This section of the FEDERAL REGISTER

contains notices to the public of the proposed

issuance of rules and regulations. The

purpose of these notices is to give interested

persons an opportunity to participate in the

rule making prior to the adoption of the final

rules.

Proposed Rules Federal Register

23732 

Vol. 76, No. 82 

Thursday, April 28, 2011 

1 See Dodd-Frank Wall Street Reform and 

Consumer Protection Act, Public Law 111–203, 124 

Stat. 1376 (2010). The text of the Dodd-Frank Act 

may be accessed at http://www.cftc.gov/ 

LawRegulation/OTCDERIVATIVES/index.htm. 2 7 U.S.C. 1 et seq. 

COMMODITY FUTURES TRADING 

COMMISSION 

17 CFR Part 23 

RIN 3038—AC97 

Margin Requirements for Uncleared 

Swaps for Swap Dealers and Major 

Swap Participants 

AGENCY: Commodity Futures Trading 

Commission. 

ACTION: Notice of proposed rulemaking. 

SUMMARY: The Commodity Futures 

Trading Commission (‘‘Commission’’ or 

‘‘CFTC’’) is proposing regulations to 

implement new statutory provisions 

enacted by Title VII of the Dodd-Frank 

Wall Street Reform and Consumer 

Protection Act (‘‘Dodd-Frank Act’’). The 

proposed regulations would implement 

the new statutory framework of Section 

4s(e) of the Commodity Exchange Act 

(‘‘CEA’’), added by Section 731 of the 

Dodd-Frank Act, which requires the 

Commission to adopt capital and initial 

and variation margin requirements for 

certain swap dealers (‘‘SDs’’) and major 

swap participants (‘‘MSPs’’). The 

proposed rules address initial and 

variation margin requirements for SDs 

and MSPs. The proposed rules will not 

impose margin requirements on nonfinancial end users. The Commission 

will propose rules regarding capital 

requirements for SDs and MSPs at a 

later date. The Commission will align 

the comment periods of these two 

proposals so that commenters will have 

an opportunity to review each before 

commenting on either. 

DATES: Comments must be received on 

or before June 27, 2011. 

ADDRESSES: You may submit comments, 

identified by RIN 3038–AC97, and 

Margin Requirements for Uncleared 

Swaps for Swap Dealers and Major 

Swap Participants by any of the 

following methods: 

• Agency Web site, via its Comments 

Online process at http:// 

comments.cftc.gov. Follow the 

instructions for submitting comments 

through the Web site. 

• Mail: Send to David A. Stawick, 

Secretary, Commodity Futures Trading 

Commission, Three Lafayette Centre, 

1155 21st Street, NW., Washington, DC 

20581. 

• Hand Delivery/Courier: Same as 

mail above. 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

Please submit your comments using 

only one method. 

All comments must be submitted in 

English, or if not, accompanied by an 

English translation. Comments will be 

posted as received to http:// 

www.cftc.gov. You should submit only 

information that you wish to make 

available publicly. If you wish the 

Commission to consider information 

that may be exempt from disclosure 

under the Freedom of Information Act, 

a petition for confidential treatment of 

the exempt information may be 

submitted according to the established 

procedures in § 145.9 of the 

Commission’s regulation, 17 CFR 145.9. 

The Commission reserves the right, 

but shall have no obligation, to review, 

pre-screen, filter, redact, refuse or 

remove any or all of your submission 

from http://www.cftc.gov that it may 

deem to be inappropriate for 

publication, such as obscene language. 

All submissions that have been redacted 

or removed that contain comments on 

the merits of the rulemaking will be 

retained in the public comment file and 

will be considered as required under the 

Administrative Procedure Act and other 

applicable laws, and may be accessible 

under the Freedom of Information Act. 

FOR FURTHER INFORMATION CONTACT: John 

C. Lawton, Deputy Director, Thomas 

Smith, Deputy Director, or Thelma Diaz, 

Associate Director, Division of Clearing 

and Intermediary Oversight, 1155 21st 

Street, NW., Washington, DC 20581. 

Telephone number: 202–418–5480 and 

electronic mail: jlawton@cftc.gov; 

tsmith@cftc.gov; or tdiaz@cftc.gov. 

SUPPLEMENTARY INFORMATION: 

I. Background 

A. Legislation Requiring Rulemaking for 

Margin Requirements of SDs and MSPs 

On July 21, 2010, President Obama 

signed the Dodd-Frank Act.1 Title VII of 

the Dodd-Frank Act amended the CEA 2

to establish a comprehensive regulatory 

framework to reduce risk, increase 

transparency, and promote market 

integrity within the financial system by, 

among other things: (1) Providing for the 

registration and comprehensive 

regulation of SDs and MSPs; 

(2) imposing clearing and trade 

execution requirements on standardized 

derivative products; (3) creating 

rigorous recordkeeping and real-time 

reporting regimes; and (4) enhancing the 

Commission’s rulemaking and 

enforcement authorities with respect to 

all registered entities and intermediaries 

subject to the Commission’s oversight. 

The legislative mandate to establish 

registration and regulatory requirements 

for SDs and MSPs appears in Section 

731 of the Dodd-Frank Act, which adds 

a new Section 4s to the CEA. Section 

4s(e) explicitly requires the adoption of 

rules establishing margin requirements 

for SDs and MSPs, and applies a 

bifurcated approach that requires each 

SD and MSP for which there is a 

prudential regulator to meet margin 

requirements established by the 

applicable prudential regulator, and 

each SD and MSP for which there is no 

prudential regulator to comply with 

Commission’s regulations governing 

margin. 

The term ‘‘prudential regulator’’ is 

defined in a new paragraph 39 of the 

definitions set forth in Section 1a of the 

CEA, as amended by Section 721 of the 

Dodd-Frank Act. This definition 

includes the Federal Reserve Board; the 

Office of the Comptroller of the 

Currency (‘‘OCC’’); the Federal Deposit 

Insurance Corporation (‘‘FDIC’’); the 

Farm Credit Administration; and the 

Federal Housing Finance Agency. The 

definition also specifies the entities for 

which these agencies act as prudential 

regulators, and these consist generally of 

Federally insured deposit institutions, 

farm credit banks, Federal home loan 

banks, the Federal Home Loan Mortgage 

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Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 23733 

3See 75 FR 71379 (Nov. 23, 2010). 

4As noted above, the Commission will propose 

rules related to capital and financial condition 

reporting in a separate release. 

Corporation, and the Federal National 

Mortgage Association. In the case of the 

Federal Reserve Board, it is the 

prudential regulator not only for certain 

banks, but also for bank holding 

companies and any foreign banks 

treated as bank holding companies. The 

Federal Reserve Board also is the 

prudential regulator for subsidiaries of 

these bank holding companies and 

foreign banks, but excluding their 

nonbank subsidiaries that are required 

to be registered with the Commission as 

a SD or MSP. 

In general, therefore, the Commission 

is required to establish margin 

requirements for all registered SDs and 

MSPs that are not banks, including 

nonbank subsidiaries of bank holding 

companies regulated by the Federal 

Reserve Board. In addition, certain swap 

activities currently engaged in by banks 

may be conducted in such nonbank 

subsidiaries and affiliates as a result of 

the prohibition on Federal assistance to 

swap entities under Section 716 of the 

Dodd-Frank Act. Generally, insured 

depository institutions (‘‘IDIs’’) that are 

required to register as SDs may be 

required to comply with Section 716 by 

‘‘pushing-out’’ to an affiliate all swap 

trading activities with the exception of: 

(1) The IDI’s hedging or other similar 

risk mitigating activities directly related 

to the IDI’s activities; and (2) the IDI 

acting as a SD for swaps involving rates 

or reference assets that are permissible 

for investment under banking law. 

B. Considerations for SD and MSP 

Rulemaking Specified in Section 4(s) 

Section 4s(e)(3)(A) states the need to 

offset the greater risk that swaps that are 

not cleared pose to SDs, MSPs, and the 

financial system, and directs the 

Commission, United States Securities 

and Exchange Commission (‘‘SEC’’), and 

prudential regulators to adopt capital 

and margin requirements that: (1) Help 

ensure the safety and soundness of the 

registrant; and (2) are appropriate for the 

risk associated with the uncleared 

swaps they hold. Section 4s(e)(3)(C) 

permits the use of noncash collateral, as 

the Commission and the prudential 

regulators each determines to be 

consistent with: (1) Preserving the 

financial integrity of markets trading 

swaps; and (2) preserving the stability of 

the United States financial system. 

C. Consultation With SEC and 

Prudential Regulators 

The Commission has worked closely 

with the prudential regulators and the 

SEC in designing these rules. Every 

effort has been made to be as consistent 

as possible with the rules being 

considered by the prudential 

authorities. Section 4s(e)(3)(D) of the 

CEA requires that the Commission, SEC, 

and prudential regulators (together, 

referred to as ‘‘Agencies’’) establish and 

maintain, to the maximum extent 

practicable, comparable minimum 

initial and variation margin 

requirements for SDs, MSPs, securitybased swap dealers (‘‘SSDs’’) and major 

security-based swap participants 

(‘‘MSSPs’’) (together, referred to as ‘‘swap 

registrants’’). Section 4s(e)(3)(D) also 

requires the Agencies to periodically, 

but not less frequently than annually, 

consult on minimum margin 

requirements for swap registrants. As 

directed by Dodd-Frank, and consistent 

with precedent for harmonizing where 

practicable the minimum margin 

requirements of dual registrants, staff 

from each of the Agencies has had the 

opportunity to provide oral and written 

comments on the proposal and the 

proposed regulations incorporate 

elements of the comments provided. 

D. Structure and Approach 

Consistent with the objectives set 

forth above, this release summarizes 

regulations that the Commission 

proposes in order to establish minimum 

initial and variation margin 

requirements for SDs and MSPs that are 

not banks. As noted in previous 

proposed rulemaking issued by the 

Commission, the Commission intends, 

where practicable, to consolidate 

regulations implementing Section 4s of 

CEA in a new Part 23.3 By this Federal 

Register release, the Commission is 

proposing to adopt Subpart E of Part 23, 

pertaining to the capital and margin 

requirements and related financial 

condition reporting requirements of SDs 

and MSPs.4

II. Proposed Margin Regulations 

A. Introduction 

Section 4s(e)(2)(B) of the CEA 

provides that: 

The Commission shall adopt rules for 

swap dealers and major swap 

participants, with respect to their 

activities as a swap dealer or major 

swap participant, for which there is not 

a prudential regulator imposing— 

(i) Capital requirements; and 

(ii) Both initial and variation margin 

requirements on all swaps that are not 

cleared by a registered derivatives 

clearing organization. 

Section 4s(e)(3)(A) of the CEA 

provides that: 

To offset the greater risk to the swap 

dealer or major swap participant and the 

financial system arising from the use of 

swaps that are not cleared, the 

requirements imposed under paragraph 

(2) shall 

(i) Help ensure the safety and 

soundness of the swap dealer or major 

swap participant; and 

(ii) Be appropriate for the risk 

associated with the non-cleared swaps. 

During the recent financial crisis, 

derivatives clearing organizations 

(‘‘DCOs’’) met all their obligations 

without any financial infusions from the 

government. By contrast, significant 

sums were expended as the result of 

losses incurred in connection with 

uncleared swaps, most notably at AIG. 

A key reason for this difference is that 

DCOs all use variation margin and 

initial margin as the centerpiece of their 

risk management programs while these 

tools were often not used in connection 

with uncleared swaps. Consequently, in 

designing the proposed margin rules for 

uncleared swaps, the Commission has 

built upon the sound practices for risk 

management employed by central 

counterparties for decades. 

Variation margin entails marking 

open positions to their current market 

value each day and transferring funds 

between the parties to reflect any 

change in value since the previous time 

the positions were marked. This process 

prevents losses from accumulating over 

time and thereby reduces both the 

chance of default and the size of any 

default should one occur. 

Initial margin serves as a performance 

bond against potential future losses. If a 

party fails to meet its obligation to pay 

variation margin, resulting in a default, 

the other party may use initial margin 

to cover most or all of any loss based on 

the need to replace the open position. 

Well-designed margin systems protect 

both parties to a trade as well as the 

overall financial system. They serve 

both as a check on risk-taking that might 

exceed a party’s financial capacity and 

as a resource that can limit losses when 

there is a failure. 

The statutory provisions cited above 

reflect Congressional recognition that (i) 

margin is an essential risk-management 

tool and (ii) uncleared swaps pose 

greater risks than cleared swaps. In 

particular, it is noteworthy that Section 

4s(e)(2)(B)(ii) requires both variation 

margin and initial margin for SDs and 

MSPs on all uncleared swaps and that 

Section 4s(e)(3)(A) explicitly refers to 

the greater risk of uncleared swaps. In 

addition to the disciplines of regular 

collection of initial and variation margin 

previously mentioned, central clearing 

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23734 Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 

5The Commission anticipates that the prudential 

regulators will publicly post their proposed rules on 

their Web sites, see, e.g., http://www.fdic.gov/. 

6Swap Trading Relationship Documentation 

Requirements for Swap Dealers and Major Swap 

Participants, 76 FR 6715 (Feb. 8, 2011). 

7 Id. 

8See Regulations Establishing and Governing the 

Duties of Swap Dealers and Major Swap 

Participants, 75 FR 71397, 71405 (Nov. 23, 2010). 

provides additional means of risk 

mitigation. 

First, unlike an SD or MSP, a DCO is 

not in the business of taking positions 

in the market. By definition, a DCO runs 

a perfectly matched book. Second, a 

DCO only deals with members who 

must meet certain financial, risk 

management, and operational standards. 

Third, a DCO may turn to those 

members to help liquidate or transfer 

open positions in the event of a member 

default. Fourth, DCOs typically, by rule, 

have the ability to mutualize a portion 

of the tail risk associated with a clearing 

member default through the use of 

guarantee funds and similar 

mechanisms. 

Concern has been expressed that the 

imposition of margin requirements on 

uncleared swaps will be very costly for 

SDs and MSPs. However, margin has 

been, and will continue to be, required 

for all cleared products. Given the 

Congressional reference to the ‘‘greater 

risk’’ of uncleared swaps and the 

requirement that margin for such swaps 

‘‘be appropriate for the risk,’’ the 

Commission believes that establishing 

margin requirements for uncleared 

swaps that are at least as stringent as 

those for cleared swaps is necessary to 

fulfill the statutory mandate. Within 

these statutory bounds the Commission 

has endeavored to limit costs 

appropriately. For example, as 

discussed below, the proposal would 

permit margin reductions for positions 

with offsetting risk characteristics. 

