On September 3, 2014, the US banking agencies (the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Office of Comptroller of the Currency), along with the Federal Housing Finance Agency (FHFA) and the Farm Credit Administration (FCA), issued for comment a proposed rule that would implement the sections of the Dodd-Frank Wall Street Reform and Consumer Protection Act, otherwise referred to as Dodd-Frank, that relate to the imposition of margin and capital requirements with respect to non-cleared transactions involving swap dealers, major swap participants, security-based swap dealers and major security based swap participants, referred to collectively as “covered swap entities,” that are subject to the jurisdiction of one of these agencies. Previously proposed regulations in 2011 to implement this requirement had not been finalized and have been redrafted to reflect revised international standards.
Under Dodd-Frank, swap dealers and major swap participants must register with the Securities and Exchange Commission (SEC) and/or the Commodity Futures Trading Commission (CFTC), depending on whether the swap transactions are security-based or not. The SEC and CFTC determine which swap transactions must be cleared by a central counterparty, such as a clearing agency. However, not every swap transaction is centrally cleared and for covered swap entities, Dodd-Frank required the banking agencies, and the FHFA, FCA, SEC, and CFTC, to issue regulations imposing margin and capital requirements on all non-cleared swaps and non-cleared security-based swaps. The agencies consulted the SEC and CFTC staffs in connection with the drafting of this proposed rule. On September 17, 2014, the CFTC issued its own revised Proposed Rule on Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants. As of September 23, 2014, the SEC had not yet proposed similar rules.
Capital and margin requirements
The proposal establishes minimum capital and margin requirements for covered swap entities with respect to all non-cleared swaps and non-cleared security based swaps, including when collateral must be posted and the forms of collateral eligible to meet the margin requirements.
The proposed capital requirements would require that a covered swap entity only need comply with its existing regulatory capital requirements. As for margin requirements, under the proposal, there is a risk-based formula for calculating margin. The amount of margin will depend on the counterparty – another swap entity, a financial end user with or without “material swaps” exposure (these are certain specified financial businesses, such as a bank holding company that is not otherwise registered as a swap entity) or an “other counterparty,” a category which includes commercial end users and sovereigns.
Covered swaps entities must collect margin only from counterparties that are other swaps entities or financial end users with “material” swaps exposure (defined as an average daily aggregate notional amount of covered swaps over a defined time period that exceeds $3 billion). A covered swaps entity is required to collect margin from “other counterparties” only when it determines that the credit risk of the transaction or the counterparty warrants it.
Exemptions, alternatives
Non-US swap transactions of non-US swap entities would not be subject to the rule. In addition, certain swap entities would be allowed to comply with another country’s requirements for non-cleared swaps if the agencies noted above jointly determine that the other country’s requirements are similar to the United States requirements.
The comment period will end on November 24, 2014.
