Vol. 79 Friday, 

No. 192 October 3, 2014 

Part II 

Commodity Futures Trading Commission 

17 CFR Parts 23 and 140 

Margin Requirements for Uncleared Swaps for Swap Dealers and Major 

Swap Participants; Proposed Rule 

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59898 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

1See Dodd-Frank Wall Street Reform and 

Consumer Protection Act, Public Law 111–203, 124 

Stat. 1376 (2010). 

2 7 U.S.C. 1 et seq. 

3Section 4s(e) also directs the Commission to 

adopt capital requirements for SDs and MSPs. The 

Commission proposed capital rules in 2011. Capital 

Requirements for Swap Dealers and Major Swap 

Participants, 76 FR 27802 (May 12, 2011). The 

Commission will address capital requirements in a 

separate release. 

COMMODITY FUTURES TRADING 

COMMISSION 

17 CFR Parts 23 and 140 

RIN 3038–AC97 

Margin Requirements for Uncleared 

Swaps for Swap Dealers and Major 

Swap Participants 

AGENCY: Commodity Futures Trading 

Commission. 

ACTION: Proposed rule; advance notice of 

proposed rulemaking. 

SUMMARY: The Commodity Futures 

Trading Commission (‘‘Commission’’ or 

‘‘CFTC’’) is proposing regulations to 

implement section 4s(e) of the 

Commodity Exchange Act (‘‘CEA’’), as 

added by section 731 of the Dodd-Frank 

Wall Street Reform and Consumer 

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

provision requires the Commission to 

adopt initial and variation margin 

requirements for certain swap dealers 

(‘‘SDs’’) and major swap participants 

(‘‘MSPs’’). The proposed rules would 

establish initial and variation margin 

requirements for SDs and MSPs but 

would not require SDs and MSPs to 

collect margin from non-financial end 

users. In this release, the Commission is 

also issuing an Advance Notice of 

Proposed Rulemaking requesting public 

comment on the cross-border 

application of such margin 

requirements. The Commission is not 

proposing rules on this topic at this 

time. It is seeking public comment on 

several potential alternative approaches. 

DATES: Comments must be received on 

or before December 2, 2014. 

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 Christopher 

Kirkpatrick, Secretary of the 

Commission, 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 of these methods. 

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 regulations, 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 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, Division of 

Clearing and Risk, 202–418–5480, 

jlawton@cftc.gov; Thomas J. Smith, 

Deputy Director, Division of Swap 

Dealer and Intermediary Oversight, 202– 

418–5495, tsmith@cftc.gov; Rafael 

Martinez, Financial Risk Analyst, 

Division of Swap Dealer and 

Intermediary Oversight, 202–418–5462, 

rmartinez@cftc.gov; Francis Kuo, 

Attorney, Division of Swap Dealer and 

Intermediary Oversight, 202–418–5695, 

fkuo@cftc.gov; or Stephen A. Kane, 

Research Economist, Office of Chief 

Economist, 202–418–5911, skane@

cftc.gov; Commodity Futures Trading 

Commission, 1155 21st Street NW., 

Washington DC 20581. 

SUPPLEMENTARY INFORMATION: 

I. Background 

A. Statutory Authority 

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 designed to reduce risk, to 

increase transparency, and to promote 

market integrity within the financial 

system by, among other things: (1) 

Providing for the registration and 

regulation of SDs and MSPs; (2) 

imposing clearing and trade execution 

requirements on standardized derivative 

products; (3) creating 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. 

Section 731 of the Dodd-Frank Act 

added a new section 4s to the CEA 

setting forth various requirements for 

SDs and MSPs. Section 4s(e) mandates 

the adoption of rules establishing 

margin requirements for SDs and 

MSPs.3 Each SD and MSP for which 

there is a Prudential Regulator, as 

defined below, must meet margin 

requirements established by the 

applicable Prudential Regulator, and 

each SD and MSP for which there is no 

Prudential Regulator must comply with 

the Commission’s regulations governing 

margin. 