The proposals set forth below were 

developed in consultation with the 

prudential regulators. They are 

consistent in almost all material 

respects with provisions that the 

Commission understands are being 

proposed by the prudential regulators.5

Salient differences will be noted below. 

The discussion below addresses: 

(i) The products covered by the 

proposed rules; (ii) the market 

participants covered by the proposed 

rules; (iii) permissible methods of 

calculating initial margin; (iv) 

permissible methods of calculating 

variation margin; (v) permissible margin 

assets; and (vi) permissible custodial 

arrangements. 

B. Products 

The proposal would cover only swaps 

executed after the effective date of the 

regulation that are not cleared by a DCO. 

The proposal would not apply to swaps 

executed before the effective date of the 

final regulation. The Commission 

believes that the pricing of existing 

swaps reflects the credit arrangements 

under which they were executed and 

that it would be unfair to the parties and 

disruptive to the markets to require that 

the new margin rules apply to those 

positions. However, the Commission 

requests comment on whether SDs and 

MSPs should be permitted voluntarily 

to include pre-effective date swaps in 

portfolios margined pursuant to the 

proposed rules. The Commission also 

anticipates that existing positions would 

be taken into account under the capital 

rule to be proposed at a later date. 

The Commission also wishes to 

emphasize that the proposal does not 

apply to forward contracts. Under the 

CEA, the CFTC does not regulate 

forward contracts. Accordingly, the 

Commission believes that the 

requirements of Section 4s(e) do not 

apply to forward contracts. 

C. Market Participants 

1. Overview 

The proposed regulations would 

impose requirements on SDs and MSPs 

for which there is no prudential 

regulator (‘‘covered swap entities’’ or 

‘‘CSEs’’). Because different types of 

counterparties may pose different levels 

of risk, the requirements would vary in 

some respects depending on the 

category of counterparty. The proposed 

regulations would not impose margin 

requirements on non-financial end 

users. 

Proposed § 23.151 would require each 

CSE to execute documentation regarding 

credit support arrangements that is 

consistent with the requirements of 

these rules with each counterparty. The 

documentation would specify in 

advance material terms such as how 

margin would be calculated, what types 

of assets would be permitted to be 

posted, what margin thresholds, if any, 

would apply, and where margin would 

be held. This provision is consistent 

with the documentation requirement 

recently proposed by the Commission as 

§ 23.504.6 Having comprehensive 

documentation in advance concerning 

these matters would allow each party to 

a swap to manage its risks more 

effectively throughout the life of the 

swap and to avoid disputes regarding 

issues such as valuation. The 

Commission solicits comment regarding 

whether it should require SDs and MSPs 

to document the procedures by which 

any disputes concerning the valuation 

of a swap or the valuation of assets 

collected or posted as initial or variation 

margin may be resolved. 

Under rules being proposed by the 

prudential regulators for SDs and MSPs 

that are banks, the parties are allowed 

to make particular variation margin 

calculations pursuant to a qualifying 

master netting agreement. The 

Commission understands that this term 

will be defined under rules proposed by 

the prudential regulators to mean a 

legally enforceable agreement to offset 

positive and negative mark-to-market 

values of one or more swaps or securitybased swaps that meet a number of 

specific criteria designed to ensure that 

these offset rights are fully enforceable, 

documented, and monitored by the 

covered swap entity. 

As noted, the Commission has 

previously proposed § 23.504, which 

requires SDs and MSPs to have swap 

trading relationship documentation 

with each counterparty. Under proposed 

§ 23.504(b)(1), this documentation ‘‘shall 

be in writing and shall include all terms 

governing the trading relationship 

between the swap dealer or major swap 

participant and its counterparty, 

including, without limitation, terms 

addressing payment obligations, netting 

of payments, events of default or other 

termination events, calculation and 

netting of obligations upon termination, 

transfer of rights and obligations, 

governing law, valuation, and dispute 

resolution procedures.’’ 7

Under proposed § 23.600(c)(4)(v)(A), 

SDs and MSPs would be required to 

have risk management policies and 

procedures addressing legal risks 

associated with their business as swap 

dealers or major swap participants, 

including risks associated with 

‘‘determinations that transactions and 

netting arrangements entered into have 

a sound legal basis.’’ 8 Taken together, it 

is the Commission’s belief that all SDs 

and MSPs entering into trading 

relationship documentation with their 

counterparties would be required to 

have a sound legal basis to determine 

that such agreements will be enforceable 

in accordance with their terms. 

The Commission solicits comment 

regarding whether proposed §§ 23.501 

and 23.600 are sufficient to ensure that 

SDs and MSPs have a sound legal basis 

for their swap documentation or 

whether the Commission should adopt 

the concept of ‘‘qualifying master netting 

agreements’’ from existing banking 

regulations. 

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Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 23735 

9 In previously proposed rules, execution has 

been defined to mean, ‘‘with respect to a swap 

transaction, an agreement by the counterparties 

(whether orally, in writing, electronically, or 

otherwise) to the terms of the swap transaction that 

legally binds the counterparties to such terms under 

applicable law.’’ Confirmation, Portfolio 

Reconciliation, and Portfolio Compression 

Requirements for Swap Dealers and Major Swap 

Participants, 75 FR 81519, 81530 (Dec. 28, 2010). 

Additionally, swap transaction has been defined to 

mean ‘‘any event that results in a new swap or in 

a change to the terms of a swap, including 

execution, termination, assignment, novation, 

exchange, transfer, amendment, conveyance, or 

extinguishing of rights or obligations of a swap.’’ Id. 

at 81531. 

10The use of the term ‘‘liquidated’’ in this context 

should be construed to include all ownership 

events related to that swap, including expiration or 

maturation. 

2. Positions Between CSEs and Other 

SDs or MSPs 

Proposed § 23.152 addresses initial 

margin and variation margin 

requirements for positions of CSEs with 

other SDs or MSPs. (The latter would 

include both SD/MSPs that are CSEs 

and SD/MSPs for which there is a 

prudential regulator.) The regulation 

would require CSEs to collect initial 

margin for every uncleared swap with 

another SD or MSP on or before the date 

of execution of the swap.9 The proposed 

rule would require the CSEs to maintain 

initial margin from its counterparty 

equal to or greater than an amount 

calculated pursuant to proposed 

§ 23.155, discussed below, until the 

swap is liquidated.10 The credit support 

arrangements between a CSE and its 

counterparty would be prohibited from 

containing a threshold below which the 

CSE was not required to post initial 

margin, i.e., zero thresholds would be 

required. 

(In order to reduce transaction costs, 

proposed § 23.150 would establish a 

‘‘minimum transfer amount’’ of 

$100,000. Initial and variation margin 

payments would not be required to be 

made if below that amount. This 

amount was selected in consultation 

with the prudential regulators. It 

represents an amount sufficiently small 

that the level of risk reduction might not 

be worth the transaction costs of moving 

the money. It only affects the timing of 

collection; it does not change the 

amount of margin that must be collected 

once the $100,000 level is exceeded.) 

CSEs also would be required to collect 

variation margin for all trades with 

another SD or MSP. Again, zero 

thresholds would be required, and the 

obligation would continue on each 

business day until the swap is 

liquidated. The proposal contains a 

provision stating that a CSE would not 

be deemed to have violated its 

obligation to collect variation margin if 

it took certain steps. Specifically, if a 

counterparty failed to pay the required 

variation margin to the CSE, the CSE 

would be required to make the 

necessary efforts to attempt to collect 

the variation margin, including the 

timely initiation and continued pursuit 

of formal dispute resolution 

mechanisms, or otherwise demonstrate 

upon request to the satisfaction of the 

Commission that it has made 

appropriate efforts to collect the 

required variation margin or 

commenced termination of the swap. 

It is the nature of the dealer business 

that dealers are at the center of the 

markets in which they participate. 

Similarly, a major swap participant, by 

its terms, is a significant trader. 

Collectively, SDs and MSPs pose greater 

risk to the markets and the financial 

system than other swap market 

participants. Accordingly, under the 

mandate of Section 4s(e), the 

Commission believes that they should 

be required to collect margin from one 

another. 

3. Positions Between CSEs and 

Financial Entities 

Proposed § 23.153 addresses initial 

margin and variation margin 

requirements for positions between 

CSEs and financial entities. Proposed 

§ 23.150 would define a financial entity 

as a counterparty that is not an SD or 

MSP and that is either: (i) A commodity 

pool as defined in Section 1a(5) of the 

Act; (ii) a private fund as defined in 

Section 202(a) of the Investment 

Advisors Act of 1940; (iii) an employee 

benefit plan as defined in paragraphs (3) 

and (32) of section 3 of the Employee 

Retirement Income and Security Act of 

1974; (iv) a person 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 

Company Act of 1956; (v) a person that 

would be a financial entity described in 

(i) or (ii) if it were organized under the 

laws of the United States or any State 

thereof; (vi) the government of any 

foreign country or a political 

subdivision, agency, or instrumentality 

thereof; or (vii) any other person the 

Commission may designate. With three 

modifications discussed below, this 

definition tracks the definition in 

Section 2(h)(7)(C) of the Act that is used 

in connection with an exception from 

any applicable clearing mandate. 

Item (v) of the proposed definition 

adds entities that would be a 

commodity pool or private fund if 

organized in the United States. The 

Commission believes that such entities 

would pose similar risks to those of 

similar entities located within the 

United States. 

Item (vi) of the proposed definition 

adds any government of any foreign 

country or any political subdivision, 

agency, or instrumentality thereof. The 

Commission notes that these types of 

sovereign counterparties do not fit 

easily into the proposed rule’s 

categories of financial and nonfinancial 

entities. In comparing the characteristics 

of sovereign counterparties with those 

of financial and nonfinancial entities, 

the Commission preliminarily believes 

that the financial condition of a 

sovereign will tend to be closely linked 

with the financial condition of its 

domestic banking system, through 

common effects of the business cycle on 

both government finances and bank 

losses, as well as through the safety net 

that many sovereigns provide to banks. 

Such a tight link with the health of its 

domestic banking system, and by 

extension with the broader global 

financial system, makes a sovereign 

counterparty similar to a financial entity 

both in the nature of the systemic risk 

and the risk to the safety and soundness 

of the covered swap entity. As a result, 

the Commission preliminarily believes 

that sovereign counterparties should be 

treated as financial entities for purposes 

of the proposed rule’s margin 

requirements. 

Item (vii) in the proposed definition 

permits the Commission to designate 

additional entities as financial entities. 

The Commission understands that the 

prudential regulators are proposing the 

same provision. This would enable 

regulators to accomplish the purposes of 

Section 4s in circumstances where they 

identify additional entities whose 

activities and risk profile warrant 

inclusion. The Commission solicits 

comment on whether these entities are 

appropriate, whether additional entities 

should be designated as financial 

entities, and what criteria should be 

applicable. 

The Commission believes that 

financial entities, which generally are 

not using swaps to hedge or mitigate 

commercial risk, potentially pose 

greater risk to CSEs than non-financial 

entities. Accordingly, if a CSE chooses 

to expose itself to such risk, it should 

take steps to mitigate such risks. 

Initial margin would be required to be 

collected by CSEs for every trade with 

a financial entity on or before the date 

of execution of the swap. The proposed 

rule would require the CSEs to maintain 

initial margin from its counterparty 

equal to or greater than an amount 

calculated pursuant to proposed 

§ 23.155, discussed below, until the 

swap is liquidated. 

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23736 Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 

11The prudential regulators proposed rulemaking 

refers to these financial entities as ‘‘low-risk’’ 

financial entities based on the relative risk posed by 

the type of counterparty. 

12Significant swap exposure is defined by 

reference to rules previously proposed by the 

Commission. See Further Definition of ‘‘Swap 

Dealer,’’ ‘‘Security-Based Swap Dealer,’’ ‘‘Major 

Swap Participant,’’ ‘‘Major Security-Based Swap 

Participant’’ and ‘‘Eligible Contract Participant’’ 75 

FR 80174 (Dec. 21, 2010). 

13Letter from Chairman Debbie Stabenow, 

Committee on Agriculture, Nutrition and Forestry, 

U.S. Senate, Chairman Frank D. Lucas, Committee 

on Agriculture, United States House of 

Representatives, Chairman Tim Johnson, Committee 

on Banking, Housing, and Urban Affairs, U.S. 

Senate, and Chairman Spencer Bachus, Committee 

on Financial Services, United States House of 

Representatives to Secretary Timothy Geithner, 

Department of Treasury, Chairman Gary Gensler, 

U.S. Commodity Futures Trading Commission, 

Chairman Ben Bernanke, Federal Reserve Board, 

and Chairman Mary Shapiro, U.S. Securities and 

Exchange Commission (April 6, 2011); Letter from 

Chairman Christopher Dodd, Committee on 

Banking, Housing, and Urban Affairs, U.S. Senate, 

and Chairman Blanche Lincoln, Committee on 

Agriculture, Nutrition, and Forestry, U.S. Senate, to 

Chairman Barney Frank, Financial Services 

Committee, United States House of Representatives, 

and Chairman Collin Peterson, Committee on 

Agriculture, United States House of Representatives 

(June 30, 2010); see also 156 Cong. Rec. S5904 

(daily ed. July 15, 2010) (statement of Sen. Lincoln) 

14Swap Trading Relationship Documentation 

Requirements for Swap Dealers and Major Swap 

Participants, 76 FR 6715 (Feb. 8, 2011). 

Zero thresholds would be required 

except for certain financial entities 11

that: (i) Are subject to capital 

requirements established by a 

prudential regulator or a State insurance 

regulator; (ii) predominantly use swaps 

to hedge; and (iii) do not have 

significant swaps exposure.12 The 

proposal set forth ranges within which 

the threshold would fall. These 

eligibility standards and ranges were 

established in consultation with the 

prudential regulators. 

The Commission solicits comment on 

whether thresholds should be permitted 

at all, and if so, what entities should be 

eligible, and at what level they should 

be set. If the Commission determines to 

permit thresholds, it anticipates that the 

final rule would establish a single level 

rather than a range. 

