November 14, 2014

Comments on “Margin and Capital Requirements for Covered Swap Entities”
issued by the U.S. prudential regulators

Japanese Bankers Association

1. Preamble(1)

We, the Japanese Bankers Association (“JBA”), would like to express our gratitude for thisopportunity to comment on a proposed joint rule “Margin and Capital Requirements for
Covered Swap Entities” (“proposed rule”) (Board: [Docket No. R–1415] RIN 7100-AD74,
FCA: RIN3052-AC69, FDIC: RIN 3064–AE21, FHFA: RIN 2590–AA45, OCC: [Docket No.
OCC–2011–0008] RIN 1557-AD43) issued on September 24, 2014 by five U.S. prudential
regulators: Board of Governors of the Federal Reserve System (“Board”); Farm Credit
Administration (“FCA”); Federal Deposit Insurance Corporation (“FDIC”); the Federal
Housing Finance Agency (“FHFA”); and Office of the Comptroller of the Currency,
Treasury (“OCC”) (collectively, the “Agencies”).

(2)

To our understanding, the primary impact of the proposed rule on Japanese financial
institutions arises when they transact with a covered swap entity. In September 2013, theBasel Committee on Banking Supervision (“BCBS”) and the Board of the International
Organization of Securities Commissions (“IOSCO”) released their final report on “Margin
requirements for non-centrally cleared derivatives” (“BCBS/IOSCO Final Report”), andnational supervisors are to establish detailed margin requirements based on that international
minimum standards. The proposed rule published accordingly by the Agencies, which
supervise the U.S. market (i.e. the world’s largest derivative market), is considered importantbecause it is deemed as a model or guidance for other jurisdictions to follow.

(3)

We would like to comment particularly from the perspectives of Asian regions, including
Japan, and jurisdictions where collateral agreements (“CSA”) are not widely used. We hopethat our comments below will be of assistance and offer an additional point of reference as
you work towards finalizing the rule so that it will become a most reasonable and fair rulefrom global perspectives and will promote the implementation of the international standards.

2. Overall comment(1) Issues and concerns arising from the existence of many different rules
Our concern about the proposed rule from the perspectives of non-U.S. financial institutions
is that it lays out some conditions favorable to U.S. financial institutions. For example,
eligible collateral for variation margin (“VM”) is limited to cash denominated in U.S. dollars
or in the currency in which payment obligations under the swap are to be settled. In addition,
it can be interpreted that cash collateral denominated in U.S. dollars is only exempted fromthe application of a haircut of 8%. First of all, it would be appreciated if the Agencies would
clarify whether this interpretation is correct; and if not, how to interpret it. The following
comment is based on the assumption that our interpretation is correct. It is our concern thatsuch conditions will drive other jurisdictions to follow suit, giving rise to various different
rules across the jurisdictions. Further, the proposed rule requires an initial margin (“IM”)
threshold amount (for the final phase) that differs from the requirement under the
BCBS/IOSCO Final Report, and uses a definition of the term “affiliate” that is different fromthe general definition (i.e. more than 50% of voting power). Given the above, if the proposed
rule is implemented as it is, banks engaging in cross-border transactions with many financial
institutions will have to abide by different rules depending on their counterparties. This
would not only make it more difficult for banks to implement regulations but, in effect,would also result in failure of internationally-agreed framework. Or, if other jurisdictions do
not follow the U.S.’s approach, it may give rise to a movement in the market where non-U.S.
entities avoid transactions with U.S. financial institutions. The Agencies are requested totake this into account and take the initiative, as U.S. regulators, in realizing smooth
introduction of reasonable and fair international regulations.
(2) T+1 IM settlement is not practical (particularly in cross-border cases)
A particular concern for financial institutions located in Asia and the Far East region is thatthe proposed rule sets the timing of IM settlement on the day a covered swap entity enters
into the transaction or the following business day (“T+1”). Given administrative procedures
necessary for the calculation of IM (e.g. pre-reconciliation), this timing requirement would
be difficult to meet even in the case of transactions between entities located within the U.S.
In the case where the time difference is large between the locations of respective parties tothe transaction (e.g. between Sydney and New York), this requirement would create severe
disadvantage for Asian financial institutions with a large time difference and is not practicalto comply with. The Agencies are requested to consider that the rule should be practical to
implement not only for transactions in the U.S. but also for cross-border transactions with
Asia, etc.

2(3) Level of requirements(Even assuming that the proposed rule will be further refined to some extent,) satisfying therequirements related to timing and deadlines under the proposed rule is considered to bedifficult and thus many jurisdictions and financial institutions may fail to comply with therule. This may give rise to an unfair playing field between jurisdictions and financial
institutions complying with the rule and those that are not in compliance with the rule. In thefirst place, this regulatory initiative has been initiated as part of internationally-agreed G20’s
program. If only some jurisdictions and financial institutions are capable of complying withthe rule, it would undermine the meaningfulness of implementing the rule as an international
agreement. Given that margin requirements are a rule established based on the international
agreement by G20 leaders and a rule which should be comply with by a larger number offinancial institutions, the level and content of the requirements should be achieved with areasonable effort even by those financial institutions in jurisdictions which have not yet
developed a sufficient framework related to operation, systems, documentation and otherrelevant areas.
(4) Necessity of integrating swap margin rules
National regulators of all major regions, i.e. EU, Japan and the U.S., have issued theirnational draft rules. Given that there are significant differences across these draft rules, it is
crucial to explore how extraterritorial application of these swap margin requirements can be
implemented in a realistic and effective manner. Basically, banks should be deemed asachieving regulatory compliance if they comply with the rules of the home jurisdiction of
their head office. However, even if approaches for cross-border application are designed in arefined manner, financial institutions engaging in cross-border transactions would need to
manage their transactions pursuant to multiple standards corresponding to the number of
their counterparty’s home jurisdictions, and as a result will virtually be unable to function.
(Further, if rules pertaining to extraterritorial application differ across jurisdictions, it would
be more difficult for them to implement swap margin requirements.) Ultimately, therefore,
the only essential solution for this issue is to promote the integration of swap margin rules.
To this end, the issue should be returned to the BCBS and IOSCO for discussion, instead ofbeing discussed and adjusted bilaterally or among multiple national regulators, as it isconsidered to be the most efficient and quickest way. If it is determined that swap margin
rules will not be integrated, regulators are expected to perform the comparability assessment
upon finalization of national rules. Since it would be difficult to initiate preparing for
implementation (e.g. documentation) until the comparability assessment is completed, somebanks may fail to meet the deadline to implement the rules, giving rise to a number ofcounterparties unable to transact with. Therefore, if swap margin rules will not be integrated,3