The term Prudential Regulator is 

defined in section 1a(39) of the CEA, as 

amended by Section 721 of the DoddFrank Act. This definition includes the 

Federal Reserve Board (‘‘FRB’’); 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 specifies the entities 

for which these agencies act as 

Prudential Regulators. These consist 

generally of federally insured deposit 

institutions, farm credit banks, federal 

home loan banks, the Federal Home 

Loan Mortgage Corporation, and the 

Federal National Mortgage Association. 

The FRB is the Prudential Regulator 

under section 4s not only for certain 

banks, but also for bank holding 

companies, certain foreign banks treated 

as bank holding companies, and certain 

subsidiaries of these bank holding 

companies and foreign banks. The FRB 

is not, however, the Prudential 

Regulator for nonbank subsidiaries of 

bank holding companies, some of which 

are required to be registered with the 

Commission as SDs or MSPs. In general, 

therefore, the Commission is required to 

establish margin requirements for all 

registered SDs and MSPs that are not 

subject to a Prudential Regulator. These 

include, among others, nonbank 

subsidiaries of bank holding companies, 

as well as certain foreign SDs and MSPs. 

Specifically, section 4s(e)(1)(B) of the 

CEA provides that each registered SD 

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Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 59899 

4Margin Requirements for Uncleared Swaps for 

Swap Dealers and Major Swap Participants, 76 FR 

23732 (April 28, 2011). 

5Margin and Capital Requirements for Covered 

Swap Entities, 76 FR 27564 (May 11, 2011). 

6These include, among others, the definition of 

financial end user, the definition of material swaps 

exposure, the requirement for two-way margin 

between SDs and financial end users, and the list 

of eligible collateral for initial margin. 

7BCBS/IOSCO, Consultative Document, Margin 

requirements for non-centrally cleared derivatives 

(July 2012). 

8BCBS/IOSCO, Quantitative Impact Study, 

Margin requirements for non-centrally cleared 

derivatives (November 2012). 

9BCBS/IOSCO, Consultative Document, Margin 

requirements for non-centrally cleared derivatives 

(February 2013). 

10BCBS/IOSCO, Margin requirements for noncentrally cleared derivatives (September 2013) 

(‘‘BCBS/IOSCO Report’’). 

and MSP for which there is not a 

Prudential Regulator shall meet such 

minimum capital requirements and 

minimum initial margin and variation 

margin requirements as the Commission 

shall by rule or regulation prescribe. 

Section 4s(e)(2)(B) provides that the 

Commission shall adopt rules for SDs 

and MSPs, with respect to their 

activities as an SD or an MSP, 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 (‘‘DCO’’). 

Section 4s(e)(3)(A) provides that to 

offset the greater risk to the SD or MSP 

and the financial system arising from 

the use of swaps that are not cleared, the 

requirements imposed under section 

4s(e)(2) shall (i) help ensure the safety 

and soundness of the SD or MSP and (ii) 

be appropriate for the risk associated 

with the non-cleared swaps. 

Section 4s(e)(3)(C) provides, in 

pertinent part, that in prescribing 

margin requirements the Prudential 

Regulator and the Commission shall 

permit the use of noncash collateral the 

Prudential Regulator or the Commission 

determines to be consistent with (i) 

preserving the financial integrity of 

markets trading swaps and (ii) 

preserving the stability of the United 

States financial system. 

Section 4s(e)(3)(D)(i) provides that the 

Prudential Regulators, the Commission, 

and the Securities and Exchange 

Commission (‘‘SEC’’) shall periodically 

(but not less frequently than annually) 

consult on minimum capital 

requirements and minimum initial and 

variation margin requirements. 

Section 4s(e)(3)(D)(ii) provides that 

the Prudential Regulators, Commission 

and SEC shall, to the maximum extent 

practicable, establish and maintain 

comparable minimum capital and 

minimum initial and variation margin 

requirements, including the use of 

noncash collateral, for SDs and MSPs. 