Similarly, variation margin would 

also be required to be collected by CSEs 

on all transactions with a financial 

entity. Zero thresholds would be 

required with the same exception 

discussed above for initial margin. Any 

applicable thresholds for initial and 

variation margin would be separate and 

therefore could be cumulative. The 

obligation would continue on each 

business day until the swap is 

liquidated. 

The Commission notes that under the 

proposed rule each CSE would be 

required to collect variation margin 

from financial entities but would not be 

required to pay variation margin to 

them. This approach is consistent with 

what the prudential regulators are 

proposing in their margin rules. The 

rationale is that when an SD pays 

variation margin to an financial entity 

that is not subject to capital 

requirements, money is flowing from a 

regulated entity to an unregulated one. 

By following this approach in its 

proposed rules, the Commission is 

endeavoring to follow Section 

4s(e)(D)(ii)’s requirement that 

Commission regulations on margin be 

comparable to those of the prudential 

regulators ‘‘to the maximum extent 

practicable.’’ 

The Commission wishes to highlight 

and solicits comment regarding the risk 

management effects of this approach 

and its appropriateness under Section 

4s(e)(E)(3)(A) of the CEA. As noted 

above, two-way variation margin has 

been a keystone of the ability of DCOs 

to manage risk. Each day current 

exposure is removed from the market 

through the payment and collection of 

variation margin for all products and all 

participants regardless of their identity 

or financial resources. 

If two-way variation margin were not 

required for uncleared swaps between 

CSEs and financial entities, the CSE’s 

exposures may be allowed to 

accumulate. In contrast to initial 

margin, which is designed to cover 

potential future exposures, variation 

margin addresses actual current 

exposures, that is, losses that have 

already occurred. Unchecked 

accumulation of such exposures was 

one of the characteristics of the financial 

crisis which, in turn, led to the 

enactment of the Dodd-Frank Act. 

Moreover, both payment and 

collection of variation margin help 

ensure the safety and soundness of the 

swap dealer or major swap participant. 

Daily collection helps the safety and 

soundness of the CSE by removing 

current exposure from each 

counterparty. But daily payment also 

helps safety and soundness by 

preventing the CSE from building up 

exposures that it cannot fulfill. 

Finally, two-way variation would 

address the risk associated with the 

non-cleared swaps held as a swap dealer 

or major swap participant. Uncleared 

swaps are likely to be more customized 

and consequently trade in a less liquid 

market than cleared swaps. As a result, 

uncleared swaps might take a longer 

time and require a greater price 

premium to be liquidated than cleared 

swaps, particularly in a distressed 

market conditions. Failure to remove 

current exposures in advance of such a 

situation through daily, two-way 

variation margin could exacerbate any 

losses in the event of a SD or MSP 

default. 

Accordingly, in addition to requesting 

comment on the proposed requirement 

for collection of variation margin set 

forth below as 23.153(b)(1), the 

Commission also requests comment on 

whether it should adopt an additional 

provision as follows: 

For each uncleared swap between a 

covered swap entity and a financial entity, 

each covered swap entity shall pay variation 

margin as calculated pursuant to § 23.156 of 

this part directly to the financial entity or to 

a custodian selected pursuant to § 23.158 of 

this part. Such payments shall start on the 

business day after the swap is executed and 

continue each business day until the swap is 

liquidated. 

Many of the considerations discussed 

above also might apply to two-way 

initial margin. The Commission solicits 

comments on whether two-way initial 

margin is appropriate for transactions 

between CSEs and financial entities. 

4. Positions Between CSEs and Nonfinancial Entities 

The proposal would not impose 

margin requirements on non-financial 

entities. Proposed § 23.150 would define 

a non-financial entity as a counterparty 

that is not a swap dealer, a major swap 

participant, or a financial entity. The 

Commission believes that such entities, 

which are using swaps to hedge 

commercial risk, pose less risk to CSEs 

than financial entities. Consistent with 

Congressional intent,13 the proposal 

would not impose margin requirements 

on such positions. 

The proposal would require that CSEs 

have credit support arrangements in 

place consistent with proposed 

§ 23.504.14 This would ‘‘help ensure the 

safety and soundness of the swap dealer 

or major swap participant’’ by providing 

clarity as its rights and obligations. The 

proposal would not dictate the terms of 

any margin arrangements other than 

stating that each covered swap entity 

may accept as margin from nonfinancial entities only assets for which 

the value is reasonably ascertainable on 

a periodic basis in a manner agreed to 

by the parties in the credit support 

arrangements. 

The parties would be free to set initial 

margin and variation margin 

requirements in their discretion and any 

thresholds agreed upon by the parties 

would be permitted. The proposal 

would require that CSEs pay and collect 

initial margin and variation margin as 

set forth in their agreements with their 

counterparties. The Commission 

understands that the proposal differs 

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Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 23737 

15This is consistent with the requirement set 

forth in Section 4s(h)(3)(B)(iii)(II) that SDs and 

MSPs must disclose to counterparties who are not 

SDs or MSPs a daily mark for uncleared swaps. 

from the proposal of the prudential 

regulators which would require that 

CSEs collect variation margin from nonfinancial entities at least once per week, 

if applicable thresholds were exceeded. 

The proposal would require each CSE 

to calculate hypothetical initial and 

variation margin amounts each day for 

positions held by non-financial entities. 

That is, the CSE must calculate what the 

margin amounts would be if the 

counterparty were another SD or MSP.15

These calculations would serve as risk 

management tools that would assist the 

CSE in measuring its exposure. 

Moreover, they would likely be 

necessary for CSEs in computing any 

capital requirements that might be 

applicable. 

D. Calculation of Initial Margin 

Proposed § 23.155 addresses how 

initial margin should be calculated. 

Models meeting specified standards 

would be permissible. If no model 

meeting the standards of the rule is 

available, the CSE would set margin in 

accordance with an alternative approach 

described below. 

1. Models 

Proposed § 23.155(b) sets forth 

requirements for models. Under 

proposed § 23.155(b)(1), the following 

would be eligible: (i) A model currently 

in use for margining cleared swaps by 

a DCO, (ii) a model currently in use for 

margining uncleared swaps by an entity 

subject to regular assessment by a 

prudential regulator, or (iii) a model 

available for licensing to any market 

participant by a vendor. Unlike the 

banking institutions that will be 

overseen by the prudential regulators, 

the CSEs subject to the Commissions 

regulations may not have proprietary 

models. Moreover, given current budget 

constraints, the Commission does not 

have the resources to review numerous 

models individually. Accordingly, at 

this time, the Commission is proposing 

to permit the use of certain nonproprietary models. The proposal, 

however, also contains a provision 

which would permit the Commission to 

issue an order that would allow the use 

of proprietary models in the future 

should the Commission obtain sufficient 

resources. 

This is an aspect of the proposal that 

differs from the prudential regulators’ 

approach. Because many banks already 

have proprietary models, and because 

the prudential regulators have the 

resources to review individual 

proprietary models, the prudential 

regulators would not permit the use of 

DCO models or the use of models 

licensed to market participants. The 

Commission solicits comment on the 

feasibility of the use of DCO models or 

third party models by CSEs for 

margining uncleared swaps. 

Proposed § 23.155(b)(2) further 

requires that a model meet specified 

standards. The following are some of the 

elements that would be required in a 

model: 

• The valuation of a swap must take 

into account all significant, identifiable 

risk factors, including any non-linear 

risk characteristics; 

• The valuation of a swap must be 

based on pricing sources that are 

accurate and reliable; 

• The model must set margin to cover 

at least 99% of price changes by product 

and by portfolio over at least a 10-day 

liquidation horizon; 

• The model must be validated by an 

independent third party before being 

used and annually thereafter; 

• The swap dealer or major swap 

participant must conduct back testing 

and stress testing of the model on a 

regular basis; and 

• If the swap product is also offered 

for non-mandatory clearing by a 

registered DCO, the initial margin 

collected may not be less than the initial 

margin required by the DCO. 

Parties could add individualized credit 

surcharges to the margin amount 

produced by the model. 

These standards are consistent with 

the standards that the Commission 

understands that the prudential 

regulators are proposing. They are also 

similar to the standards the Commission 

has used in evaluating DCO margin 

models, and that prudential regulators 

have used in assessing bank margin 

models. 

Proposed § 23.155(b)(3) would require 

that models be filed with the 

Commission. The filing would include a 

complete explanation of: 

• The manner in which the model 

meets the requirements of this section; 

• The mechanics of the model; 

• The theoretical basis of the model; 

• The empirical support for the 

model; and 

• Any independent third party 

validation of the model. 

Under proposed § 23.155(b)(4), the 

Commission could approve or deny the 

application by an SD or MSP to use an 

initial margin model, or approve an 

amendment to the application, in whole 

or in part, subject to any conditions or 

limitations the Commission may 

require, if the Commission finds the 

approval to be necessary or appropriate 

in the public interest after determining, 

among other things, whether the 

applicant had met the requirements of 

the section and was in compliance with 

other applicable rules promulgated 

under the Act and by self-regulatory 

organizations. 

Under proposed § 23.155(b)(4), the 

Commission also could at any time 

require a CSE to provide further data or 

analysis concerning the amount of 

initial margin required or on deposit. In 

addition, the Commission could at any 

time require a CSE to modify the model 

to address potential vulnerabilities. 

These measures are designed to be 

prudent safeguards to be used to address 

weaknesses that may only become 

apparent over time. 

2. Alternative Method 

Proposed § 23.155(c) provides that if a 

model meeting the standards of the rule 

is not used, margin must be calculated 

in accordance with a specified 

alternative method. The Commission 

determined that a potentially effective 

way to measure the risk of uncleared 

swaps in cases where models were 

unavailable would be to base the margin 

requirements on the margin 

requirements for related cleared 

products. 

Proposed § 23.155(c)(1) provides that 

the CSE identify in the credit support 

arrangements the swap cleared by a 

DCO in the same asset class as the 

uncleared swap for which the terms and 

conditions most closely approximate the 

terms and conditions of the uncleared 

swap. If there is no cleared swap whose 

terms and conditions closely 

approximate the uncleared swap, the 

swap dealer or major swap participant 

must identify in the credit support 

arrangements the futures contract 

cleared by a DCO in the same asset class 

as the uncleared swap which most 

closely approximates the uncleared 

swap and would be most likely to be 

used to hedge the uncleared swap. 

The CSE would ascertain the margin 

the DCO would require for the position. 

The CSE would then multiply the 

amount for a cleared swap by 2.0 in 

order to determine the margin required 

for the uncleared swap or multiply the 

amount for a cleared futures contract by 

4.4 in order to determine the margin 

required for the uncleared swap. 

The multiplier is calculated by 

comparing the anticipated liquidation 

time horizon for the cleared product to 

the anticipated liquidation time horizon 

for the uncleared swap and then 

applying several add-ons for additional 

risk factors. To illustrate, typically, a 

cleared futures contract is margined 

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23738 Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 

16 In rules the Commission previously proposed 

for DCOs, cleared swaps traded on a swap 

execution facility or executed bilaterally would be 

subject to a minimum five-day liquidation period 

for purposes of calculating initial margin, whereas 

swaps traded on a designated contract market may 

be subject to a minimum one-day requirement. Risk 

Management Requirements for Derivatives Clearing 

Organizations, 76 FR 3698, 3704–05 (Jan. 20, 2011). 

To the extent that a cleared swap was subject to the 

one-day requirement, the appropriate multiplier 

would be the same as the futures multiplier. 

17Swap Trading Relationship Documentation 

Requirements for Swap Dealers and Major Swap 

Participants, 76 FR 6715 (Feb. 8, 2011). 

using a one-day liquidation time period, 

while under the proposal, an uncleared 

swap would be margined using a 10-day 

period. A standard way to measure the 

increase in risk over the longer period 

is to multiply the margin for the shorter 

period by the square root of the longer 

period. The square root of 10 is 3.162. 

The proposal would increase this 

number to address several additional 

risks. A 10% cushion would be added 

to reflect that a 10-day period may be 

insufficient for some customized 

products. An additional 10% cushion 

would be added to reflect that the 

square root method assumes a normal 

distribution of prices which might not 

be true for customized products. An 

additional 20% cushion would be 

added to reflect the basis risk between 

the cleared and uncleared products. 

Taking into account these add-ons 

yields a total multiplier of 4.4. 

A similar calculation for cleared 

swaps yields a multiplier of 2.0. The 

margin for cleared swaps generally 

would be higher than the margin for 

cleared futures because cleared swaps 

generally would be subject to a 5-day 

liquidation time.16 The greater 

similarity in the anticipated liquidation 

time results in a smaller multiplier 

when comparing uncleared swaps to 

cleared swaps than when comparing 

uncleared swaps to cleared futures. 

This alternative model is another 

aspect of the proposal that differs from 

the prudential regulators’ approach. 

Their alternative uses percentages of 

notional value. The Commission 

considered using a similar approach but 

recognized that the use of notional 

percentages is an imprecise measure 

that does not capture the nuances of risk 

and it appeared to be more appropriate 

to base initial margins for uncleared 

swaps on those required by DCOs for 

similar cleared swaps. The Commission 

invites comment on the relative merits 

of the two alternative approaches. In 

this regard, the Commission requests 

comment on the appropriateness of the 

levels of initial margin set forth in the 

prudential regulators’ alternative 

approach. 

Proposed § 23.155(c)(2) addresses 

portfolio offsets for swaps with 

correlated risk profiles under the 

alternative method. Again, the proposal 

is conservative. Reductions in margin 

based on offsetting risk characteristics of 

products would not be permitted across 

asset classes except between currencies 

and interest rates. Any reductions in 

margin based on offsetting risk 

characteristics of products within an 

asset class must have a sound 

theoretical basis and significant 

empirical support. No reduction may 

exceed 50% of the amount that would 

be required for the swap in the absence 

of a reduction. 

Proposed § 23.155(c)(3) provides for 

modifications for particular products or 

positions. Each CSE would be required 

to monitor the coverage provided by 

margin established pursuant to this 

paragraph (c) and collect additional 

margin if appropriate to address the risk 

posed by particular products or 

positions. 