it is critical to complete the comparability assessment as soon as practical.
(5) Timing of implementation
As a compliance date, a transition period of at least two years after the finalization of the rules andcompletion of the comparability assessment should be provided to implement VM requirements,
and a longer transition period to implement IM requirements; given (a) the proposed rule is not
finalized yet, (b) details of many areas need to be discussed and adjusted between the public andprivate sectors, (c) a great deal of efforts and resource is necessary to prepare for implementationand (d) specific actions cannot be initiated until the comparability assessment is completed.

3. Scope of application(1) Covered entitiesi)

The proposed rule refers to entities that are subject to the rule as “covered swap
entities.” “Financial end users,” on the other hand, are not directly subject to the rule but
need to exchange VM (and IM, if necessary) when transacting with a covered swap
entity. The financial end users include entities which are engaged in derivatives
transactions but do not necessarily assume the exchange of VM or IM, such as securities
investment funds and securitization vehicles (see 57361; 3rd Column; 2nd Paragraph).

ii)

Securities investment funds and securitization vehicles are merely entities that engage inminimum derivatives activities needed for business purposes, and due to suchcharacteristics do not always maintain the liquidity to enable the exchange of VM.
Indirectly mandating these entities to exchange VM may undermine the sustainability of
their business model, and thus the Agencies are requested to address this matter
carefully. Further, these entities, due to their characteristics, are not necessarily engaged
in many derivatives transactions. It is therefore requested that these entities are treatedin a manner similarly to non-financial entities.

iii) The scope of entities directly or indirectly subject to exchange of VM is not consistentacross jurisdictions. To avoid undue confusion, national regulators are requested to unify
the criteria of covered entities as much as possible. In addition to the above-mentioned
securities investment funds and securitization vehicles, the treatment of SPCs and SPVs
should be consistent across jurisdictions.
(2) Phase-in of IM requirementsi)

The proposed rule adopts a phase-in approach to introduce IM requirements similarly to
the BCBS/IOSCO Final Report, EU’s draft rules and Japan’s draft rules, however the
IM threshold amount for the final compliance date (i.e. the threshold applicable from
December 1, 2019) is inconsistent with other proposed rules. Specifically, while otherrules sets a threshold of €8 billion for the final compliance date, the proposed rule sets a4threshold of zero in the case of transactions between covered swap entities (see57388;§_.1 and 57358; 3rd Column; 2nd Paragraph) and substantially a threshold of
US$3 billion in the case of transactions between a covered swap entity and financial end
user (see 57391; 1st-3rd Column and §_.3-(a)).
ii)

Given the above, the proposed rule results in an inconsistency with the BCBS/IOSCO
Final Report, EU’s draft rules and Japan’s draft rules, which may cause unnecessary
confusion among market participants. It is understood that due consideration have been
given in setting a threshold of US$3 billion, which is referred to as a “material swaps
exposure” in the proposed rule (see 57366; 3rd Column). Nonetheless, the Agencies arerequested to develop requirements in a manner to ensure international consistency andavoid unnecessary confusion because the proposed rule has an impact not only on
entities within the U.S. but also on those outside the U.S. In addition, such inconsistency
will obviously drive regulatory arbitrage. Specifically, financial institutions whoseamount of transactions is in between two different thresholds would inevitably avoid
transactions with U.S. financial institutions if the terms and conditions are the same. The
Agencies are requested to also take this into account and carefully consider the necessityof setting a threshold specific to the U.S. rules. In terms of the criteria for assessing
whether thresholds are exceeded, the BCBS/IOSCO Final Report, EU’s draft rules andJapan’s draft rules use month-end average notional amount of transactions over threemonths (i.e. June, July and August) whereas the proposed rule uses average daily
aggregate notional amount of transactions over the same periods. Aggregating thesedaily amounts on a group basis and retaining such data after aggregation as evidence
would be a burdensome task. As it would be difficult in practice to arbitrarily reduce
only month-end amounts, it is requested that the Agencies reconsider adopting
month-end average notional amount from perspectives of reducing unnecessary burden
and ensuring consistency between international rules.

4. Collateral operation(1) Content of requirements (§_.3)
The proposed rule requires not only the collection of VM or IM but also the posting of thesemargins. We understand that the Agencies attach importance to requiring a covered swap
entity to post margin to other financial entities in order to forestall a build-up of potentiallydestabilizing exposures in the financial system (see 57354; 1st Column; 2nd Paragraph).
Nonetheless, requiring the posting, as well as the collection, of minimum IM and VM
amounts is likely to further increase practical burdens or confusion of market participantsbecause, in the absence of explicit rule concerning dispute resolution, a judgment on to what5