B. Previous Proposal 

Following extensive consultation and 

coordination with the Prudential 

Regulators, the Commission published 

proposed rules for public comment in 

2011.4 The Prudential Regulators 

published substantially similar rules 

two weeks later.5

The Commission received 102 

comment letters. The Prudential 

Regulators received a comparable 

number. The commenters included 

financial services industry associations, 

agricultural industry associations, 

energy industry associations, insurance 

industry associations, banks, brokerage 

firms, investment managers, insurance 

companies, pension funds, commercial 

end users, law firms, public interest 

organizations, and other members of the 

public. The commenters addressed 

numerous topics including applicability 

of the rules to certain products, 

applicability to certain market 

participants, margin calculation 

methodologies, two-way vs. one-way 

margin, margin thresholds, permissible 

collateral, use of independent 

custodians, rehypothecation of 

collateral, and harmonization with other 

regulators. 

The Commission has taken the 

comments it received into consideration 

in developing the further proposal 

contained herein. This proposal differs 

in a number of material ways from the 

previous proposal 6 and the Commission 

has determined that it is appropriate to 

issue a new request for comment. The 

Prudential Regulators have also decided 

to issue a new request for comment. The 

public is invited to comment on any 

aspect of the current proposal. 

C. International Standards 

While the comments on the 2011 

proposal were being reviewed, 

regulatory authorities around the world 

determined that global harmonization of 

margin standards was an important goal. 

The CFTC and the Prudential Regulators 

decided to hold their rulemakings in 

abeyance pending completion of the 

international efforts. 

In October 2011, the Basel Committee 

on Banking Supervision (‘‘BCBS’’) and 

the International Organization of 

Securities Commissions (‘‘IOSCO’’), in 

consultation with the Committee on 

Payment and Settlement Systems 

(‘‘CPSS’’) and the Committee on Global 

Financial Systems (‘‘CGFS’’), formed a 

working group to develop international 

standards for margin requirements for 

uncleared swaps. Representatives of 

more than 20 regulatory authorities 

participated. From the United States, 

the CFTC, the FDIC, the FRB, the OCC, 

the Federal Reserve Bank of New York, 

and the SEC were represented. 

In July 2012, the working group 

published a proposal for public 

comment.7 In addition, the group 

conducted a Quantitative Impact Study 

(‘‘QIS’’) to assess the potential liquidity 

and other quantitative impacts 

associated with margin requirements.8

After consideration of the comments 

on the proposal and the results of the 

QIS, the group published a near-final 

proposal in February 2013 and 

requested comment on several specific 

issues.9 The group considered the 

additional comments in finalizing the 

recommendations set out in the report. 

The final report was issued in 

September 2013.10 This report (the 

‘‘2013 international framework’’) 

articulates eight key principles for noncleared derivatives margin rules, which 

are described below. These principles 

represent the minimum standards 

approved by BCBS and IOSCO and 

recommended to the regulatory 

authorities in member jurisdictions of 

these organizations. 

1. Appropriate Margining Practices 

Should be in Place With Respect to all 

Non-Cleared Derivative Transactions 

The 2013 international framework 

recommends that appropriate margining 

practices be in place with respect to all 

derivative transactions that are not 

cleared by central counterparties 

(‘‘CCPs’’). The 2013 international 

framework does not include a margin 

requirement for physically settled 

foreign exchange (‘‘FX’’) forwards and 

swaps. The framework also would not 

apply initial margin requirements to the 

fixed physically-settled FX component 

of cross-currency swaps. 

2. Financial Firms and Systemically 

Important Nonfinancial Entities 

(Covered Entities) Must Exchange Initial 

and Variation Margin 

The 2013 international framework 

recommends bilateral exchange of 

initial and variation margin for noncleared derivatives between covered 

entities. The precise definition of 

‘‘covered entities’’ is to be determined 

by each national regulator, but in 

general should include financial firms 

and systemically important nonfinancial entities. Sovereigns, central 

banks, certain multilateral development 

banks, the Bank for International 

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59900 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

Settlements (BIS), and non-systemic, 

non-financial firms are not included as 

covered entities. 

