one method over the other should be based
on fundamental considerations apart from which method produces the most favorable margin results.
The Prudential Regulators noted that they generally would frown upon “cherry picking” between the
standardized approach and internal model-based margins, either across different types of swaps or
for a particular counterparty.
2. Variation Margin Calculation
Under the re-proposal, variation margin would be a payment by one party to its counterparty of the
change in value of the obligations under one or more swaps between the parties since the last such
payment. The 2014 Proposal would require a CSE to collect or post variation margin on all swaps
with a swap entity or financial end user (regardless of whether the financial end user has a material
swaps exposure) daily. The 2014 Proposal would not permit a CSE to adopt a threshold amount for
posting or collecting variation margin on swaps with swap entities or financial end users. A CSE
could calculate variation margin on an aggregate net basis for swaps governed by a master netting
agreement that meets specified conditions.10
D. Other Margin Requirements
A CSE would not be required to post or collect any margin from any counterparty under a minimum
transfer amount of $650,000. A CSE also would be required to execute trading documentation that
grants the CSE the contractual right to collect margin in amounts and under the circumstances neces-
10 Swaps entered into before the applicable compliance date that are subject to the master netting agreement would
need to be included in the aggregate calculation.
sary to meet the 2014 Proposal’s requirements, details the specifications for determining the value of
each swap for variation margin purposes and provides valuation dispute procedures.
E. Phase-In and Comments
Initial margin requirements would be phased in over a four-year period based on volume of swap activity.
Beginning on December 1, 2015, the requirements would only apply to a CSE where both the
CSE (combined with its affiliates) and the CSE’s counterparty (combined with its affiliates) have an
aggregate notional amount of covered swaps exceeding $4 trillion, declining to $3 trillion in 2016, $2
trillion in 2017 and $1 trillion in 2018 (using the aggregate notional amount for the preceding June,
July and August of the relevant year) until December 1, 2019, when the initial margin requirements
would apply to any CSE. Variation margin requirements would have no phase-in and would go into
effect on December 1, 2015.
The comment period for the 2014 Proposal will close 60 days after the proposed rule is published in
the Federal Register.
F. CFTC and SEC Re-Proposals
On September 17, 2014, the CFTC voted to re-propose its own non-cleared margin requirements.
The CFTC requirements would apply to swap dealers and major swap participants that are not CSEs
(i.e., swap dealers and major swap participants that are not subject to regulation by the Prudential
Regulators). The CFTC said its re-proposal tracks the Prudential Regulators’ re-proposal and phasein
approach in most respects. One difference between the two proposals is that the CFTC asks commenters
to weigh in on three potential approaches to how its non-cleared margin rules would apply in
a cross-border context, while the Prudential Regulators’ 2014 Proposal provides only one approach
to applying the Prudential Regulators’ rules in a cross-border context.
The SEC also is expected to re-propose its non-cleared margin proposal but has not yet done so.
(continued on next page)
Prudential Regulators’ Proposed Margin Requirements for Non-Cleared Swaps
Type Initial Margin Calculating Initial
Segregation Variation Margin
Swap Entity CSE must collect
from, and post
to, at least the
amount of initial
under the 2014
Proposal at least
CSE may use
or an internal
approved by the
CSE may adopt
a maximum initial
amount of $65
which it need not
post or collect
Cash, gold, certain
is subject to
All initial margin
posted by CSE
and all initial
by CSE in
with the 2014
at a Third-Party
CSE must collect
from and post to
at least once per
Only USD or
the currency in
the swap are
required to be
Same as above Same as above Same as above Same as above Same as above Same as above Same as above
Financial End User
CSE not required
to post. CSE not
required to collect
except at times
and in forms and
credit risk and risk
of the swap
CSE must be
by CSE not
required to be
Same as above Not limited, instead
Same as above Same as above Same as above Same as above Same as above CSE not required
to post. CSE not
required to collect,
except at times
and in forms and
credit risk and risk
of the swap
Same as above