Under proposed § 23.155(c)(4), the 

Commission could at any time require 

the CSE to post or collect additional 

margin because of additional risk posed 

by a particular product. Furthermore, 

the Commission could at any time 

require a CSE to post or collect 

additional margin because of additional 

risk posed by a particular party to the 

swap. For example, if the Commission 

were to learn that a particular 

counterparty was experiencing financial 

difficulty, it might need to take steps to 

ensure that the CSE held margin 

appropriate for the risk associated with 

the position. These measures are 

designed to be prudent safeguards 

similar to those discussed above. 

E. Calculation of Variation Margin 

Proposed § 23.156 addresses how 

variation margin should be calculated. 

Proposed § 23.156(b) sets forth several 

requirements. The valuation of each 

swap must be determined pursuant to a 

method agreed upon by the parties in 

the credit support arrangements. It must 

be consistent with the requirements set 

forth in proposed Section 23.504(b) of 

this part.17 It must be set forth with 

sufficient specificity to allow the 

counterparty, the Commission, and any 

applicable prudential regulator to 

calculate the requirement 

independently. 

Under proposed § 23.155(c), the 

Commission could at any time require 

the CSE to provide further data or 

analysis concerning the methodology. 

Furthermore, the Commission could at 

any time require a CSE to modify the 

methodology to address potential 

vulnerabilities. These measures are 

designed to be prudent safeguards to be 

used to address weaknesses that may 

only become apparent over time. 

As noted above, the Commission 

previously proposed § 23.504(b)(4), 

which would require that the swap 

trading documentation include written 

documentation in which the parties 

agree on the methods, procedures, rules 

and inputs for determining the value of 

each swap at any time from execution 

to the termination, maturity, or 

expiration of the swap. The agreed 

methods, procedures, rules and inputs 

would be required to constitute a 

complete and independently verifiable 

methodology for valuing each swap 

entered into between the parties. 

Proposed § 23.504(b)(4)(iii) would 

require that the methodology include 

complete alternative methods for 

determining the value of the swap in the 

event that one or more inputs to the 

methodology become unavailable or fail, 

such as during times of market stress or 

illiquidity. The provisions proposed in 

this release are intended together with 

those previously proposed rules to 

ensure that all swap positions are 

accurately and reliably marked to 

market and all valuation disputes are 

resolved in a timely manner, thereby 

reducing risk. 

F. Forms of Margin 

Proposed § 23.157 addresses the types 

of assets that would be acceptable as 

margin in transactions involving CSEs. 

There are differences between initial 

margin and variation margin and within 

each category depending on 

counterparties. 

1. Initial Margin 

Proposed § 23.157(a)(2) provides that 

CSEs may only accept as initial margin 

from SDs, MSPs, or financial entities, 

the following assets: 

• Immediately available cash funds 

denominated in U.S. dollars or the 

currency in which payment obligations 

under the swap are required to be 

settled; 

• Any obligation which is a direct 

obligation of, or fully guaranteed as to 

principal and interest by, the United 

States or an agency of the United States; 

or 

• Any senior debt obligation of the 

Federal National Mortgage Association, 

the Federal Home Loan Mortgage 

Corporation, a Federal Home Loan 

Bank, the Federal Agricultural Mortgage 

Corporation, or any obligation that is an 

‘‘insured obligation,’’ as that term is 

defined in 12 U.S.C. 2277a(3), of a Farm 

Credit System bank. 

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Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 23739 

18Protection of Collateral of Counterparties to 

Uncleared Swaps; Treatment of Securities in a 

Portfolio Margining Account in a Commodity 

Broker Bankruptcy, 75 FR 75432 (Dec. 3, 2010). 

These are assets for which there are 

deep and liquid markets and, therefore, 

assets that can be readily valued and 

easily liquidated. The Commission 

requests comment on whether 

additional types of assets should be 

acceptable. 

To the extent a non-financial entity 

and a CSE have agreed that the nonfinancial entity will post initial margin, 

proposed § 23.157(a)(3) provides 

flexibility for initial margin posted by 

non-financial entities with CSEs as to 

what assets are permissible. The 

standard is simply that the value of the 

asset is reasonably ascertainable on a 

periodic basis. This is in accordance 

with the statement in Section 4s(e)(3)(C) 

that the Commission permit the use of 

non-cash collateral as it determines 

consistent with preserving the financial 

integrity of the markets and preserving 

the stability of the United States 

financial system. The Commission 

understands that current market 

practice would support a periodic 

valuation of the assets used as noncash 

collateral, but solicits comment from 

market participants regarding how 

practical the requirement is. In 

particular, the Commission requests 

comment on how frequently such 

collateral could and should be valued. 

The Commission understands that 

this differs from the proposal of the 

prudential regulators. The prudential 

regulators would require CSEs to collect 

as initial margin for non-financial 

entities only the assets listed previously 

to cover any exposure above the credit 

exposure limit. 

2. Variation Margin 

Proposed § 23.157(b) would require 

that variation payments by CSEs, or 

financial entities be in cash or United 

States Treasury securities. This is 

consistent with the general purpose of 

variation margin of eliminating current 

exposure through the use of liquid, 

easily valued assets. 

To the extent a non-financial entity 

and a CSE have agreed that the nonfinancial entity will post variation 

margin, proposed § 23.157(b)(3) 

provides flexibility for variation margin 

posted by non-financial entities with 

CSEs as to what assets are permissible. 

The standard is simply that the value of 

the asset is reasonably ascertainable on 

a periodic basis. As was the case for 

initial margin, this is in accordance with 

the statement in Section 4s(e)(3)(C) that 

the Commission permit the use of noncash collateral. 

Proposed § 23.157(c) establishes 

haircuts for assets received by a CSE 

from an SD, MSP, or financial entity as 

follows: 

MARGIN VALUE RANGES FOR NON-CASH COLLATERAL

[% of market value] 

Duration (years) 

0–5 5–10 > 10 

U.S. Treasuries and Fully Guaranteed Agencies: 

Bills/Notes/Bonds/Inflation Indexed .................................................................................................. [98–100] [95–99] [94–98] 

Zero Coupon, STRIPs ...................................................................................................................... [97–99] [94–98] [90–94] 

FHFA–Regulated Institutions Obligations and Insured Obligations of FCS Banks: 

Bills/Notes/Bonds .............................................................................................................................. [96–100] [94–98] [93–97] 

Zero Coupon ..................................................................................................................................... [95–99] [93–97] [89–93] 

These haircuts were based on a 

consultation with prudential regulators 

who use them in other contexts. 

Proposed § 23.157(d) would authorize 

certain actions by the Commission 

regarding margin assets. The 

Commission could: 

• Require a CSE to provide further 

data or analysis concerning any margin 

asset posted or received; 

• Require a CSE to replace a margin 

asset posted to a counterparty with a 

different margin asset to address 

potential risks posed by the asset; 

• Require a CSE to require a 

counterparty that is an SD, MSP, or a 

financial entity to replace a margin asset 

posted with the CSE with a different 

margin asset to address potential risks 

posed by the asset; 

• Require a CSE to provide further 

data or analysis concerning margin 

haircuts; or 

• Require a CSE to modify a margin 

haircut applied to an asset received 

from an SD or MSP, or a financial entity 

to address potential risks posed by the 

asset. 

All these actions are intended to be 

methods for ensuring the safety and 

soundness of the CSE and protecting the 

financial system. 

G. Custodial Arrangements 

Proposed § 23.158 addresses custodial 

arrangements. The proposal is intended 

to safeguard margin assets. 

Under proposed § 23.158(a) each CSE 

must offer each counterparty the 

opportunity to select a custodian that is 

not affiliated with the CSE. Further, 

each CSE must hold initial margin 

received from a counterparty that is an 

SD or MSP at a custodian that is 

independent of the CSE and the 

counterparty. Similarly, a CSE that posts 

initial margin with a counterparty that 

is an SD or MSP must require the 

counterparty to hold the initial margin 

at a custodian that is independent of the 

SD or MSP and the counterparty. 

Further, the proposal would require 

that the custodian be subject to the same 

insolvency regime as the CSE. This 

would facilitate quicker recovery of 

margin assets. 

Under proposed § 23.158(b)(1) each 

CSE must specify in each custodial 

agreement that the custodian may not 

rehypothecate margin assets or reinvest 

them in assets that are not permitted 

forms of margin. Further, upon 

certification to the custodian in 

accordance with the provisions of 

23.602(b)(1) by a party that it is entitled 

to receipt of margin, the custodian must 

release margin to the certifying party.18

Under proposed § 23.158(b)(2), upon 

receipt of initial margin from a 

counterparty, no CSE may post such 

assets as margin for a swap, a securitybased swap, a commodity for future 

delivery, a security, a security futures 

product, or any other product subject to 

margin. These provisions are designed 

to prevent the same asset from being 

passed around as margin for multiple 

positions. 

Under proposed § 23.158(c), the 

Commission may at any time require a 

CSE to provide further data or analysis 

concerning any custodian. Further, the 

Commission may at any time require a 

CSE participant to move assets held on 

behalf of a counterparty to another 

custodian to address risks posed by the 

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23740 Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 

19See Regulations Establishing and Governing the 

Duties of Swap Dealers and Major Swap 

Participants, 75 FR 71397, 71404 (Nov. 23, 2010) 

(requiring that SDs and MSPs ‘‘take into account 

market, credit, liquidity, foreign currency, legal, 

operational, settlement, and any other applicable 

risks together with a description of the risk 

tolerance limits set by the swap dealer or major 

swap participant and the underlying 

methodology’’). Additionally, the risk tolerance 

limits would have to be reviewed and approved 

quarterly by senior management and annually by 

the governing body, and exceptions to risk tolerance 

limits would require prior approval of a supervisor 

in the risk management unit. 

original custodian. These provisions are 

designed to protect the assets of the 

parties to the contract. 

H. Request for Comment 

The Commission requests comment 

on all aspects of the proposed rules 

regarding margin. In particular, the 

Commission requests comment on the 

following: 

• Are proposed §§ 23.501 and 23.600 

sufficient to ensure that SDs and MSPs 

have a sound legal basis for their swap 

documentation, or should the 

Commission adopt the concept of 

‘‘qualifying master netting agreements’’ 

from existing banking regulations? 

• It is the Commission’s 

understanding that the prudential 

regulators would require SDs and MSPs 

that are banks to appropriately take into 

account and address the credit risk 

posed by the counterparty and the risks 

of uncleared swaps, and further the 

prudential authorities would require 

SDs and MSPs that are banks to enforce 

those credit limit policies, or credit 

thresholds, with regard to the banks’ 

counterparties. The Commission 

previously proposed § 23.600(c)(1),19

which would require SDs and MSPs to 

set risk tolerance limits for themselves. 

One of the critical risk limits in any risk 

management program would relate to 

credit risk. The Commission solicits 

comment regarding whether it should 

adopt a requirement, similar to the one 

proposed by the prudential authorities, 

requiring non-bank SDs and MSPs to 

enforce their credit risk limits as a 

matter of policy. 

• What effects will the proposed rules 

have on the overall liquidity of the 

financial markets? 

• Would the proposed rules have 

differing effects on liquidity by asset 

class? 

• Would the proposed rules have 

differing effects on liquidity by class of 

participant? 

• Should the Commission permit 

thresholds for either initial margin or 

variation margin? 

• If so, what standards should apply? 

• Is the proposed definition of 

financial entity appropriate? 

• Should the Commission instead 

define financial entity as a person that 

is not eligible to claim an exception 

from mandatory clearing under section 

2(h)(7) of the Act? 

• Should the Commission exercise 

authority to designate additional 

persons as financial entities? 

• If so, what standards should apply? 

• Do the definitions adequately 

identify financial entities that have 

different levels of risk? 

• Should nonfinancial entities also be 

separated according to levels of risk? 

• If so, on what basis (e.g., in a 

manner similar to the classification of 

financial entities)? 

• If so, how should the requirement 

apply differently to such nonfinancial 

entities? 

• Is the classification of sovereign 

counterparties as financial entities 

appropriate in light of the risks posed by 

these counterparties? 

• If not, what other classification 

would be appropriate, and why? 

• Should sovereign counterparties 

receive their own distinct counterparty 

classification that is different from those 

classifications in the proposed rule? 

• If so, why? 

• How should the permitted 

uncollateralized exposures to a 

sovereign counterparty differ from those 

that are allowed for financial or nonfinancial entities? 

• Is it appropriate to distinguish 

between financial and non-financial 

counterparties for the purpose of this 

risk-based approach? 

• Does the proposed rule require 

greater clarity with respect to the 

treatment of U.S. Federal, State, or 

municipal government counterparties? 

If so, how should such counterparties be 

treated? 

• Should a counterparty that is a bank 

holding company or nonbank financial 

firm subject to enhanced prudential 

standards under Section 165 of the 

Dodd-Frank Act be treated similarly to 

swap entity counterparties? 

• Should counterparties that are 

small financial institutions using 

derivatives to hedge their risks be 

treated in the same manner as nonfinancial entities for purposes of the 

margin requirements? 

• Would requiring a CSE to post 

initial margin to non-SD/MSP 

counterparties reduce systemic risk 

(e.g., by reducing leverage in the 

financial system or reducing systemic 

vulnerability to the failure of a covered 

swap entity)? 

• Are there alternatives that address 

those risks more efficiently or with 

greater transparency? 

• Would requiring a CSE to post 

initial margin to non-SD/MSP 

counterparties raise any concerns with 

respect to the safety and soundness of 

the CSE, taking into consideration the 

requirement that initial margin be 

segregated and held with a third party 

custodian? 

• Would requiring a CSE to post 

initial margin to non-SD/MSP 

counterparties remove one or more 

incentives for that CSE to choose, where 

possible, to structure a transaction so 

that it need not be cleared through a 

DCO in order to avoid pledging initial 

margin? 

• Would this approach be consistent 

with the statutory factors the 

Commission is directed to take into 

account under sections 4s of the Act? 

• Is one-way initial margin in trades 

between CSEs and financial entities 

consistent with the requirement under 

Section 4s(e) that margin requirements 

offset the greater risk arising from the 

use of swaps that are not cleared? 

• Is one-way variation margin in 

trades between CSEs and financial 

entities consistent with the requirement 

under Section 4s(e) that margin 

requirements offset the greater risk 

arising from the use of swaps that are 

not cleared? 

• Is one-way initial margin in trades 

between CSEs and financial entities 

consistent with the requirement under 

Section 4s(e) that margin requirements 

help ensure the safety and soundness of 

SDs and MSPs? 