extent negotiation with counterparties needs to be made will differ on a case-by-case basis.
In light of the fact that the BCBS/IOSCO Final Report, EU’s draft rules and Japan’s draft
rules do not require the posting of margins, the Agencies are requested to avoid incorporating
an inconsistent requirement in the U.S. rule.
Under cross-border transactions, the proposed rule allows a covered swap entity to post
margin pursuant to a foreign regulatory framework which the counterparty is subject to andhas been determined to be comparable by the Agencies (see 57395; §_.9- (d)- (4) and 57380;
2nd Column; 2nd Paragraph). This framework is based on the assumption that the amount of
IM calculated by a covered swap entity will be greater than the amount calculated by thecounterparty and thus should not raise any problem for the counterparty. In some cases,
however, the amount requested by the counterparty could be greater than the amountcalculated by the covered swap entity. Further, with regard to substituted compliance, theproposed rule provides that the Agencies will make an assessment and determination
regarding the comparability of a foreign regulatory framework jointly with foreignauthorities of that framework (see 57380; 2nd Column; 3rd Paragraph). On the other hand,with regard to substituted compliance for posting requirement, it can be interpreted that suchdetermination relies solely on the Agencies’ judgment (see 57395; §_.9-(d)- (4)). In the latter
case, if a covered swap entity demands a smaller amount of IM, the counterparty might haveno choice but to agree to that amount. If the posting requirement will be imposed, albeit ourrequest stated above, the Agencies are requested to confirm whether a covered swap entity isdeemed as satisfying its posting requirement by posting margin in the amount calculated by
the counterparty.
(2) T+1 settlement and daily operation (§_.3 and §_.4)
The proposed rule requires a covered swap entity to valuate margin requirements “on at leasta daily basis.” Further, IM needs to be posted or collected in response to execution of newtransactions, changes in a portfolio composition or changes in the required IM amounts
resulting from calculations per internal margin models or the standardized look-up table. If
our interpretation is correct, margin must be posted or collected on the business day
following the day a transaction is entered into (“T+1”) or on the day the transaction isentered into (“T+0”) (see 57368; C.Section_.3-2.-d.). (Or if the proposed rule does notnecessarily intend to designate the timing of exchanging margin, please advise whether it
only intends to require a margin calculation from the business day following the date on
which a transaction is entered into. Our comment below is made assuming that ourinterpretation is correct.)
Given that the BCBS/IOSCO Final Report does not refer to the timing of posting orcollecting margin and does not require daily calculation of margin requirements, it is6considered that the proposed rule provides a tighter rule for both points.
i) T+1 posting/collection requirements
Under the existing margin posting/collection process implemented on a bilateral basis, itwould be difficult to calculate margin requirements reflecting information as of theclose of the NYSE on the previous business day and then to issue margin calls during
the business hours in Asia (i.e. actually a few hours later). Many globally-active
financial institutions operating on the Asian time often use data as of two previous
business days. Further, given a standard settlement cycle of government bonds, which
are frequently used as collateral, it would be difficult to post/collect margin on thebusiness day following the day of notifying margin calls. Currently, a standard
settlement cycle of the U.S. government bonds is the trade date + 1 business day(“T+1”) while many other governments bonds that are pledged as collateral are shifting
to a settlement cycle of T+2. (For example, Europe has adopted the “T+2” settlement
cycle from the fourth quarter of this year and Japanese government bonds (JGBs)
shifted to the “T+2” settlement cycle from the “T+3” cycle in April 2012. They are
unlikely to shift to the “T+1” cycle in the near future.) Under such circumstances, itwould be difficult to implement the “T+1” margin posting/collection cycle in all cases.
This is particularly the case when transactions are executed across borders. If bothparties to the transaction are located within the U.S., the “T+1” margin
posting/collection requirements should be relatively easy to satisfy because there is noor only a small time difference and an established settlement system or framework isalready in place. On the other hand, where there is a large time difference between theparties to the transaction (e.g. between Sydney and New York), it would be difficult toestablish a process adaptable to the “T+1” margin posting/collection because of the timerequired for negotiating the required amount of margin and the difference of holidays, aswell as given the current practice which is taking about “T+4” for margin settlement(see the diagram in Appendix 1 for details). It would be a possible option to establish a
new collateral management process/procedure within the U.S. and make a settlement in
USD. This however would require additional costs and resources that are only
affordable by a very limited number of financial institutions. Additionally, such option
would increase the difficulty of pledging collateral denominated in a currency other thanthe currency of the home jurisdiction, incentivizing entities to enter into derivativetransactions with those counterparties within the same territory and thus undermining
global, cross-border transactions. Moreover, in the case of IM, it should be noted that
additional time is required to give instructions on margin settlement to global custodians,
Japan’s trust banks and other entities assuming asset segregation functions (which

7requires about two days in the case of JPY cash/JGB settlement under current practices).
Therefore, instead of designating a uniform timing of posting/collecting margin by
specifying “within XX day(s),” the Agencies should take into consideration thatcollateral operations will be performed under cross-border transactions as well and thatthe shortest possible time to meet the posting/collection requirement differs dependingon locations and types of collateral; and therefore are requested to make a feasible ruleby, for example, deeming entities as satisfying the requirement provided that they are
adopting the market’s best practice. It should also be noted that the “Supervisory
guidance for managing risks associated with the settlement of foreign exchangetransactions” published by the BCBS/Committee on Payment and Settlement Systems(CPSS) in February 2013 recommends the use of CLS and that, if such use is madeobligatory, settlement periods will become longer.
ii)

Frequency of margin calculation
Under current market practices, regional banks with a low operational capacity still
calculate margin on a weekly or monthly basis in many cases. Requiring daily operation,in addition to mandatory conclusion of a number of CSAs, will significantly increaseadministrative burden. Although daily operation is preferable for the purpose of
settlement risk and credit risk management, given current situations, the requirement
should not be tightened relative to the BCBS/IOSCO Final Report. Even if therequirement is decided to be enhanced in some way, the Agencies are requested to give
flexibility to some extent by, for example, providing a transition period.