Under the 2013 international 

framework, all covered entities that 

engage in non-cleared derivatives 

should exchange, on a bilateral basis, 

the full amount of variation margin with 

a zero threshold on a regular basis (e.g., 

daily). All covered entities are also 

expected to exchange, on a bilateral 

basis, initial margin with a threshold 

not to exceed Ö50 million. The 

threshold applies on a consolidated 

group, rather than legal entity, basis. In 

addition, and in light of the permitted 

initial margin threshold, the 2013 

international framework recommends 

that entities with a level of non-cleared 

derivative activity of Ö8 billion notional 

or more would be subject to initial 

margin requirements. 

3. The Methodologies for Calculating 

Initial and Variation Margin Should (i) 

Be Consistent Across Covered Entities, 

and (ii) Ensure That All Counterparty 

Risk Exposures Are Covered With a 

High Degree of Confidence 

The 2013 international framework 

states that the potential future exposure 

of a non-cleared derivative should 

reflect an estimate of an increase in the 

value of the instrument that is 

consistent with a one-tailed 99% 

confidence level over a 10-day horizon 

(or longer, if variation margin is not 

collected on a daily basis), based on 

historical data that incorporates a period 

of significant financial stress. 

The 2013 international framework 

permits the amount of initial margin to 

be calculated by reference to internal 

models approved by the relevant 

national regulator or a standardized 

margin schedule, but covered entities 

should not ‘‘cherry pick’’ between the 

two calculation methods. Models may 

allow for conceptually sound and 

empirically demonstrable portfolio risk 

offsets where there is an enforceable 

netting agreement in effect. However, 

portfolio risk offsets may only be 

recognized within, and not across, 

certain well-defined asset classes: 

credit, equity, interest rates and foreign 

exchange, and commodities. A covered 

entity using the standardized margin 

schedule may adjust the gross initial 

margin amount (notional exposure 

multiplied by the relevant percentage in 

the table) by a ‘‘net-to-gross ratio,’’ 

which is also used in the bank 

counterparty credit risk capital rules to 

reflect a degree of netting of derivative 

positions that are subject to an 

enforceable netting agreement. 

4. To Ensure That Assets Collected as 

Collateral Can Be Liquidated in a 

Reasonable Amount of Time To 

Generate Proceeds That Could 

Sufficiently Protect Covered Entities 

From Losses in the Event of a 

Counterparty Default, These Assets 

Should Be Highly Liquid and Should, 

After Accounting for an Appropriate 

Haircut, be Able To Hold Their Value in 

a Time of Financial Stress 

The 2013 international framework 

recommends that national supervisors 

develop a definitive list of eligible 

collateral assets. The 2013 international 

framework includes examples of 

permissible collateral types, provides a 

schedule of standardized haircuts, and 

indicates that model-based haircuts may 

be appropriate. In the event that a 

dispute arises over the value of eligible 

collateral, the 2013 international 

framework provides that both parties 

should make all necessary and 

appropriate efforts, including timely 

initiation of dispute resolution 

protocols, to resolve the dispute and 

exchange any required margin in a 

timely fashion. 

5. Initial Margin Should be Exchanged 

on a Gross Basis and Held in Such a 

Way as to Ensure That (i) the Margin 

Collected Is Immediately Available to 

the Collecting Party in the Event of the 

Counterparty’s Default, and (ii) the 

Collected Margin Is Subject to 

Arrangements That Fully Protect the 

Posting Party 

The 2013 international framework 

provides that collateral collected as 

initial margin from a ‘‘customer’’ 

(defined as a ‘‘buy-side financial firm’’) 

should be segregated from the initial 

margin collector’s proprietary assets. 

