On October 22, the US prudential regulators (the Federal Deposit Insurance Corporation, Board of Governors of the Federal Reserve, Comptroller of the Currency, Farm Credit Administration and Federal Housing Finance Agency) jointly adopted final rules that set margin requirements for swap dealers and major participants (collectively, Swap Entities) regulated by those agencies with respect to swaps and security-based swaps that are not cleared with a derivatives clearing organization or clearing agency. The final rules are generally consistent with the international standards for non-cleared swap margin published by the Basel Committee on Banking Supervision and the Board of the International Organization of Securities Commissions in September 2013 (International Standards) and will be implemented in phases starting on September 1, 2016. The rules are not intended to have retroactive effect, but will apply to both pre-compliance date swaps and post-compliance date swaps if the two types of transactions are documented in a single master netting agreement.
The substance of the final rules is very similar to that of the margin rules proposed by the prudential regulators last year so the margin requirements for a particular swap or security-based swap are determined by the regulatory categorization of the two counterparties. If the swap is between two Swap Entities or between a Swap Entity and a financial end user with “material swaps exposure”, there are mandatory initial margin (IM) and variation margin (VM) requirements. If the swap is between a Swap Entity and a financial end user that does not have a material swaps exposure, only VM applies. There are no mandatory margin requirements for any other pairs of counterparties, but swap dealers remain free to impose traditional contractual margin requirements as they see fit. When IM is mandatory, it must be segregated with a custodian that is not affiliated with the party receiving the IM and cannot be rehypothecated.
Some significant points in the final rules that are different from what was proposed last year are as follow:
- The definition of “affiliate” is now based on financial consolidation.
- The measure of material swaps exposure has been increased from $3 billion to $8 billion, but all other US Dollar amounts in the rules that are derived from the International Standards have been reduced to reflect changes in the Euro-US Dollar exchange rate since the International Standards were published.
- Swaps with affiliates are still subject to the rules, but the rules now specify that: (1) such swaps need only be counted once in calculating aggregate group transaction activity, (2) each affiliate may be granted a separate margin threshold of $20 million, (3) non-cash IM from an affiliate can be held by a Swap Entity or an affiliated custodian; and (4) the exposure on some affiliate swaps can be modeled using a shorter assumed holding period.
- The rules do not apply to any swap that has the benefit of an exemption or exception from clearing enumerated in the Terrorism Risk Insurance Program Reauthorization Act of 2015 (TRIPRA). (This element of the final rules is being introduced in a separate final rule that also exempts swaps involving banks with $10 billion or less in total assets.)
The effective date of the rules is April 1, 2016, but there are various compliance dates:
- September 1, 2016 for IM and VM for any swap if both counterparties have material swaps exposure (measured for business days in March, April and May of 2016) that exceeds $3 trillion.
- March 1, 2017 for VM for swaps involving any other Swap Entity.
- September 1, 2017 for IM for any swap if both counterparties have material swaps exposure (measured for business days in March, April and May of 2017) that exceeds $2.25 trillion.
- September 1, 2018 for IM for any swap if both counterparties have material swaps exposure (measured for business days in March, April and May of 2018) that exceeds $1.5 trillion.
- September 1, 2019 for IM for any swap if both counterparties have material swaps exposure (measured for business days in March, April and May of 2019) that exceeds $.75 trillion.
- September 1, 2020 for IM for any other Swap Entity.
The text of the two new final rules can be found here.