On October 30, 2015, 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 and the Farm Credit Administration (the “Agencies”), announced that each Agency had finalized regulations to implement the sections of the Dodd-Frank Act that impose margin and capital requirements for transactions involving registered swap dealers or security-based swap dealers (“covered swap entities”) that are subject to the jurisdiction of one of these Agencies and that have not been cleared by a derivatives clearing organization or clearing agency (“non-cleared transactions”). The effective date is April 1, 2016, with phased-in compliance dates for certain aspects of the regulation between September 1, 2016 and September 1, 2020.

The Agencies’ first regulatory proposal on this subject in 2011 was never finalized; proposed regulations were redrafted to reflect revised international standards and issued for comment in September 2014.

Under Dodd-Frank, swap dealers 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 swaps transactions must be cleared by a central counterparty, such as a clearing house. However, not every swap transaction is centrally cleared, and for covered swap entities, Dodd-Frank requires the Agencies, SEC, and CFTC, to issue regulations imposing margin and capital requirements on covered swap entities for all non-cleared swaps and non-cleared security-based swaps.

Transactions with Nonfinancial Entities Excluded

In January 2015, the President signed the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA), one provision of which excluded transactions involving nonfinancial entities entering into swaps to mitigate or hedge commercial risk from these margin and capital requirements. These exclusions are being implemented by an interim final rule, which is a companion document to the final rule. The interim final rule is effective April 1, 2016 (the same date as the final rule). Comments must be received on or before January 31, 2016.

Capital and Margin Requirements

With respect to the minimum capital requirement portion of the final rule, a covered swap entity need only comply with its existing regulatory capital requirements.

Under the margin requirement, there is a risk-based formula for calculating margin, both on an initial basis at the time of the transaction (“initial margin”) and additional margin depending upon the change in mark-to-market value of the swap over time (“variation margin”). The amount of margin will depend on the category of counterparty (to the extent not excluded under TRIPRA) – another swap entity, a financial end user with a “material swaps” exposure (these are certain specified financial businesses, such as a bank holding company, that are not otherwise registered as swap entities), a financial end user without such a “material swaps” exposure, or other counterparties (including sovereigns and multilateral development banks). There also are specific provisions for inter-affiliate swaps between a covered swap entity and its affiliates.

Under the final rule, covered swap entities generally must collect margin only from counterparties that are other swap entities or financial end users with “material swaps” exposure (defined generally as an average daily aggregate notional amount of covered swaps over a defined time period that exceeds $8 billion) and in some circumstances, financial end users without “material swaps” exposure. A covered swap entity is required to collect margin from other counterparties (again, to the extent not excluded under TRIPRA) only when it determines that the credit risk of the transaction or the counterparty warrants it.

Eligible collateral, which may need to be placed with a third-party custodian, generally is limited to high-quality, liquid assets that are expected to remain liquid (such as cash and US government securities) and certain non-cash collateral at a discounted value.

Non-US swaps and security-based swaps of non-US swap entities are not subject to the final rule. In addition, certain swap entities are allowed to comply with another country’s requirements for non-cleared swaps if the Agencies jointly determine that the other country’s requirements are similar to the US requirements.

The Agencies’ staff consulted with their counterparts at the CFTC and SEC in developing the final rule. The CFTC and the SEC have yet to finalize similar regulations for non-bank swap dealers and security-based swap dealers under their direct jurisdiction, although the CFTC is expected to finalize its regulations soon.