The initial margin collector also should 

give the customer the option to 

individually segregate its initial margin 

from other customers’ margin. In very 

specific circumstances, the initial 

margin collector may use margin 

provided by the customer to hedge the 

risks associated with the customer’s 

positions with a third party. To the 

extent that the customer consents to 

rehypothecation, it should be permitted 

only where applicable insolvency law 

gives the customer protection from risk 

of loss of initial margin in instances 

where either or both of the initial 

margin collector and the third party 

become insolvent. Where a customer 

has consented to rehypothecation and 

adequate legal safeguards are in place, 

the margin collector and the third party 

to which customer collateral is 

rehypothecated should comply with 

additional restrictions detailed in the 

2013 international framework, including 

a prohibition on any further 

rehypothecation of the customer’s 

collateral by the third party. 

6. Requirements for Transactions 

Between Affiliates Are Left to the 

National Supervisors 

The 2013 international framework 

recommends that national supervisors 

establish margin requirements for 

transactions between affiliates as 

appropriate in a manner consistent with 

each jurisdiction’s legal and regulatory 

framework. 

7. Requirements for Margining NonCleared Derivatives Should Be 

Consistent and Non-Duplicative Across 

Jurisdictions 

Under the 2013 international 

framework, home-country supervisors 

may allow a covered entity to comply 

with a host-country’s margin regime if 

the host-country margin regime is 

consistent with the 2013 international 

framework. A branch may be subject to 

the margin requirements of either the 

headquarters’ jurisdiction or the host 

country. 

8. Margin Requirements Should Be 

Phased in Over an Appropriate Period 

of Time 

The 2013 international framework 

phases in margin requirements between 

December 2015 and December 2019. 

Covered entities should begin 

exchanging variation margin by 

December 1, 2015. The date on which a 

covered entity should begin to exchange 

initial margin with a counterparty 

depends on the notional amount of noncleared derivatives (including 

physically settled FX forwards and 

swaps) entered into both by its 

consolidated corporate group and by the 

counterparty’s consolidated corporate 

group. 

Currency denomination. The 2013 

international framework recommends 

specific quantitative levels for several 

requirements such as the level of 

notional derivative exposure that results 

in an entity being subject to the margin 

requirements (Ö8 billion), permitted 

initial margin thresholds (Ö50 million), 

and minimum transfer amounts 

(Ö500,000). In the 2013 international 

framework, all such amounts are 

denominated in Euros. In this proposal 

all such amounts are denominated in 

U.S. dollars. The Commission is aware 

that, over time, amounts that are 

denominated in different currencies in 

different jurisdictions may fluctuate 

relative to one another due to changes 

in exchange rates. 

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Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 59901 

11See The Financial Crisis Inquiry Commission, 

The Financial Crisis Inquiry Report: Final Report of 

the National Commission on the Causes of the 

Financial and Economic Crisis in the United States 

(Official Government Edition) at 265–268 (2011), 

available at http://fcic-static.law.stanford.edu/cdn_

media/fcic-reports/fcic_final_report_full.pdf. 

12 Id. at 344–352, 350. See also United States 

Department of the Treasury, Office of Financial 

Stability, Troubled Asset Relief Program, Four Year 

Retrospective: An Update on the Wind Down of 

TARP, pp. 3, 18–19. Treasury and the Federal 

Reserve committed $182 billion to stabilize AIG. 

Ultimately all of this was recovered plus a return 

of $22.7 billion. 

13For purposes of this proposal, the term ‘‘SD’’ 

means any swap dealer registered with the 

Commission. Similarly, the term ‘‘MSP’’ means any 

major swap participant registered with the 

Commission. 

14As required by section 4s of the CEA, the 

Commission staff also has consulted with the SEC 

staff. 

15Proposed Regulation § 23.150. 

16The term uncleared swap is defined in 

proposed Regulation § 23.151. 

17A schedule of compliance dates is set forth in 

proposed Regulation § 23.160. 