• Is one-way variation margin in 

trades between CSEs and financial 

entities consistent with the requirement 

under Section 4s(e) that margin 

requirements help ensure the safety and 

soundness of SDs and MSPs? 

• Is one-way initial margin in trades 

between CSEs and financial entities 

consistent with the requirement under 

Section 4s(e) that margin requirements 

be appropriate for the risks associated 

with uncleared swaps? 

• Is one-way variation margin in 

trades between CSEs and financial 

entities consistent with the requirement 

under Section 4s(e) that margin 

requirements be appropriate for the 

risks associated with uncleared swaps? 

• Is one-way initial margin in trades 

between CSEs and financial entities 

consistent with the requirement under 

section 15(b) that the Commission 

endeavor to take the least 

anticompetitive means of achieving the 

objectives of the Act? 

• Is one-way variation margin in 

trades between CSEs and financial 

entities consistent with the requirement 

under section 15(b) that the Commission 

endeavor to take the least 

anticompetitive means of achieving the 

objectives of the Act? 

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Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 23741 

• If initial and variation margin are 

not required to be paid by CSEs to nonSDs/MSPs, does it create an expectation 

that a swap dealer subject to oversight 

by a prudential regulator is more 

creditworthy than other swap dealers 

because it might receive a financial 

backstop? 

• What are the bankruptcy 

implications for counterparties of SDs or 

MSPs if initial and variation margin are 

not required to be paid by CSEs to nonSDs/MSPs? 

• Is the minimum transfer amount 

appropriate? 

• Are there widely-available initial 

margin models that could be used? 

• Is the adaptation of DCO models for 

use for uncleared swaps feasible? 

• Should models approved by foreign 

regulators be permitted? 

• Should models be limited to models 

based on value-at-risk concepts, or are 

other models appropriate to measure 

initial margin? 

• If so, how should those models 

apply and be incorporated into the 

various aspects of the proposed rule? 

• To the extent that the parties’ swap 

trading relationship documentation 

would permit portfolio margining of 

swaps, should SDs and MSPs be 

permitted to include swaps executed 

prior to the effective date of these 

margin rules in their calculation of 

initial margin, provided that the parties 

would include all swaps covered by that 

documentation (i.e., they would not be 

permitted to selectively include certain 

swaps in the portfolio)? 

• Should offsetting exposures, 

diversification, and other hedging 

benefits be recognized more broadly 

across substantially dissimilar asset 

classes? 

• If so, what limits, if any, would be 

placed on the recognition of offsetting 

exposures, diversification, and other 

hedging benefits, and how could these 

be measured, monitored and validated 

on an ongoing and consistent basis 

across substantially dissimilar asset 

classes? 

• Should the minimum time horizon 

vary across swaps? For example, should 

it vary based on asset class? 

• If so, how should the horizons 

differ and what would be the basis for 

the different horizons? 

• Can initial margin models be 

calibrated to a stress period in a 

transparent and consistent manner? 

• Are there any other systemic risk 

implications of requiring that initial 

margin be calibrated to a period of 

financial stress rather than to a recent or 

normal historical period? 

• Is the proposed prudential standard 

for initial margin of a 99th percentile 

price move over a 10-day horizon, 

calibrated using historical data 

incorporating a period of significant 

financial stress, appropriate? 

• Is a 10-day horizon sufficient to 

cover the likely liquidation period on 

uncleared swaps? 

• Will the requirement to calibrate to 

a period of significant financial stress 

reduce the potential procyclicality of 

the margin requirement sufficiently? For 

example, would a minimum margin 

requirement as a backstop to the 

modeled initial margin amounts be a 

prudent approach to addressing 

procyclicality concerns? 

• Is ‘‘period of significant financial 

stress’’ a well-understood concept? How 

might it be clarified? 

• What would be the benefits and 

costs of replacing the requirement to 

calibrate the initial margin model using 

a period of significant financial stress 

with a requirement to calibrate the 

initial margin model using a longer 

historical data sample (such as 10 

years), as an alternative way to reduce 

the potential procyclicality of the 

margin requirement? 

• Should market participants be able 

to comply with the requirement to 

calibrate the initial margin requirement 

to a historical period of significant 

financial stress for newer products with 

little, if any, market history? 

• If so, how? 

• Should CSEs be required to disclose 

their models to their counterparties who 

are not SDs or MSPs? 

• How closely does the alternative 

methodology approximate risk? 

• Would a percentage of notional 

value approach be appropriate under 

any circumstances? 

• With respect to either alternative for 

calculating initial margin requirements, 

should swap positions that pose no 

counterparty risk to the covered swap 

entity, such as a sold call option with 

the full premium paid at inception of 

the trade, be excluded from the initial 

margin calculation? 

• Is the list of acceptable forms of 

margin appropriate? 

• Should the types of eligible 

collateral listed be broadened to other 

types of assets (e.g. securities backed by 

high-quality mortgages or issues with a 

third-party guarantee)? 

• If so, how might the systemic risk 

issue be effectively mitigated? 

• Should the types of eligible 

collateral listed be broadened to include 

immediately-available cash funds 

denominated in foreign currency, even 

where such currency is not the currency 

in which payment obligations under the 

swap are required to be settled? 

• If so, which currencies (e.g., those 

accepted by a derivatives clearing 

organization as initial margin for a 

cleared swap)? 

• If so, what haircut, if any, should 

apply to such foreign currency? 

• What criteria and factors could be 

used to determine the set of acceptable 

non-cash collateral? 

• How could appropriate haircuts be 

determined for valuing these assets for 

margin purposes? 

• Should the types of eligible 

collateral listed be broadened to include 

foreign sovereign debt securities? 

• If so, which foreign sovereign debt 

securities (e.g., those accepted by a 

derivatives clearing organization as 

initial margin for a cleared swap)? 

• If so, what haircut, if any, should 

apply? 

• Should fixed income securities 

issued by a well-known seasoned issuer 

that has a high credit standing, are 

unsubordinated, historically display 

low volatility, are traded in highly 

liquid markets, and have valuations that 

are readily calculated be added to the 

list of eligible collateral for initial 

margin? 

• If so, how should the concept of a 

‘‘high credit standing’’ be defined in a 

way that does not reference credit 

ratings? 

• Should there be any limits on the 

types of collateral accepted by CSEs 

from non-financial entities? 

• The proposal states that each 

covered swap entity shall accept as 

margin from non-financial entities only 

assets for which the value is reasonably 

ascertainable on a periodic basis in a 

manner agreed to by the parties in the 

credit support arrangements. Should the 

Commission be more specific with 

regard to how non-traditional collateral 

should be valued? 

• Should the Commission be more 

specific with regard to how frequently 

margin assets should be valued? 

• Is the table of haircuts appropriate? 

• Are the proposed custodial 

arrangements appropriate? 

• Is it necessary to require segregation 

of initial margin in order to address the 

systemic risk issues discussed above? 

• What alternatives to segregation 

would effectively address these 

systemic risk issues? 

• What are the potential operational, 

liquidity and credit costs of requiring 

segregation of initial margin by swap 

entities? 

• What would be the expected 

liquidity impact and cost of the 

proposed segregation requirement on 

market participants? 

• How can the impact of the proposed 

rule on the liquidity and costs of swaps 

market participants be mitigated? 

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23742 Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 

20 5 U.S.C. 601 et seq. 

21 47 FR 18618 (Apr. 30, 1982). 

22 Id. at 18619. 

23 Id. 

24 Id. at 18620. 

25 44 U.S.C. 3501 et seq. 

26 7 U.S.C. 19(a). 

• Are the limitations placed on 

rehypothecation and reinvestment 

under the proposed rule appropriate or 

necessary? 

• Would additional or alternative 

limitations be appropriate? 

• Should certain forms of 

rehypothecation (e.g., the lending of 

securities pledged as collateral) or 

additional types of reinvestment be 

permitted? 

• Is the proposed rule’s requirement 

that the custodian must be located in a 

jurisdiction that applies the same 

insolvency regime to the custodian as 

would apply to the covered swap entity 

necessary or appropriate? 

• Would additional or alternative 

requirements regarding the location of 

the custodian be appropriate? 

• Are there circumstances where 

rehypothecation should be permitted? 

• What role could self-regulatory 

organizations play in overseeing 

compliance with the proposed 

regulations? 

• In designing these rules, the 

Commission has taken care to minimize 

the burden on those parties that will not 

be registered with the Commission as 

SDs and MSPs. To the extent that 

market participants believe that 

additional measures should be taken to 

reduce the burden or increase the 

benefits of documenting swap 

transactions, the Commission welcomes 

all comments. 

• Pursuant to Section 716, certain 

‘‘push-out’’ entities might initially be 

subject to the margin rules of the 

prudential regulators, but by July of 

2013 would come under the margin 

rules of the Commission. The 

Commission requests comment on what 

steps would be appropriate to facilitate 

a smooth transition for such entities and 

their counterparties. 

• The Commission recognizes that 

there will be differences in the size and 

scope of the business of particular SDs 

and MSPs. Therefore, comments are 

solicited on whether certain provisions 

of the proposed regulations should be 

modified or adjusted to reflect the 

differences among SDs and MSPs or 

differences among asset classes. 

• How long would SDs and MSPs 

require to come into compliance with 

the proposed rules? Will compliance 

take less time for swaps between such 

registrants and longer for swaps 

between registrants and non-registrants? 

III. Related Matters 

A. Regulatory Flexibility Act 

The Regulatory Flexibility Act (RFA) 

requires that agencies consider whether 

the regulations they propose will have 

a significant economic impact on a 

substantial number of small entities.20

The Commission previously has 

established certain definitions of ‘‘small 

entities’’ to be used in evaluating the 

impact of its regulations on small 

entities in accordance with the RFA.21

The proposed regulations would affect 

SDs and MSPs. 

SDs and MSPs are new categories of 

registrants. Accordingly, the 

Commission has not previously 

addressed the question of whether such 

persons are, in fact, small entities for 

purposes of the RFA. The Commission 

previously has determined, however, 

that futures commission merchants 

(‘‘FCMs’’) should not be considered to be 

small entities for purposes of the RFA.22

The Commission’s determination was 

based, in part, upon the obligation of 

FCMs to meet the minimum financial 

requirements established by the 

Commission to enhance the protection 

of customers’ segregated funds and 

protect the financial condition of FCMs 

generally.23 Like FCMs, SDs will be 

subject to minimum capital and margin 

requirements and are expected to 

comprise the largest global financial 

firms. The Commission is required to 

exempt from SD registration any entities 

that engage in a de minimis level of 

swaps dealing in connection with 

transactions with or on behalf of 

customers. The Commission believes 

that this exemption would exclude 

small entities from registration. 

Accordingly, for purposes of the RFA 

for this rulemaking, the Commission is 

hereby determining that SDs are not 

‘‘small entities’’ for essentially the same 

reasons that FCMs have previously been 

determined not to be small entities and 

in light of the exemption from the 

definition of SD for those engaging in a 

de minimis level of swap dealing. 

The Commission also has previously 

determined that large traders are not 

‘‘small entities’’ for RFA purposes.24 In 

that determination, the Commission 

considered that a large trading position 

was indicative of the size of the 

business. MSPs, by statutory definition, 

maintain substantial positions in swaps 

or maintain outstanding swap positions 

that create substantial counterparty 

exposure that could have serious 

adverse effects on the financial stability 

of the United States banking system or 

financial markets. Accordingly, for 

purposes of the RFA for this 

rulemaking, the Commission is hereby 

determining that MSPs are not ‘‘small 

entities’’ for essentially the same reasons 

that large traders have previously been 

determined not to be small entities. 

The Commission also previously has 

determined that ECPs are not small 

entities for RFA purposes. Because ECPs 

are not small entities, and persons not 

meeting the definition of ECP may not 

conduct transactions in uncleared 

swaps, the Commission need not 

conduct a regulatory flexibility analysis 

respecting the effect of these proposed 

rules on ECPs. 

Accordingly, this proposed rule will 

not have a significant economic effect 

on any small entity. Therefore, the 

Chairman, on behalf of the Commission, 

hereby certifies pursuant to 5 U.S.C. 

605(b) that the proposed regulations 

will not have a significant economic 

impact on a substantial number of small 

entities. 

B. Paperwork Reduction Act 

The Paperwork Reduction Act 

(PRA) 25 imposes certain requirements 

on Federal agencies (including the 

Commission) in connection with their 

conducting or sponsoring any collection 

of information as defined by the PRA. 

This proposed rulemaking would result 

in the collection of information 

requirements within the meaning of the 

PRA, as discussed below. The 

collections of information that are 

proposed by this rulemaking are found 

in proposed § 23.151 and § 23.155 and 

are necessary to implement new Section 

4s(e) of the CEA, which expressly 

requires the Commission to adopt rules 

governing margin requirements for SDs 

and MSPs. For the sake of operational 

efficiency, the Commission will be 

submitting a consolidated PRA proposal 

for both the capital and margin rules to 

the Office of Management and Budget 

(OMB) for review in accordance with 44 

U.S.C. 3507(d) and 5 CFR 1320.11. 

Collection of Information. 

(Regulations and Forms Pertaining to 

the Financial Integrity of the 

Marketplace, OMB Control Number 

3038–0024.) 

C. Cost-Benefit Analysis 

Section 15(a) of the CEA 26 requires 

the Commission to consider the costs 

and benefits of its actions before issuing 

a rulemaking under the CEA. Section 

15(a) specifies that the costs and 

benefits shall be evaluated in light of 

five broad areas of market and public 

concern: (1) Protection of market 

participants and the public; (2) 

efficiency, competitiveness, and 

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Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 23743 

financial integrity of futures markets; (3) 

price discovery; (4) sound risk 

management practices; and (5) other 

public interest considerations. The 

Commission may in its discretion give 

greater weight to any one of the five 

enumerated areas and could in its 

discretion determine that, 

notwithstanding its costs, a particular 

regulation is necessary or appropriate to 

protect the public interest or to 

effectuate any of the provisions or to 

accomplish any of the purposes of the 

CEA. 

Summary of proposed requirements. 