(3) Impact on the existing transactions (§_.4)
Where margin is already being exchanged based on the ISDA CSA, the burden ofoverlapped management arising from the existence of both new and old contracts
should be prevented. Therefore, the proposed rule should clarify that there is no impact
on relevant practices even after the enforcement of the VM requirements and that
entities are allowed to exchange margin by aggregating existing and new transactions.
(4) Eligible collateral and haircuts (§_.6)i)

The proposed rule limits eligible collateral for VM to cash only. (According to ourinterpretation) cash collateral should be denominated either in U.S. dollars or in thesettlement currency (of the swap transaction). The issue here is that under the swap
where payment obligations are settled in the currency other than U.S. dollars (e.g. eurointerest rate swap), cash collateral denominated in the currency other than that
settlement currency (e.g. JPY cash collateral) will not be permitted to be used as VM.
This would not only undermine the discretion of financial institutions but also would
create a considerably unfair playing field for non-U.S. financial institutions relative to8

U.S. financial institutions because the former will need to obtain foreign currency topledge collateral, which will increase collateral cost and the liquidity risk of foreign
funds. Further, the unavailability of securities (e.g. government bonds) as VM would
prompt pressure to sell those securities, aggravate liquidity risk and give rise to otherproblems. According to a survey conducted by the ISDA Japan in 2014 and a similar
survey conducted by the ISDA on a global basis, the percentage of cash collateral
received was only 43.3% and 74.9%, respectively. Given this, limiting VM to cash may
trigger various risks and side effects. The proposed rule explains that the Agencies havedetermined to limit eligible collateral for VM to cash by taking into account the 2013
Standard Credit Support Annex (“SCSA”) and general market practices by central
counterparties (“CCP”), and also for the purpose of applying a zero haircut (see 57371;
F.Section_.6-2.-a.). We understand the rationale but recommend that the Agencies
should expand the list of eligible collateral similarly to IM given that the SCSA has beenused only by a limited number of entities and its use is not likely to prevail in the near
future and that the use of CCP is developing but has not widely spread yet on a
G20-global scale.
ii)

Under the proposed rule, an additional haircut (8%) to be applied when the currency ofcollateral and settlement (of the swap transaction) is different is limited to IM. In
addition, (similarly to VM) for the purpose of the IM requirements, only cash collateraldenominated in U.S. dollars is not subject to an additional haircut (8%) (see 57355; 1stColumn; 2nd Paragraph and 57372; 2nd Column; 3rd Paragraph). This may be an approachto give preferential treatment to USD cash. However, neither the BCBS/IOSCO Final
Report, EU draft rules nor Japan’s draft rules provide for a treatment that gives
advantage to the home currency. The above treatment is understandable if the proposed
rule is a regulation solely governing the U.S. and only applies to transactions within the
U.S., but would cause a number of issues because the proposed rule is a regulation
drafted based on the international agreement and applies globally across borders. In theevent that countries in Europe or Asia take the same approach, covered entities engaging
in cross-border transactions would have to manage and operate collateral in accordancewith the number of standards corresponding to the number of counterparty’s
jurisdictions, giving rise to a concern that the proposed rule would not, in practice,function as an internationally-agreed rule. The Agencies therefore are requested toconsult on an international basis whether to adopt a preferential treatment to the U.S.
currency, and make a careful judgment.

iii) As mentioned above, under the proposed rule, an additional haircut (8%) is applied
when the currency of collateral and settlement (of the swap transaction) is different. It is

9unclear whether this settlement currency represents the currency used to calculate
margin on a portfolio-by-portfolio basis or the currency in which each transaction within
the portfolio is settled. Therefore, the Agencies are requested to provide a clear guidanceon when the currency of collateral and the currency of settlement is deemed as different.
For example, please clarify whether currency swap between U.S. dollars and Japanese
yen with cash collateral denominated in Japanese yen is included in such a case.
(5) Minimum Transfer Amount (§_.5)
The proposed rule indicates that a minimum transfer amount (“MTA”) of US$650,000 is
applied to the required cumulative amount of VM and IM (see 57357; 1st Column; 4thParagraph and 57370; 2nd Column; 3rd Paragraph). It is considered that this intends to clarify
how MTA should be operated, which was not explicitly stipulated in the BCBS/IOSCO Final
Report. However, requiring the application of MTA to a cumulative amount of VM and IM
will be difficult to implement in practice and will cause undue burden on market participantsbecause: (a) VM is exchanged directly with a counterparty whereas IM is exchanged via acustodian, etc. and (b) posting/collection of VM and IM may be implemented in a different
timeframe and by different divisions/entities in some cases under existing collateralmanagement practices. For example, if a division in Tokyo undertakes the responsibility of
IM management and a division in New York undertakes the responsibility of VM
management, they will have to operate MTA individually. The proposed rule should delete
the descriptions that might deny such a collateral management framework and allow
application of MTA separately to VM and IM. In this respect, Japan’s draft rule can bereferred to as it allows application of MTA separately to VM and IM by including theprovision regarding MTA separately for both VM and IM.
(6) Documentation of margin matters (§_.10)
It is requested that the proposed rule clarifies that the documentation requirement for the VM
calculation method will be satisfied by the provision pertaining to the calculation agent,
which is generally included in the ISDA CSA, and so the VM calculation method does notneed to be stipulated in the contract.

5. Internal IM models(1) Calculation requirements: Asset class classification (57375; H.Section_.8-2.-a.-ii.)i)

Under the proposed rule, the Agencies are aware that classifying swaps into asset classes
on a transaction-by-transaction basis is problematic, and seek comment for alternative
approaches. More specifically, the Agencies expect that the covered swap entity would
make a determination as to which asset class best represents the swap based on a holistic
view of the underlying swap. Further, they propose that if it is difficult to determine the10asset class, a swap be classified into the “unclassified swaps” category and those swaps
under this category be aggregated to calculate the gross IM amount.
ii)

However, taking into consideration that risk characteristics of hybrid transactions varydepending on market conditions, it would not be appropriate to classify a swap into a
specific asset class over the entire transaction period based on type of transactions.
Further, to avoid disputes arising from a difference in the asset class classification, allmarket participants would need to consent to classification methods for all types ofvarious OTC derivatives before the implementation of the proposed rule, which isdeemed to be difficult given a limited timeframe. Moreover, calculating the gross IM
amount based on aggregated value of swaps for which classification is difficult would
considerably undermine incentive to use internal models that take into account the effectof offsets.