18See CFTC Ltr. No. 14–107 (August 18, 2014) 

(granting no-action relief to Clearing Corporation of 

India Ltd.); CFTC Ltr. No. 14–87 (June 26, 2014) 

(granting no-action relief to Korea Exchange, Inc.); 

CFTC Ltr. No. 14–68 (May 7, 2014) (granting noaction relief to OTC Clearing Hong Kong Limited 

Continued 

The Commission seeks comment on 

whether and how fluctuations resulting 

from exchange rate movements should 

be addressed. In particular, should these 

amounts be expressed in terms of a 

single currency in all jurisdictions to 

prevent such fluctuations? Should the 

amounts be adjusted over time if and 

when exchange rate movements 

necessitate realignment? Are there other 

approaches to deal with fluctuations 

resulting from significant exchange rate 

movements? Are there other issues that 

should be considered in connection to 

the effects of fluctuating exchange rates? 

II. Proposed Margin Regulations 

A. Introduction 

During the financial crisis of 2008– 

2009, DCOs met all their obligations 

without any financial support from the 

government. By contrast, significant 

sums were expended by governmental 

entities as the result of losses incurred 

in connection with uncleared swaps. 

For example, a unit of American 

International Group (‘‘AIG’’) entered 

into many credit default swaps and did 

not post initial margin or regularly pay 

variation margin on these positions.11

AIG was unable to meet its obligations 

and the Federal Reserve and the 

Department of the Treasury expended 

large sums of money to meet these 

obligations.12

A key reason for this difference in the 

performance of cleared and uncleared 

swaps is that DCOs use variation margin 

and initial margin as the centerpiece of 

their risk management programs while 

these tools often were not universally 

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 serves as a 

mechanism for periodically recognizing 

changes in the value of open positions 

and reducing unrealized losses to zero. 

Open positions are marked to their 

current market value each day and 

funds are transferred 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 some or all of any loss. Because 

the payment of variation margin 

prevents losses from compounding over 

an extended period of time, initial 

margin only needs to cover any 

additional losses that might accrue 

between the previous time that variation 

margin was paid and the time that the 

position is liquidated. 

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 by a party to meet its 

obligations. 

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. As 

discussed further below, many 

commenters expressed concern that the 

imposition of margin requirements on 

uncleared swaps will be very costly for 

SDs and MSPs.13 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, as detailed further below. 

The discussion below addresses: (i) 

The products covered by the proposed 

rules; (ii) the market participants 

covered by the proposed rules; (iii); the 

nature and timing of the margin 

obligations; (iv) the methods of 

calculating initial margin; (v) the 

methods of calculating variation margin; 

(vi) permissible forms of margin; (vii) 

custodial arrangements; (viii) 

documentation requirements; (ix) the 

implementation schedule; and (x) 

advance notice of proposed rulemaking 

on the cross-border application of the 

rules. 

In developing the proposed rules, the 

Commission staff worked closely with 

the staff of the Prudential Regulators.14

In most respects, the proposed rules 

would establish a similar framework for 

margin requirements as the Prudential 

Regulators’ proposal. Key differences 

are noted in the discussion below. 

The proposed rules are consistent 

with the 2013 international framework. 

In some instances, as contemplated in 

the framework, the proposed rules 

provide more detail than the framework. 

In a few other instances, the proposed 

rules are stricter than the framework. 

Any such variations from the framework 

are noted in the discussion below. 

B. Products 

As noted above, section 4s(e)(2)(B)(ii) 

of the CEA directs the Commission to 

establish both initial and variation 

margin requirements for SDs and MSPs 

‘‘on all swaps that are not cleared.’’ The 

scope provision of the proposed rules 15

states that the proposal would cover 

swaps that are uncleared swaps 16 and 

that are executed after the applicable 

compliance date.17

The term ‘‘cleared swap’’ is defined in 

section 1a(7) of the CEA to include any 

swap that is cleared by a DCO registered 

with the Commission. The Commission 

notes, however, that SDs and MSPs also 

clear swaps through foreign clearing 

organizations that are not registered 

with the Commission. The Commission 

believes that a clearing organization that 

is not a registered DCO must meet 

certain basic standards in order to avoid 

creating a mechanism for evasion of the 

uncleared margin requirements. 