The proposed regulations would 

implement certain provisions of section 

731 of the Dodd-Frank Act, which adds 

new sections 4s(e) of the CEA. Under 

the proposal, each CSE would be 

required to execute swap trading 

relationship documentation regarding 

credit support arrangements with each 

swap counterparty, including other SDs 

or MSPs. The proposed regulations also 

would require each CSE to calculate and 

to collect from its counterparties, that 

are SDs, MSPs, or financial entities, 

initial margin for each bilateral swap 

transaction that was not cleared by or 

through a derivatives clearing 

organization. The proposal also would 

requires each CSE to calculate each 

business day, and collect from its 

counterparties, that are SDs, MSPs, or 

financial entities, variation margin for 

each bilateral swap transaction that is 

not cleared by or through a derivatives 

clearing organization. CSEs, however, 

are not required to collect initial margin 

or exchange variation margin with a 

counterparty that qualifies as a nonfinancial entity. 

Costs. The Commission recognizes 

that to the extent SDs and MSPs 

currently do not post initial margin with 

one another, and have thresholds for 

variation margin, the proposal will 

impose costs upon them. The 

Commission further recognizes that to 

the extent that financial entities 

currently do not post initial margin or 

have high variation margin thresholds, 

the proposal will impose costs upon 

them. 

The Commission notes that while the 

amounts of initial margin that would be 

required to be posted would be 

substantial, initial margin is a 

performance bond. Thus, the cost is not 

equal to the total initial margin posted, 

but rather the opportunity cost of 

immobilizing those assets. That is, SDs, 

MSPs, and financial entities would 

likely receive a lower return on the 

resources posted as margin than they 

would receive if they were free to apply 

those resources to other uses. 

With respect to variation margin, 

sound risk management dictates that 

counterparties mark open positions to 

the market. Therefore, the costs here 

would also be opportunity costs. That 

is, to the extent SDs, MSPs, and 

financial entities currently have 

variation margin thresholds, they might 

be required to pay variation margin 

more frequently or earlier than would 

occur in the absence of the rule. 

The Commission does not believe that 

the requirement that the parties 

document their credit support 

arrangements will impose significant 

costs. The Commission understands that 

such documentation is widespread if 

not universal. 

Benefits. The Commission believes 

that the benefits of the proposal are very 

significant. The economy recently 

experienced a severe recession. A key 

contributing factor was the problems 

suffered by large institutions in the 

financial services sector. Those 

problems were, in part, attributable to 

positions those firms held in swaps. 

Many of those firms are likely to be 

SDs, MSPs, or financial entities. As 

discussed more fully above, the 

Commission believes that the proposed 

margin requirements will significantly 

decrease the risk that SDs, MSPs, and 

financial entities will incur such 

extreme losses on their swap positions 

as to imperil the financial system of the 

United States. In addition to this 

systemic benefit, the proposal would 

benefit each of the individual 

participants in the swaps market by 

increasing the security of their positions 

as well as the financial integrity of their 

counterparties. In this regard, the 

Commission notes that the requirements 

proposed here are substantially the 

same as the requirements that the 

prudential regulators are proposing. 

In sum, the Commission believes that 

the benefits to the overall financial 

system, and to the individual 

participants in the swaps market, 

outweigh the costs to those participants. 

Public Comment. The Commission 

invites public comment on its costbenefit considerations. Commentators 

are also invited to submit any data or 

other information that they may have 

quantifying or qualifying the costs and 

benefits of the Proposal with their 

comment letters. 

List of Subjects in 17 CFR Part 23 

Swaps, Swap dealers, Major swap 

participants, Capital and margin 

requirements. 

For the reasons stated in this release, 

the Commission proposes to amend 17 

CFR part 23, as proposed to be added at 

75 FR 71379, published November 23, 

2010, as follows: 

PART 23—SWAP DEALERS AND 

MAJOR SWAP PARTICIPANTS 

1. The authority citation for part 23 to 

read as follows: 

Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b–1, 6c, 

6p, 6r, 6s, 6t, 9, 9a, 12, 12a, 13b, 13c, 16a, 

18, 19, 21. 

2. Subpart E is added to read as 

follows: 

Subpart E—Capital and Margin 

Requirements for Swap Dealers and Major 

Swap Participants 

Sec. 

23.100–23.149 [Reserved] 

23.150 Definitions applicable to margin 

requirements. 

23.151 Documentation of credit support 

arrangements. 

23.152 Margin treatment for uncleared 

swaps between covered swap entities 

and swap dealers and major swap 

participants. 

23.153 Margin treatment for uncleared 

swaps between covered swap entities 

and financial entities. 

23.154 Margin treatment for uncleared 

swaps between covered swap entities 

and non-financial entities. 

23.155 Calculation of initial margin. 

23.156 Calculation of variation margin. 

23.157 Forms of margin. 

23.158 Custodial arrangements. 

Subpart E—Capital and Margin 

Requirements for Swap Dealers and 

Major Swap Participants 

§§ 23.100 through 23.149 [Reserved] 

§ 23.150 Definitions applicable to margin 

requirements. 

For the purposes of §§ 23.150 through 

23.158 of this part: 

Asset class means a group of products 

that are based on similar types of 

underlying assets. Swaps shall be 

grouped within the following asset 

classes: agricultural, credit, currency, 

energy, equity, interest rate, metals, and 

other. 

Back test means a test that compares 

initial margin requirements with 

historical price changes to determine 

the extent of actual margin coverage. 

Counterparty means the person 

opposite whom a covered swap entity 

executes a swap. 

Covered swap entity means a swap 

dealer or major swap participant for 

which there is no prudential regulator. 

Custodian means a person selected by 

the parties to a swap to hold margin on 

their behalf. 

Financial entity means a counterparty 

that is not a swap dealer or a major 

swap participant and that is one of the 

following: 

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23744 Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 

(1) A commodity pool as defined in 

Section 1a(5) of the Act, 

(2) A private fund as defined in 

Section 202(a) of the Investment 

Advisors Act of 1940, 

(3) An employee benefit plan as 

defined in paragraphs (3) and (32) of 

section 3 of the Employee Retirement 

Income and Security Act of 1974, 

(4) A person 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 Company Act 

of 1956, 

(5) A person that would be a financial 

entity described in paragraph (1) or (2) 

if it were organized under the laws of 

the United States or any State thereof; 

(6) The government of any foreign 

country or a political subdivision, 

agency, or instrumentality thereof; or 

(7) Any other person the Commission 

may designate. 

Initial margin means money, 

securities, or property posted by a party 

to a swap as performance bond to cover 

potential future exposures arising from 

changes in the market value of the 

position. 

Liquidation time horizon means the 

time period needed to replace a swap. 

Minimum transfer amount means an 

initial margin or variation margin 

amount that is less than $100,000. 

Non-financial entity means a 

counterparty that is not a swap dealer, 

a major swap participant, or a financial 

entity. 

Regulatory capital means the amount 

of capital required under § 23.101 of this 

part. 

Significant swaps exposure means 

(1) Swap positions that equal or 

exceed either of the following 

thresholds: 

(i) $2.5 billion in daily average 

aggregate uncollateralized outward 

exposure; or 

(ii) $4 billion in daily average 

aggregate uncollateralized outward 

exposure plus daily average aggregate 

potential outward exposure. 

(2) For purposes of this definition the 

terms daily average aggregate 

uncollateralized outward exposure and 

daily average aggregate potential 

outward exposure each has the meaning 

specified for that term in § 1.3(uuu) of 

this part for purposes of calculating 

substantial counterparty exposure under 

that regulation. 

State insurance regulator means an 

insurance authority of a State that is 

engaged in the supervision of insurance 

companies under State insurance law. 

Stress test means a test that compares 

the impact of a potential extreme price 

move, change in option volatility, or 

change in other inputs that affect the 

value of a position, to the initial margin 

held for that position to measure the 

adequacy of such initial margin. 

Swap trading relationship 

documentation means the 

documentation described in § 23.504 of 

this part. 

Threshold means an amount below 

which initial margin or variation margin 

that otherwise would be due is not 

required to be paid. 

Uncleared swap means a swap 

executed after the effective date of this 

rule that is not submitted for clearing to 

a derivatives clearing organization. 

Variation margin means a payment 

made by a party to a swap to cover the 

current exposure arising from changes 

in the market value of the position since 

the trade was executed or the previous 

time the position was marked to market. 

§ 23.151 Documentation of credit support 

arrangements. 

(a) Each covered swap entity shall 

execute with each counterparty swap 

trading relationship documentation 

regarding credit support arrangements 

that complies with the requirements of 

§ 23.504 of this part and this subpart E. 

(b) The credit support arrangements 

shall specify the following: 

(1) The methodology to be used to 

calculate initial margin for uncleared 

swaps entered into between the covered 

swap entity and the counterparty; 

(2) The methodology to be used to 

calculate variation margin for uncleared 

swaps entered into between the covered 

swap entity and the counterparty; 

(3) To the extent that the alternative 

method is used pursuant to § 23.155(c), 

the parties shall specify the reference 

contracts to be used; 

(4) Any thresholds below which 

initial margin need not be posted by the 

counterparty; and 

(5) Any thresholds below which 

variation margin need not be paid by the 

counterparty. 

§ 23.152 Margin treatment for uncleared 

swaps between covered swap entities and 

swap dealers or major swap participants. 

(a) Initial margin. (1) On or before the 

date of execution of an uncleared swap 

between a covered swap entity and a 

swap dealer or major swap participant, 

each covered swap entity shall require 

the counterparty to post initial margin 

equal to or greater than an amount 

calculated pursuant to § 23.155 of this 

part with a custodian selected pursuant 

to § 23.158 of this part. 

(2) Until such an uncleared swap is 

liquidated, each covered swap entity 

shall require the counterparty to 

maintain initial margin equal to or 

greater than an amount calculated 

pursuant to § 23.155 of this part with a 

custodian selected pursuant to § 23.158 

of this part. 

(3) If the credit support arrangements 

with a counterparty require the 

counterparty to post and/or maintain an 

amount greater than the amount 

calculated pursuant to § 23.155 of this 

part, the covered swap entity shall 

require the counterparty to post and/or 

maintain such greater amount. 

(4) Each covered swap entity shall 

require the counterparty to post and 

maintain the entire initial margin 

amount required under this paragraph 

(a) unless the amount is less than the 

minimum transfer amount. There shall 

be no other exceptions for amounts 

below a threshold. 

(b) Variation margin. (1) For each 

uncleared swap between a covered swap 

entity and a swap dealer or major swap 

participant, each covered swap entity 

shall require the counterparty to pay 

variation margin as calculated pursuant 

to § 23.156 of this part directly to the 

covered swap entity or to a custodian 

selected pursuant to § 23.158 of this 

part. Such payments shall start on the 

business day after the swap is executed 

and continue each business day until 

the swap is liquidated. 

(2) For each uncleared swap between 

a covered swap entity and a swap dealer 

or major swap participant, each covered 

swap entity shall require the 

counterparty to pay the entire variation 

margin amount as calculated pursuant 

to § 23.156 of this part when due unless 

the amount is less than the minimum 

transfer amount. There shall be no other 

exceptions for amounts below a 

threshold. 

(3) To the extent that more than one 

uncleared swap is executed pursuant to 

swap trading relationship 

documentation between a covered swap 

entity and its counterparty, a covered 

swap entity may calculate and comply 

with the variation margin requirements 

of this paragraph on an aggregate basis 

with respect to all uncleared swaps 

governed by such agreement, so long as 

the covered swap entity complies with 

these variation margin requirements 

with respect to all uncleared swaps 

governed by such agreement regardless 

of whether the uncleared swaps were 

entered into on or after the effective 

date. 

(4) A covered swap entity shall not be 

deemed to have violated its obligation to 

collect variation margin from a 

counterparty if: 

(i) The counterparty has refused or 

otherwise failed to provide the required 

variation margin to the covered swap 

entity; and 

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(ii) The covered swap entity has: 

(A) Made the necessary efforts to 

attempt to collect the required variation 

margin, including the timely initiation 

and continued pursuit of formal dispute 

resolution mechanisms, or has 

otherwise demonstrated upon request to 

the satisfaction of the Commission that 

it has made appropriate efforts to collect 

the required variation margin; or 

(B) Commenced termination of the 

swap or security-based swap with the 

counterparty. 

§ 23.153 Margin treatment for uncleared 

swaps between covered swap entities and 

financial entities. 

(a) Initial margin. (1) On or before the 

date of execution of an uncleared swap 

between a covered swap entity and a 

financial entity, the covered swap entity 

shall require the financial entity to post 

initial margin equal to or greater than an 

amount calculated pursuant to § 23.155 

of this part. Upon request of the 

financial entity, the initial margin shall 

be held at a custodian selected pursuant 

to § 23.158 of this part. 

(2) Until such an uncleared swap is 

liquidated, the covered swap entity 

shall require the financial entity to 

maintain initial margin equal to or 

greater than an amount calculated 

pursuant to § 23.155 of this part. 

(3) If the credit support arrangements 

with a financial entity require the 

financial entity to post and/or maintain 

an amount greater than the amount 

calculated pursuant to § 23.158 of this 

part, the covered swap entity shall 

require the financial entity to post and/ 

or maintain such greater amount. 

(4) Except as provided in paragraph 

(c) of this section each covered swap 

entity shall require each financial entity 

to post and maintain the entire initial 

margin amount required under this 

paragraph (a) unless the amount is less 

than the minimum transfer amount. 

(5) On or before the date of execution 

of an uncleared swap between a covered 

swap entity and a financial entity, the 

covered swap entity shall post any 

initial margin that may be required 

pursuant to the credit support 

arrangement between them. 

(6) Until such an uncleared swap is 

liquidated, the covered swap entity 

shall maintain any initial margin that 

may be required pursuant to the credit 

support arrangement between them. 

(7) The credit support arrangements 

between a covered swap entity and a 

financial entity may provide for a 

threshold below which the covered 

swap entity is not required to post 

initial margin. 

(b) Variation margin. (1) For each 

uncleared swap between a covered swap 

entity and a financial entity, each 

covered swap entity shall require the 

financial entity to pay variation margin 

as calculated pursuant to § 23.156 of 

this part directly to the covered swap 

entity or to a custodian selected 

pursuant to § 23.158 of this part. Such 

payments shall start on the business day 

after the swap is executed and continue 

each business day until the swap is 

liquidated. 

(2) Except as provided in paragraph 

(c) of this section, for each uncleared 

swap between a covered swap entity 

and a financial entity, each covered 

swap entity shall require the financial 

entity to pay the entire variation margin 

amount as calculated pursuant to 

§ 23.156 of this part when due unless 

the amount is less than the minimum 

transfer amount. 