iii) As an alternative approach, we would like to propose asset class classification based onsensitivities, which is an approach recommended in the letter of July 14, 2014 submitted
by the ISDA and the Securities Industry and Financial Markets Association (“SIFMA”)
to the European Supervisory Authorities (“ESA”) 1. This approach will:

enabletheIMcalculation

thatappropriatelyreflects

theeffectofoffsets/correlations between risk factors;more clarify the relationship between linear risk factors and asset classclassification;

enable the calculation without setting assumptions regarding correlations between
risk factors belonging to different asset classes; andenable avoidance of overlapped investments in systems modification and otherareas because the calculation of risk sensitivities is required for all financial
institutions upon implementation of a new standardised approach (so-called thesensitivity-based approach) proposed under the Fundamental Review of the TradingBook (“FRTB”). In addition, this approach will prevent a significant gap in theamount of IM requirements between banks using internal models and banks using
the standardised approach, which is a concern inherent in the IM calculation, andthe resulting segmentation of the market.

Further, as mentioned in the ISDA’s supplementary proposal 2 on the FX haircut dated
August 17, 2014 and submitted to the ESA, this approach is able to reflect, in an
economically reasonable manner, an additional haircut arising from a currency
12

http://www.sifma.org/issues/item.aspx?id=8589949919
See “ISDA letter to the ESAs on Proposed Margin Requirements: Analysis of Currency Mismatch Haircut”(August 17, 2014) from ISDA website. (http://www2.isda.org/functional-areas/risk-management/)11

mismatch between the IM calculation (of which currency is different from the currencyof each swap in the portfolio) and the collateral asset.
(2) Calculation requirements: Risks to be captured (57374; H.Section_.8-2.-a. and 57394;§_.8-(d)-(9))i)

The proposed rule requires covered swap entities to capture all of the material risks that
affect the valuation of the transaction, specifically requiring capturing of basis risk, riskof changes in the volatility and nonlinear risks.

ii)

Instruments that are covered by the proposed rule are primarily non-centrally cleared
exotic instruments. As the market price and sensitivity of exotic instruments relies
heavily on the pricing model of each company, a difference in the required amount of
IM calculated between market participants will increase if vega (the first ordersensitivity to changes in the volatility), as well as delta (the first order sensitivity tochanges in underlying assets), is incorporated in the IM calculation. This would makedispute resolution difficult and may ultimately reduce the liquidity of transactions.

iii) If capturing of nonlinear risks is required, the workload to calculate forward margin
requirements will extremely increase; making it difficult to appropriately reflect funding
cost of margin into the price. If, as a result, the pricing becomes conservative, theliquidity of the derivatives market may decrease and, in times of stress, may further
aggravate. This might undermine the regulatory objective of preventing systemic risks.
Given that most risks can be captured by delta, the Agencies need to carry out acost-benefit analysis of additionally imposing a requirement to capture nonlinear risks
and the resulting impact on the market liquidity.
iv) To implement the proposed rule, there are a number of issues to be addressed across theentire operational processes related to the exchange of VM and IM and credit
monitoring, etc., as well as the development of IM calculation systems. To have in place
processes and procedure capable of implementing the proposed rule within a limited
timeframe, financial institutions should establish each operational process under theassumption that IM models that reduce potential dispute as much as possible will be
used. Therefore, at least at an early stage after the enforcement of the proposed rule in
December 2015, the Agencies are requested not to require capturing of above-mentioned
risks.
(3) Calculation requirements: Netting sets (57393; §_.8-(b)-(2))i)

Under the proposed rule, if swaps entered into before and after the applicable
compliance date (“legacy trade” and “new trade,” respectively) are covered by the same
ISDA master agreement, both legacy trade and new trade are required to be included in
the aggregate in the IM calculation.

12

ii)

Compared to the case where IM is calculated solely for new trade, if IM is calculated forlegacy trade and new trade in the aggregate, the required amount of IM may become
excessive. This contradicts with the objective of the BCBS/IOSCO Final Report toavoid a rapid dry up of liquidity and market turmoil by phasing in the regulation.

iii) If, on the other hand, financial institutions seek to exclude legacy trade from the IM
calculation, they need to cover legacy trade and new trade under separate ISDA masteragreements. In such cases, the effect of close-out netting upon default decreases andthus credit risks of the overall financial system increases; thereby undermining theobjective of introducing the proposed rule. The proposed rule therefore should delete
this requirement; or if it is difficult to do so, should be amended to require legacy trade
to be included in the IM calculation only when legacy trade and new trade are covered
under the same CSA. (See Appendix 2 for detail.)(4) Operational requirements: Model validation (57374; H.Section_.8-2-a and 57394;§_.8-(d)-(12), (13), (e), (f))i)

First of all, we would like to express our disagreement to the proposed requirement
setting forth the internal management standards for IM models at the same level as thoserequired for internal regulatory capital models.

ii)

As stated in the BCBS/IOSCO Final Report, capital and margin requirements are thetwo core regulatory tools to protect the financial system from the default of derivatives
market participants. The balance between survivor-pay and defaulter-pay should always
be carefully considered from the perspectives of micro risks of individual financial
institutions and ensuring the stability and efficiency of the derivatives market.

iii) Unlike internal regulatory capital models, IM models are used to calculate the amount ofmargin to be exchanged with the counterparty. The IM models therefore have thefollowing preconditions and characteristics:

The appropriateness of models cannot be assessed based on the conservativeness ofvalues (i.e. values calculated are large);Discontinuous changes in values by model calibration, etc. should be avoided inorder to mitigate the impact on funding plans of the counterparty, and ultimately ofthe overall markets; andConsistency should be maintained across all market participants in terms of, among
other things, the standards and methodologies of validating models so as to enablea novation which is a risk mitigation technique in times of financial crisis.