(3) For each uncleared swap between 

a covered swap entity and a financial 

entity, each covered swap entity shall 

pay any variation margin that may be 

required pursuant to the credit support 

arrangements between them. 

(4) The credit support arrangements 

between a covered swap entity and a 

financial entity may provide for a 

threshold below which the covered 

swap entity is not required to pay 

variation margin. 

(5) To the extent that more than one 

uncleared swap is executed pursuant to 

swap trading relationship 

documentation between a covered swap 

entity and its counterparty that permits 

netting, a covered swap entity may 

calculate and comply with the variation 

margin requirements of this paragraph 

on an aggregate basis with respect to all 

uncleared swaps governed by such 

agreement, provided that the covered 

swap entity complies with these 

variation margin requirements for all 

uncleared swaps governed by such 

agreement regardless of whether the 

uncleared swaps were entered into on or 

after the effective date. 

(6) A covered swap entity shall not be 

deemed to have violated its obligation to 

collect variation margin from a 

counterparty if: 

(i) The counterparty has refused or 

otherwise failed to provide the required 

variation margin to the covered swap 

entity; and 

(ii) The covered swap entity has: 

(A) Made the necessary efforts to 

attempt to collect the required variation 

margin, including the timely initiation 

and continued pursuit of formal dispute 

resolution mechanisms, or has 

otherwise demonstrated upon request to 

the satisfaction of the Commission that 

it has made appropriate efforts to collect 

the required variation margin; or 

(B) Commenced termination of the 

swap or security-based based swap with 

the counterparty. 

(7) For risk management purposes, 

each covered swap entity shall calculate 

each day a hypothetical variation 

margin requirement for each such 

uncleared swap as if the counterparty 

were a swap dealer and compare that 

amount to any variation margin required 

pursuant to the credit support 

arrangements. 

(c) Thresholds. (1) A covered swap 

entity may apply a threshold to the 

initial margin and variation margin 

requirements of a counterparty that is a 

financial entity if the counterparty 

makes the following representations to 

the covered swap entity in connection 

with entering into an uncleared swap 

with the covered swap entity: 

(i) The counterparty is subject to 

capital requirements established by a 

prudential regulator or State insurance 

regulator; 

(ii) The counterparty does not have a 

significant uncleared swaps exposure; 

and 

(iii) The counterparty predominantly 

uses uncleared swaps to hedge or 

mitigate the risks of its business 

activities, including interest rate, or 

other risk arising from the business of 

the counterparty. 

(2) The initial margin threshold shall 

be the lesser of [$15 to 45] million or 

[0.1 to 0.3]% of the covered swap 

entity’s regulatory capital. 

(3) The variation margin threshold 

shall be the lesser [$15 to 45] million or 

[0.1 to 0.3]% of the covered swap 

entity’s regulatory capital. 

§ 23.154 Margin treatment for uncleared 

swaps between covered swap entities and 

non-financial entities. 

(a) Initial margin. (1) On or before the 

date of execution of an uncleared swap 

between a covered swap entity and a 

non-financial entity, the covered swap 

entity shall require such non-financial 

entity to post any initial margin that 

may be required pursuant to the credit 

support arrangement between them. 

(2) Until such an uncleared swap is 

liquidated, the covered swap entity 

shall require the counterparty to 

maintain any initial margin that may be 

required pursuant to the credit support 

arrangement between them. 

(3) The credit support arrangements 

between a covered swap entity and a 

non-financial entity may provide for a 

threshold below which the nonfinancial entity is not required to post 

initial margin. 

(4) On or before the date of execution 

of an uncleared swap between a covered 

swap entity and a non-financial entity, 

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23746 Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 

the covered swap entity shall post any 

initial margin that may be required 

pursuant to the credit support 

arrangement between them. 

(5) Until such an uncleared swap is 

liquidated, the covered swap entity 

shall maintain any initial margin that 

may be required pursuant to the credit 

support arrangement between them. 

(6) The credit support arrangements 

between a covered swap entity and a 

non-financial entity may provide for a 

threshold below which the covered 

swap entity is not required to post 

initial margin. 

(7) For risk management and capital 

purposes, each covered swap entity 

shall calculate each day a hypothetical 

initial margin requirement for each such 

uncleared swap as if the counterparty 

were a swap dealer and compare that 

amount to any initial margin required 

pursuant to the credit support 

arrangements. 

(b) Variation margin. (1) For each 

uncleared swap between a covered swap 

entity and a non-financial entity, each 

covered swap entity shall require the 

non-financial entity to pay any variation 

margin that may be required pursuant to 

the credit support arrangements 

between them. 

(2) The credit support arrangements 

between a covered swap entity and a 

non-financial entity may provide for a 

threshold below which the nonfinancial entity is not required to pay 

variation margin. 

(3) For each uncleared swap between 

a covered swap entity and a nonfinancial entity, each covered swap 

entity shall pay any variation margin 

that may be required pursuant to the 

credit support arrangements between 

them. 

(4) The credit support arrangements 

between a covered swap entity and a 

non-financial entity may provide for a 

threshold below which the covered 

swap entity is not required to pay 

variation margin. 

(5) To the extent that more than one 

uncleared swap is executed pursuant to 

swap trading relationship 

documentation between a covered swap 

entity and its counterparty that permits 

netting, a covered swap entity may 

calculate and comply with the variation 

margin requirements of this paragraph 

on an aggregate basis with respect to all 

uncleared swaps governed by such 

agreement, provided that the covered 

swap entity complies with these 

variation margin requirements for all 

uncleared swaps governed by such 

agreement regardless of whether the 

uncleared swaps were entered into on or 

after the effective date. 

(6) For risk management purposes, 

each covered swap entity shall calculate 

each day a hypothetical variation 

margin requirement for each such 

uncleared swap as if the counterparty 

were a swap dealer and compare that 

amount to any variation margin required 

pursuant to the credit support 

arrangements. 

§ 23.155 Calculation of initial margin. 

(a) Means of calculation. (1) Each 

covered swap entity shall calculate 

initial margin using the methodology 

specified in the credit support 

arrangements with the counterparty 

provided that the methodology shall be 

consistent with the requirements of this 

section. 

(2) Each covered swap entity shall 

calculate initial margin for itself and for 

each counterparty that is a swap dealer, 

major swap participant, or financial 

entity, using either: 

(i) A risk-based model that meets the 

requirements of paragraph (b) of this 

section; or 

(ii) The alternative method set forth in 

paragraph (c) of this section. 

(b) Models. (1) Eligibility. To be 

eligible for use by a covered swap 

entity, a model shall meet the standards 

set forth in paragraph (b)(2) of this 

section, be filed with the Commission 

by a covered swap entity pursuant to 

paragraph (b)(3), be approved by the 

Commission pursuant to paragraph 

(b)(4) of this section and either be: 

(i) Currently used by a derivatives 

clearing organization for margining 

cleared swaps; 

(ii) Currently used by an entity subject 

to regular assessment by a prudential 

regulator for margining uncleared 

swaps; or 

(iii) Made available for licensing to 

any market participant by a vendor. 

(2) Standards. Each model shall 

conform to the following standards: 

(i) The valuation of each uncleared 

swap shall be determined consistent 

with the requirements of § 23.504(b) of 

this part; 

(ii) The model shall have a sound 

theoretical basis and significant 

empirical support; 

(iii) The model shall use factors 

sufficient to measure all material risks; 

(iv) To the extent available, the model 

shall use at least one year of historic 

price data and must incorporate a 

period of significant financial stress 

appropriate to the uncleared swaps to 

which the model is applied; 

(v) Any portfolio offsets or reductions 

shall have a sound theoretical basis and 

significant empirical support; 

(vi) The model shall set margin to 

cover at least 99% of price changes by 

product and by portfolio over at least a 

10-day liquidation time horizon; 

(vii) The model must be validated by 

an independent third party before being 

used and annually thereafter; 

(viii) The methodology shall be stated 

with sufficient specificity to allow the 

counterparty, the Commission, and any 

applicable prudential regulator to 

calculate the margin requirement 

independently; 

(ix) The covered swap entity shall 

monitor margin coverage each day; 

(x) The covered swap entity shall 

conduct back tests at least monthly; 

(xi) The covered swap entity shall 

conduct stress tests at least monthly; 

(xii) The covered swap entity shall 

document all material aspects of its 

valuation procedures and initial margin 

model; and 

(xiii) If an uncleared swap or portfolio 

is available for clearing by a derivatives 

clearing organization but is not subject 

to mandatory clearing, the model shall 

include a factor requiring that the initial 

margin shall be equal to or greater than 

an amount that would be required by 

the derivatives clearing organization. 

(3) Filing with the Commission. (i) 

Each covered swap entity shall file each 

model that it uses with the Commission. 

(ii) The filing shall include a complete 

explanation of: 

(A) The manner in which the model 

meets the requirements of this section; 

(B) The mechanics of the model; 

(C) The theoretical basis of the model; 

(D) The empirical support for the 

model; and 

(E) Any independent third party 

validation of the model. 

(4) Commission action. (i) The 

Commission may approve or deny the 

application, or approve an amendment 

to the application, in whole or in part, 

subject to any conditions or limitations 

the Commission may require, if the 

Commission finds the approval to be 

necessary or appropriate in the public 

interest after determining, among other 

things, whether the applicant has met 

the requirements of this section and is 

in compliance with other applicable 

rules promulgated under the Act and by 

self-regulatory organizations. 

(ii) The Commission may at any time 

require a covered swap entity to provide 

further data or analysis concerning a 

model. 

(iii) The Commission may at any time 

require a covered swap entity to modify 

a model to address potential 

vulnerabilities. 

(iv) At any time after the effective date 

of this rule, the Commission may in its 

sole discretion determine by written 

order that covered swap entities may 

apply for approval under this section to 

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Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 23747 

calculate initial margin using 

proprietary models. 

(c) Alternative Method. If a model 

meeting the standards set forth in 

paragraph (b) of this section is not used, 

initial margin shall be calculated in 

accordance with this paragraph. 

(1) General rule. Initial margin shall 

be calculated as follows: 

(i) The covered swap entity shall 

identify in the credit support 

arrangements the swap cleared by a 

derivatives clearing organization in the 

same asset class as the uncleared swap 

for which the terms and conditions most 

closely approximate the terms and 

conditions of the uncleared swap. If 

there is no cleared swap whose terms 

and conditions closely approximate the 

uncleared swap, the covered swap 

entity shall identify in the credit 

support arrangements the futures 

contract cleared by a derivatives 

clearing organization in the same asset 

class as the uncleared swap which most 

closely approximates the uncleared 

swap and would be most likely to be 

used to hedge the uncleared swap. 

(ii) The covered swap entity shall 

calculate the number of units of the 

cleared swap or cleared futures contract 

necessary to equal the size of the 

uncleared swap. 

(iii) The covered swap entity shall 

ascertain the margin the derivatives 

clearing organization would require for 

a position of the size indentified in 

paragraph (c)(1)(ii) of this section. 

(iv) The covered swap entity shall 

multiply the amount ascertained in 

paragraph (c)(1)(iii) of this section for a 

cleared swap by 2.0 in order to 

determine the margin required for the 

uncleared swap or multiply the amount 

ascertained in paragraph (c)(1)(iii) of 

this section for a cleared futures 

contract by 4.4 in order to determine the 

margin required for the uncleared swap. 

(2) Portfolio-based reductions. (i) 

Reductions in margin based on 

offsetting risk characteristics of products 

shall not be applied across asset classes 

except that reductions may be applied 

between the currency asset class and the 

interest rate asset class. 

(ii) Any reductions in margin based 

on offsetting risk characteristics of 

products within an asset class shall 

have a sound theoretical basis and 

significant empirical support. 

(iii) No reduction shall exceed 50% of 

the amount that would be required for 

the uncleared swap in the absence of a 

reduction. 

(3) Modifications for particular 

products or positions. Each covered 

swap entity shall monitor the coverage 

provided by margin established 

pursuant to this paragraph (c) and 

collect additional margin if appropriate 

to address the risk posed by particular 

products or positions. 

(4) Commission action. (i) The 

Commission may at any time require a 

covered swap entity to post or collect 

additional margin because of additional 

risk posed by a particular product. 

(ii) The Commission may at any time 

require a covered swap entity to post or 

collect additional margin because of 

additional risk posed by a particular 

party to the uncleared swap. 

§ 23.156 Calculation of variation margin. 

(a) Means of calculation. (1) Each 

covered swap entity shall calculate 

variation margin using a methodology 

specified in the credit support 

arrangements with the counterparty. 

(2) Each covered swap entity shall 

calculate variation margin for itself and 

for each counterparty that is a swap 

dealer, major swap participant, or 

financial entity using a methodology 

that meets the requirements of 

paragraph (b) of this section. 

(b) Methodology. Each methodology 

shall conform to the following 

standards: 

(1) The valuation of each swap shall 

be determined consistent with the 

requirements of § 23.504(b) of this part; 

(2) The variation methodology must 

be stated with sufficient specificity to 

allow the counterparty, the 

Commission, and any applicable 

prudential regulator to calculate the 

margin requirement independently. 

(c) Commission action. (1) The 

Commission may at any time require 

covered swap entity to provide further 

data or analysis concerning the 

methodology, including: 

(i) An explanation of the manner in 

which the methodology meets the 

requirements of this section; 

(ii) A description of the mechanics of 

the methodology; 

(iii) The theoretical basis of the 

methodology; and 

(iv) The empirical support for the 

methodology. 

(2) The Commission may at any time 

require a covered swap entity to modify 

the methodology to address potential 

vulnerabilities. 

§ 23.157 Forms of margin. 

(a) Initial margin. (1) Each covered 

swap entity shall post and accept as 

initial margin only assets specified in 

the credit support arrangements with 

the counterparty. 

(2) Each covered swap entity shall 

post and accept as initial margin only 

the following assets if the counterparty 

is a swap dealer, a major swap 

participant, or a financial entity: 

(i) Immediately available cash funds 

denominated in U.S. dollars or the 

currency in which payment obligations 

under the swap are required to be 

settled; 

(ii) Any obligation which is a direct 

obligation of, or fully guaranteed as to 

principal and interest by, the United 

States or an agency of the United States; 

or 

(iii) Any senior debt obligation of the 

Federal National Mortgage Association, 

the Federal Home Loan Mortgage 

Corporation, a Federal Home Loan 

Bank, the Federal Agricultural Mortgage 

Corporation, or any obligation that is an 

‘‘insured obligation,’’ as that term is 

defined in 12 U.S.C. 2277a(3), of a Farm 

Credit System bank. 

(3) Each covered swap entity shall 

accept as initial margin from nonfinancial entities only assets for which 

the value is reasonably ascertainable on 

a periodic basis in a manner agreed to 

by the parties in the credit support 

arrangements. 

(4) A covered swap entity may not 

collect, as initial margin or variation 

margin required by the part, any asset 

that is an obligation of the counterparty 

providing such asset. 

(b) Variation margin. (1) Each covered 

swap entity shall pay and collect as 

variation margin only assets specified in 

the credit support arrangements with 

the counterparty. 

(2) Each covered swap entity shall pay 

and collect as variation margin only 

cash or United States Treasury 

securities if the counterparty is a swap 

dealer, a major swap participant, or a 

financial entity. 

(3) Each covered swap entity shall 

accept as variation margin from nonfinancial entities only assets for which 

the value is reasonably ascertainable on 

a periodic basis in a manner agreed to 

by the parties in the credit support 

arrangements. 

(c) Haircuts. (1) Each covered swap 

entity shall apply haircuts to any asset 

posted or received as margin as 

specified in the credit support 

arrangements with the counterparty. 

(2) Each covered swap entity shall 

apply haircuts to any asset received as 

margin that reflect the credit and 

liquidity characteristics of the asset. 

(3) Each covered swap entity shall 

apply haircuts, at a minimum, to assets 

received as margin if the counterparty is 

a swap dealer, a major swap participant, 

or a financial entity in accordance with 

the following table: 

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23748 Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 

MARGIN VALUE RANGES FOR NON-CASH COLLATERAL

[% of market value] 

Duration (years) 

0–5 5–10 > 10 

(i) U.S. Treasuries and Fully Guaranteed Agencies: 

(A) Bills/Notes/Bonds/Inflation Indexed ............................................................................................ [98–100] [95–99] [94–98] 

(B) Zero Coupon, STRIPs ................................................................................................................ [97–99] [94–98] [90–94] 

(ii) FHFA–Regulated Institutions Obligations and Insured Obligations of FCS Banks: 

(A) Bills/Notes/Bonds ........................................................................................................................ [96–100] [94–98] [93–97] 

(B) Zero Coupon ............................................................................................................................... [95–99] [93–97] [89–93] 

(d) Commission action. (1) The 

Commission may at any time require a 

covered swap entity to provide further 

data or analysis concerning any margin 

asset posted or received. 

(2) The Commission may at any time 

require a covered swap entity to replace 

a margin asset posted to a counterparty 

with a different margin asset to address 

potential risks posed by the asset. 

(3) The Commission may at any time 

require a covered swap entity to require 

a counterparty that is a swap dealer, a 

major swap participant, or a financial 

entity to replace a margin asset posted 

with the covered swap entity with a 

different margin asset to address 

potential risks posed by the asset. 

(4) The Commission may at any time 

require a covered swap entity to provide 

further data or analysis concerning 

margin haircuts. 

(5) The Commission may at any time 

require a covered swap entity to modify 

a margin haircut applied to an asset 

received from a swap dealer, a major 

swap participant, or a financial entity to 

address potential risks posed by the 

asset. 

§ 23.158 Custodial arrangements. 

(a) Location of assets. (1) Each 

covered swap entity shall specify in the 

credit support arrangements with each 

counterparty where margin assets will 

be held. 

(2) Each covered swap entity shall 

offer each counterparty the opportunity 

to select a custodian that is not affiliated 

with the swap dealer or major swap 

participant. 

(3) Each covered swap entity shall 

hold initial margin received from a 

counterparty that is a swap dealer or 

major swap participant at a custodian 

that is independent of the covered swap 

entity and of the counterparty. 

(4) Each covered swap entity that 

posts initial margin with a counterparty 

that is a swap dealer or major swap 

participant shall require that the 

counterparty hold initial margin 

received at a custodian that is 

independent of the covered swap entity 

and of the counterparty. 

(5) The independent custodian shall 

be located in a jurisdiction that applies 

the same insolvency regime to the 

custodian as would apply to the covered 

swap entity. 

(b) Use of assets. (1) For each 

uncleared swap between a covered swap 

entity and a swap dealer, major swap 

participant, or a financial entity, the 

covered swap entity shall enter into a 

tri-party custodial agreement with the 

counterparty and the custodian that 

provides that: 

(i) Neither the covered swap entity 

nor the counterparty may rehypothecate 

margin assets; 

(ii) The custodian may not 

rehypothecate margin assets; 

(iii) The custodian may not reinvest 

any margin held by the custodian in any 

asset that would not qualify as eligible 

collateral under § 23.157(a) of this part; 

(iv) Upon certification in accordance 

with 23.602(b)(1) by one of the parties 

that it is entitled to control of the 

margin under the agreement, the 

custodian shall release the margin to the 

certifying party; and 

(v) The certifying party shall 

indemnify the custodian against any 

claim that the margin assets should not 

have been released. 

(2) Upon receipt of initial margin from 

a counterparty, no covered swap entity 

shall post such assets as margin for a 

swap, a security-based swap, a 

commodity for future delivery, a 

security, a security futures product, or 

any other product subject to margin. 

(c) Commission action. (1) The 

Commission may at any time require a 

covered swap entity to provide further 

data or analysis concerning any 

custodian. 

(2) The Commission may at any time 

require a covered swap entity to move 

assets held on behalf of a counterparty 

to another custodian to address risks 

posed by the original custodian. 

Issued in Washington, DC, on April 12, 

2011, by the Commission. 

David A. Stawick, 

Secretary of the Commission. 

Note: The following appendices will not 

appear in the Code of Federal Regulations: 

Appendices To Swap Dealer and Major 

Swap Participant Margin Requirements 

for Uncleared Swaps—Commission 

Voting Summary and Statements of 

Commissioners 

Appendix 1—Commission Voting 

Summary 

On this matter, Chairman Gensler and 

Commissioners Dunn, Sommers and Chilton 

voted in the affirmative; Commissioner 

O’Malia voted in the negative. 

Appendix 2—Statement of Chairman 

Gary Gensler 

I support the proposed rulemaking. Margin 

requirements for swaps that are not cleared 

between financial entities help ensure the 

safety and soundness of swap dealers and 

major swap participants. 

The proposed rules would address margin 

requirements for uncleared swaps entered 

into by nonbank swap dealers or major swap 

participants. The prudential regulators today 

are proposing margin rules for the dealers 

that they regulate. For trades between swap 

dealers (or major swap participants), the 

rules would require paying and collecting 

initial and variation margin for each trade. 

For trades between swap dealers (or major 

swap participants) and financial entities, the 

rules would require the dealer (or major swap 

participant) to collect, but not pay, initial and 

variation margin for each trade, subject in 

certain circumstances to permissible 

thresholds. The proposed rule allows 

thresholds for margin for financial entities 

where they are subject to capital 

requirements established by a prudential 

regulator or a State insurance regulator and 

they are using their uncleared swaps to hedge 

or mitigate risk of their business activities. 

The proposed rule would not require 

margin to be paid or collected on transactions 

involving non-financial end-users hedging or 

mitigating commercial risk. Congress 

recognized the different levels of risk posed 

by transactions between financial entities 

and those that involve non-financial entities, 

as reflected in the non-financial end-user 

exception to clearing. Transactions involving 

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Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / Proposed Rules 23749 

non-financial entities do not present the 

same risk to the financial system as those 

solely between financial entities. The risk of 

a crisis spreading throughout the financial 

system is greater the more interconnected 

financial companies are to each other. 

Interconnectedness among financial entities 

allows one entity’s failure to cause 

uncertainty and possible runs on the funding 

of other financial entities, which can spread 

risk and economic harm throughout the 

economy. 

CFTC staff worked very closely with 

prudential regulators to establish initial and 

variation margin requirements that are 

comparable to the maximum extent 

practicable. 

[FR Doc. 2011–9598 Filed 4–27–11; 8:45 am] 

BILLING CODE 6351–01–P 

POSTAL SERVICE 

39 CFR Part 111 

Intelligent Mail Package Barcode 

(IMpb) Implementation for Commercial 

Parcels 

AGENCY: Postal ServiceTM. 

ACTION: Proposed rule. 

SUMMARY: The Postal Service is 

proposing to revise Mailing Standards 

of the United States Postal Service, 

Domestic Mail Manual (DMM®) to 

require the use of a unique tracking 

barcode on all commercial parcels, 

except Standard Mail® parcels, claiming 

presort and destination entry pricing by 

January 2012; and to encourage use of 

unique tracking barcodes by providing 

free Delivery Confirmation® service on 

all commercial parcels except Standard 

Mail parcels. 

DATES: Submit comments on or before 

May 31, 2011. 

ADDRESSES: Mail or deliver written 

comments to the manager, Product 

Classification, U.S. Postal Service, 475 

L’Enfant Plaza SW., Room 4446, 

Washington, DC 20260–5015. You may 

inspect and photocopy all written 

comments at USPS® Headquarters 

Library, 475 L’Enfant Plaza SW., 11th 

Floor North, Washington, DC, between 

9 a.m. and 4 p.m., Monday through 

Friday. E-mail comments, containing 

the name and address of the commenter, 

may be sent to: 

MailingStandards@usps.gov, with a 

subject line of ‘‘IMpb.’’ Faxed comments 

are not accepted. 

FOR FURTHER INFORMATION CONTACT: 

Juliaann Hess at 202–268–7663 or Kevin 

Gunther at 202–268–7208. 

SUPPLEMENTARY INFORMATION: The Postal 

Service is currently enhancing its 

operational capability to allow for the 

scanning of Intelligent Mail® package 

barcodes (IMpb) and other extra services 

barcodes via automated processing 

equipment and Intelligent Mail 

scanning devices. Once fully 

implemented, tracking data, including 

acceptance, enroute, and delivery status 

data, will be available for use by 

commercial mailers who use extra 

services on their packages. 

IMpb can offer a number of additional 

benefits by allowing the potential for 

mailers to access piece-level visibility 

throughout USPS processing and 

delivery operations. The IMpb will 

include: 

• A routing code to facilitate the 

processing of packages on automated 

sorting equipment. 

• A channel-specific Application 

Identifier (AI) that associates the 

barcode to the payment method, 

supporting revenue assurance. 

• A 3-digit service type code, which 

will identify the exact mail class and 

service combination, eliminating the 

need for multiple barcodes on a 

package. 

• An option to use a 6-digit or 9-digit 

numeric Mailer ID (MID), to 

accommodate all mailers. 

These enhancements will add datastream efficiency within mail 

processing, delivery, payment, and 

reporting. Intelligent Mail package 

barcodes also include specific ‘‘mail 

class only’’ service type codes that may 

be used for packages without extra 

services. 

To increase IMpb use within the 

mailing community, the Postal Service 

proposes to encourage use of unique 

tracking barcodes by including Delivery 

Confirmation at no additional charge on 

all commercial parcels except Standard 

Mail parcels; and to require the use of 

a unique tracking barcode on all 

commercial parcels (except Standard 

Mail parcels) claiming presort and 

destination entry pricing. 

The provision that allows Delivery 

Confirmation to be offered without 

charge requires prior action by the 

Postal Service Board of Governors and 

the Postal Regulatory Commission. 

Assuming such action is completed as 

intended, the Postal Service proposes to 

make these new standards effective 

concurrent with the effective date of the 

first market dominant price change in 

2012 (or January 2012, if no market 

dominant price change is scheduled for 

early 2012). The Postal Service plans to 

provide an optional-use transitional 

period, until June 4, 2012, to allow 

mailers sufficient time to effect the 

necessary changes to their software and 

systems. Merchandise Return Service 

(MRS) mailpieces and Business Reply 

Mail®(BRM) parcels would also qualify 

for free Delivery Confirmation service at 

no charge. 

Except for users of PC Postage®, the 

Postal Service proposes to require an 

Intelligent Mail package barcode (IMpb) 

for all parcels that include tracking or 

extra services and all parcels claiming 

presort and destination entry pricing, 

effective June 3, 2013. In addition, the 

Postal Service proposes to require use of 

version 1.6 Shipping Services Electronic 

Manifest Files by June 3, 2013; and to 

require that these files include each 

destination ZIP + 4® code, or each 

destination delivery address by that 

date. This new file format will also 

require a new version of the customer 

extract file. The Postal Service proposes 

to require all parcels shipped using PC 

Postage systems to bear a IMpb, and to 

use version 1.6 Shipping Services 

Electronic Manifest, by June 4, 2012. 

To support future sorting efficiencies, 

the USPS strongly encourages mailers to 

place a ZIP + 4 code or destination 

address in the electronic files for each 

mailpiece as soon as possible. Mailers 

using the IMpb are also encouraged to 

include the additional two-digit 

delivery point code in the electronic 

file. The Postal Service proposes to 

require mailers to include the 

destination ZIP + 4 code (or destination 

address) in the electronic file for all 

records by June 3, 2013. 

These proposed standards will also 

require a postal routing code on all 

parcels and Priority Mail pieces, 

preferably as a concatenated IMpb or 

extra services barcode. When a 

concatenated IMpb or extra services 

barcode is not used, a separate postal 

routing barcode must be included in 

addition to the IMpb. Flat or lettershaped Priority Mail® or Critical MailTM

pieces may use the Intelligent Mail 

barcode (IMb) or POSTNET for the 

postal routing barcode. 

Under these proposed standards, 

(except for Standard Mail) mailers of 

presorted parcels, parcels claiming 

destination entry prices, or parcels 

bearing PC Postage, and who do not 

purchase a trackable extra service, or 

make use of the Delivery Confirmation 

service provided at no charge, must use 

(at a minimum) a ‘‘mail-class only’’ IMpb 

service type code that represents the 

class or subclass of the mailpiece that is 

being shipped. 

The Postal Service also proposes to 

modify the current requirement for 

mailers to use an extra service-specific, 

human-readable, service banner text 

format when printing an IMpb. Current 

standards require a different humanreadable service banner text for each 

extra service selected by the mailer. The 

Postal Service proposes to provide only 

mstockstill on DSKH9S0YB1PROD with PROPOSALS