Further, with regard to loss absorption, it should also be noted that unlike margins to
CCP, capital serves as a buffer for IM required under the proposed rule.
iv) Given above, unlike internal regulatory capital models, IM models need to be13

implemented based on interaction between all market participants and national
supervisors instead of one-on-one interaction between each market participant and the
Agencies. The proposed rule should take this point into account and the requirement beamended to align with such practice. Assuming that a robust capital buffer is secured
under internal regulatory capital models, the IM model governance should focus moreon the stability, transparency and efficiency of the derivatives market. It is notconsidered reasonable to require both models to establish an equally-robust governanceframework.
(5) Others: Standardized initial margins (57377; H.Section_.8-2.-b.-i.)i)

The proposed rule seeks comment on whether the Agencies should adopt an alternative
method to the net-to-gross ratio approach to recognize risk offsets under the
standardized initial margin requirement.

ii)

For the purpose of counterparty credit risk (“CCR”) exposure calculation, it has been
decided that the current exposure method (“CEM”), which uses the NGR, will be
replaced by the SA-CCR (i.e. a standardized approach for measuring CCR). It isrequested that the effect of offsets will be recognized , in the same way as in SA-CCR,
for the purpose of the standardized initial margin requirements under the proposed rule.

(6) Others: Request for early announcement regarding model application proceduresi)

The Agencies are requested to inform, at the earliest possible stage, those financial
institutions to which the proposed rule will be applied from December 2015 of
information on documents and data necessary for IM model application and the timeline
to submit such data.

6. Others(1) Treatment of counterparties in jurisdictions where the legal enforceability of close-out andcollateral netting is not confirmed
The proposed rule could be construed as not explicitly excluding from the scope of its
application those counterparties in jurisdictions where the legal enforceability of close-out is
not confirmed. If a financial institution enters into a collateral agreement with such a
counterparty and collects/posts collateral thereunder, but subsequently such agreement isdenied of its enforceability of close-out and collateral netting; the financial institutions may
incur a significant loss.
Ex1. Assume an entity which engages in two transactions with a counterparty in ajurisdiction where the legal enforceability of close-out is unconfirmed. The entity’s
exposure to the counterparty is +30 under one transaction and -40 for the othertransaction, and that these transactions are netted against each other. In this case,14net exposure of the entity will be -10. The calculation of VM to be posted is basedon the assumption that an effective close-out is legally enforceable (because if a
different assumption is applied, it is impossible to agree on the amount of VM to
be exchanged (unless all transactions are in the same direction)). In this case,therefore, the entity will post 10 VM. In practice, however, exposure to thecounterparty to be recognized should be +30 (=30 + 0, assuming that -40 is 0)
taking into account actual risks because these are transactions with counterparties
in a jurisdiction where the legal enforceability of close-out is not confirmed. Morespecifically, in this case, the entity takes an additional risk of 10 for thecounterparty to which it already has exposure of +30, upon entering into acollateral agreement with that counterparty. The reason for assuming an additionalrisk is that a collateral agreement is required even for a transaction with thosecounterparties for which the enforceability of close-out cannot be confirmed.
Ex2. Assume an entity which engages in a transaction with a counterparty in ajurisdiction where the legal enforceability of collateral netting is not confirmed.
The entity has a total exposure of -30 to the counterparty and pledges collateral of
30. In this case, the entity will incur zero loss upon default of the counterparty ifcollateral netting is enforceable, but will be required to fulfill a payment obligationof -30 if it is concluded as not enforceable. In addition, collateral of 30 that has
been posted will be treated as general receivables and thus will not be returned,
imposing loss of 30 on the entity. Had the entity not entered into a CSA, it would
have been required only to fulfill the payment obligation of -30, and thus would
have not incurred any loss. This indicates that the entity would suffer more loss
because of entering into the CSA.
It is reasonable to allow entities to decide whether to enter into a collateral agreement at theirdiscretion by taking into account the above possible cases and risks. Further, the Agencies
should not uniformly require entering into collateral agreements and collection/posting ofcollateral for all of those jurisdictions where the legal enforceability is not confirmed.
Otherwise, entities would have to avoid transactions with counterparties in thosejurisdictions, which may deny access of such jurisdictions to the derivatives markets.
Some, on the other hand, may view that it is not preferable to exempt counterparties in suchjurisdictions from the proposed rule because that may incentivize entities to transact withcounterparties in these jurisdictions and that the Agencies should rather promote theestablishment of a framework which ensures the enforceability of close-out by including thecounterparties in such jurisdictions in the scope of the proposed rule. However, it is virtually
impossible to engage in the excessive volume of unsecured transactions with a counterparty

15

with whom close-out is not enforceable; given that such a transaction requires a higher credit
line, as well as higher capital charge for regulatory capital calculation purposes, relative to asimilar but secured transaction with a counterparty with whom close-out is enforceable
because exposures are managed on a gross basis and the effect of collateral cannot bereflected for risk management purposes. Therefore, even if those jurisdictions in which thelegal enforceability of close-out is not confirmed are exempted from the margin rules,transactions are unlikely to flow into those jurisdictions. As a derivatives market participant,we welcome the framework that increases the number of jurisdictions where close-out
netting is enforceable. However, applying the margin rules to those jurisdictions whereclose-out is not enforceable would deny access of entities in such jurisdictions to derivatives
markets, depriving them of a market risk management tool, as well as would require
additional (and uncontrollable) risk-taking through posting collateral for those transactingwith counterparties in such jurisdictions. These consequences would contradict the objectiveof the margin requirements to mitigate the systemic risk. If the Agencies intend to increase
the number of jurisdictions where close-out and collateral netting are enforceable, anappropriate measure should be discussed earnestly because there should be a more direct way
having less negative impact, such as a peer review by the Financial Stability Board, rather
than an indirect way having more negative impact, such as the margin rules.
If the proposed rule intends to include in the scope of its application those jurisdictions
where the legal enforceability of close-out or collateral netting is not confirmed, it should
provide exceptions allowing entities to decide at their discretion whether to enter into acollateral agreement until the legal enforceability of close-out/collateral netting is ensured.
Even if such legal enforceability is ensured, a sufficient lead time is needed to prepare for the
implementation of the margin requirements ---it should be noted that the percentage of theuse of collateral agreements in such jurisdictions is considered to be very low--- and the
Agencies are requested to set compliance dates by taking this into account.
(2) Confirmation of the enforceability of close-out (57364; 2nd - 3rd Column and 57389; 2nd - 3rd
Column)Several conditions need to be satisfied to qualify for an eligible master netting agreement.
Specifically, in addition to the granting of the right to close out under the master netting
agreement, the proposed rule requires that the exercise of the right to terminate will not be
hampered other than in the case of “stays” provided for under certain U.S. receivership,conservatorship or resolution regimes (or similar laws of foreign jurisdictions) or in acontractual agreement subject to such laws. Unlike the close-out case (for which the ISDA
has summarized and published a legal opinion on behalf of the industry), there is noestablished way to confirm the latter case and it is not even clear what specific cases are

16

assumed. It is therefore still premature to require this condition and this could be consideredwhen a confirmation method is established.
(3) Cross-border application<Request for a substituted compliance determination>
The proposed rule excludes from coverage of its margin requirements any foreign
non-cleared (security-based) swap (i.e. a non-cleared (security-based) swap in which bothparties and any guarantor on either side is not a U.S. entity or its branch and is not controlled
directly or indirectly by a U.S. entity). Covered swap entities, on the other hand, have room
for substituted compliance under certain circumstances, but is permitted to make a request
for substituted compliance determination only if directly supervised by the authorities
administering the foreign regulatory framework for non-cleared (security-based) swaps. It is
unclear as to why the proposed rule limits the availability of substituted compliance to thecase where covered swap entities are directly supervised. It is considered that such a limit is
not necessary.
<Scope of cross-border application>i)

To our understanding, if a non-U.S. SD (not guaranteed by a U.S. entity) and a non-U.S.
financial end user enters into a transaction, the proposed rule will be applied as shownin the table below (see 57395; §_.9 ).
Non-U.S. financial end user
NY branch

HO and branches otherthan in NY

The proposed rule will

The proposed rule willSD

apply, but substituted

apply, but substituted(notcompliance may becompliance may bepermitted.

permitted.

Non-U.S.

NY branchguaranteed
by a U.S.

HO andThe proposed rule will

Excluded from the scope

entity)branches otherapply, but substitutedof application of thethan in NY

compliance may be

proposed rule

permitted.
Generally when the CSA is used, the amount of margin is calculated for multiple head
offices and branches covered by a single agreement. If substituted compliance is not
permitted, the U.S. margin requirements may be applied to transactions outside the U.S.
which are not subject to the proposed rule (e.g. a transaction between the head offices
outside the U.S.) because a single agreement is entered into. In such circumstances, forexample, if transactions between Japanese financial institutions would also be required
to use cash denominated in U.S. dollars for VM purposes, such treatment is considered17

to be the cross-border application beyond the reasonable level. The Agencies arerequested to respect the framework of the BCBS/IOSCO Final Report in terms ofcross-border application and allow entities in principle to comply with the proposed ruleby satisfying the margin rules of the jurisdiction where the head office is located inorder to avoid confusion in the markets.
ii)

To our understanding, if a non-U.S. SD (guaranteed by a U.S. entity) and a non-U.S.
financial end user enter into a transaction, the non-U.S. SD will not be eligible for
substituted compliance and will be subjected to the proposed rule (see 57395; §_.9 ).
If a margin framework (regardless of its level of development of the jurisdiction)functions appropriately, an event of default of either party to the transaction would be
addressed as a problem between both the parties and should not affect other entities.
More specifically, even if the non-U.S. SD is guaranteed by a U.S. parent company,
impact within the U.S. arising from such default should be extremely limited. Therefore,
in respect of this type of transaction, the Agencies are requested to also respect theframework of the BCBS/IOSCO Final Report in terms of cross-border application andallow entities in principle to comply with the proposed rule by satisfying the margin
rules of the jurisdiction where the head office is located.

iii) However, even if approaches for cross-border application are designed in a refinedmanner, financial institutions engaging in cross-border transactions will need to manage
their transactions pursuant to multiple standards corresponding to the number of theircounterparty’s home jurisdictions, and as a result will virtually be unable to function.
(Further, if cross-border application rules differ across jurisdictions, it will be moredifficult to implement swap margin requirements.) Ultimately, therefore, the best
essential solution for this issue is to integrate swap margin rules. To this end, the issue
should be returned to the BCBS and IOSCO for discussion and adjustment, instead ofbeing discussed and adjusted bilaterally or among multiple national regulators, as it isconsidered to be the most efficient and quickest way.
If it is determined that swap margin rules will not be integrated, regulators are expected
to perform the comparability assessment upon finalization of national rules. Since itwould be difficult to start preparing for implementation on a full scale (e.g.
documentation) until the comparability assessment is completed, some banks may fail tomeet the deadline to implement the rules, giving rise to a number of counterparties
unable to transact with. Therefore, if swap margin rules will not be integrated, it iscritical to complete the comparability assessment as soon as practical.
(4) Interaffiliate transactions (57388; 1st Column)
The proposed rule imposes margin requirements also on interaffiliate transactions (including

18

the case where the counterparty is non-financial entity). Although we understand that the
proposed rule intends to mitigate the systemic risk by applying the margin requirements
without exception, the necessity for imposing the proposed rule on interaffiliate transactions
is not considered to be high, and at least, it is not necessary to apply the proposed rule fromthe date of its enforcement. This is because; (a) risks arising from interaffiliate transactions
are generally much lower than external transactions, (b) although organized as alocally-incorporated company in accordance with local authorities’ intention, etc., many
affiliates are substantially managed integrally with the bank similarly to the structure of thehead office and branches and thus transactions with the affiliates do not differ in substancefrom transactions with the head office and branches, (c) imposing the margin rules oninteraffiliate transactions may undermine the establishment of an efficient booking systemand (d) it is practically difficult to enter into the CSA with all covered counterparties,
including affiliates, within a considerably limited timeframe by no later than the compliancedate. Given above, it is recommended that the Agencies address this issue carefully by also
taking into account international regulatory developments.
Further, an entity is deemed as an affiliate even when only 25% of its voting power is owned.
This definition may raise the following concerns: (a) an entity over which the firm does nothave strong control may be treated as an affiliate, giving rise to problems in, for example,
allocating the initial margin thresholds; (b) where engaged in a number of cross-bordertransactions with financial institutions, the firm may have to take different approaches
depending on the home jurisdiction of its counterparties, increasing the difficulty to comply
with the requirements and also undermining the internationally-agreed framework; (c) unlike
where the definition of “more than 50%” is applied, an affiliate may belong to multiple
groups if the definition of “more than 25%” is applied, making it complicated and difficult toadjust thresholds among those groups.
(5) Documentation of margin matters (57381; J.Section_.10 and 57395;§_.10)
Covered swap entities are required to execute necessary trading documentation that specifies
IM models validation and other matters. While the documentation requirements are integral
part of model governance, it is not practical to require all covered entities to establish andmaintain the documentation processes/procedures at an equivalent level of robustness.
Instead, it is recommended that the level of documentation requirement should take into
account the composition and size of derivatives portfolios of covered entities. Particularly
when the application of a certain standardized model is permitted as proposed by the ISDA
and other organizations, the standardization and unification of documentation requirements
should also be permitted.

19

(6) Mandatory use of “third-party custodian” (57355; 1st Column)
The proposed rule requires covered swap entities to use custodians that are not affiliates.
However, the necessity of this requirement is considered to be low for the following reasons:(a) custodians are required by law to ensure bankruptcy remote, and thus decline in thecreditworthiness of their (derivatives) counterparties will not directly affect thecreditworthiness of their assets trusted to custodians, (b) custodians are highly rated ingeneral and due to the nature of their business strive to maintain stable creditworthiness and(c) in practice, custodians to be used are not unilaterally determined by either of the parties
but are decided through consultation between both the parties. If requiring the use ofthird-party custodians, it is recommended to take more realistic approach; for example,
requiring a covered entity to prepare more than one options for custodians and give thecounterparty latitude to select a third-party custodian.

20

[IM operation] Why T+1 as transfer timing doesn't work for Asian banks ?

Appendix 1[Assumption]･ Japanese bank located in Tokyo makes a collateral demand on US bank located in New York.

All communications are made by emails

Tokyo TimeBusiness hours

Business hours

Business hours

T (Today)

T+1

T+2

Business hours

Business hours

T+3③Portfolio Data

T+4

Business hours

Business hours

T+5

T+5

⑤Reconciliation⑨Collateral Delivery〔Custodian for Japanese Bank〕①Trade⑥Margin Call

②Portfolio Data

⑦Reply⑧Agreement④Reconciliation⑩Collateral Delivery〔Custodian for US Bank〕

NY timeBusiness hours
T

New Trade

Business hours
T+1

Pre-Portfolio Reconciliation Process

Business hours
T+2

Business hours
T+3

Business hours
T+4

Collateral Negotiation Process< Note >Pre-Reconciliation･ This is a new process which is required to fix the portfolio subject to IM calculation between the parties. It will take at least two days if the parties exchange the trade databy email due to the time zone difference between Tokyo and New York.
･ It is assumed that the portfolio as of T-1 will be used. There is a possibility, however, that some parties cannot gather the trade data on a group basis globally and finish
the IM calculation on the day T. In that case, the portfolio as of T-2 is supposed to be used inevitably.
Collateral Negotiation･ This process is normally made via emails. Due to the time zone difference between Tokyo and New York, the collateral details to be delivered cannot be agreed
during the business hours of the day on which the margin call is issued.
･ The above case is the best case where no dispute occur. In case any dispute arises, it may possibly take more few days to agree on any collateral delivery until the
dispute is solved.
Collateral Delivery･ Delivery timing may differ depending on the collateral type(Cash, Security, etc), In case of JGB, which is most likely to be mainly used for IM by Japanese banks,
it will be delivered in two days after the agreement according to the market practice as illustrated above. As for other type of collaterals such as cash, it may be able tobe delivered on the following day after the agreement.

Business hours
T+5

Collateral Delivery Process

Business hours
T+6

Appendix 2
A. Claims and debts upon default - Single master agreement

Legacy Trade JPY1 billion

Non-default bankDefault bank

New Trade JPY 0.2 billion

Initial Margin JPY 1 billion

JPY1 billion of claim arising from Legacy Trade and JPY0.2 billion of debt arising from New Tradeare offset under the close-out netting. As a result, the non-default bank has JPY0.8 billion of claim,
and receives payment of its claim from JPY1 billion of Initial Margin, and return the remaining
JPY0.2billion to the default bank. (The non-default bank incurs no loss.)

B. Claims and debts upon default - Multiple master agreements

Legacy Trade JPY1 billion
Non-default bankDefault bank

New Trade JPY 0.2 billion

Initial Margin JPY 1 billion

JPY1 billion of claim arising from Legacy Trade and JPY0.2 billion of debt arising from New Tradewill not be subject to close-out netting. As a result, the non-default bank has JPY1 billion of claims,
while owes JPY0.2 billion debts to be repaid and needs to return JPY1 billion of Initial Margin.
JPY1 billion claims will be notified as a defaulted claim (The non-default bank incurs JPY1 billion
of loss if there is no dividend.)