Accordingly, the Commission is 

proposing to include in the definition of 

cleared swaps certain swaps that have 

been accepted for clearing by an entity 

that has received a no-action letter from 

the Commission staff or exemptive relief 

from the Commission permitting it to 

clear such swaps for U.S. persons 

without being registered as a DCO.18

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59902 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

and certain of its clearing members); CFTC Ltr. No. 

14–27 (Mar. 20, 2014) (extending previous grant of 

no-action relief to Eurex Clearing AG and certain of 

its clearing members); CFTC Ltr. No. 14–07 (Feb. 6, 

2014) (granting no-action relief to ASX Clear 

(Futures) Pty Limited); and CFTC Ltr. No. 13–73 

(Dec. 19, 2013) (extending previous grant of noaction relief to Japan Securities Clearing 

Corporation and certain of its clearing members). 

19A QCCP is a clearing organization that meets 

the standards to be designated as such set forth by 

the Basel Committee for Banking Supervision in the 

report ‘‘Capital requirements for bank exposures to 

central counterparties’’ (April 2014). 

20See proposed Regulation § 23.154(b)(2) for 

initial margin and proposed Regulation § 23.153(c) 

for variation margin. 

21 Determination of Foreign Exchange Swaps and 

Foreign Exchange Forwards Under the Commodity 

Exchange Act, 77 FR 69694 (Nov. 20, 2012). 

22This term is defined in proposed Regulation 

§ 23.151. 

23This term is defined in proposed Regulation 

§ 23.151. 

24This term is defined in proposed Regulation 

§ 23.151 to include entities that are not SDs, MSPs, 

or financial entities. 

25 ‘‘The precise definition of financial firms, nonfinancial firms, and systemically important nonfinancial firms will be determined by appropriate 

national regulation.’’ See BCBS/IOSCO Report at 9. 

The Commission requests comment 

on whether it is appropriate to exclude 

swaps that are cleared by an entity that 

is not a registered DCO. If so, the 

Commission further requests comment 

on whether the proposed rule captures 

the proper clearing organizations. For 

example, should the Commission 

require that the clearing organizations 

be qualifying central counterparties 

(‘‘QCCPs’’) 19 or be subject to regulation 

and supervision that is consistent with 

the CPSS–IOSCO Principles for 

Financial Market Infrastructures 

(‘‘PFMIs’’)? 

Because the pricing of swaps reflects 

the credit arrangements under which 

they were executed, it could be unfair 

to the parties and disruptive to the 

markets to require that the rules apply 

to positions executed before the 

applicable compliance dates. The rules, 

however, would permit SDs and MSPs 

voluntarily to include swaps executed 

before the applicable compliance date in 

portfolios margined pursuant to the 

proposed rules.20 Many market 

participants might do so to take 

advantage of netting effects across 

transactions. 

As a result of the determination by the 

Secretary of the Treasury to exempt 

foreign exchange swaps and foreign 

exchange forwards from the definition 

of swap,21 the following transactions 

would not be subject to the 

requirements: (i) Foreign exchange 

swaps; (ii) foreign exchange forwards; 

and (iii) the fixed, physically settled 

foreign exchange transactions associated 

with the exchange of principal in crosscurrency swaps. 

In a cross-currency swap, the parties 

exchange principal and interest rate 

payments in one currency for principal 

and interest rate payments in another 

currency. The exchange of principal 

occurs upon the inception of the swap, 

with a reversal of the exchange of 

principal at a later date that is agreed 

upon at the inception of the swap. The 

foreign exchange transactions associated 

with the fixed exchange of principal in 

a cross-currency swap are closely 

related to the exchange of principal that 

occurs in the context of a foreign 

exchange forward or swap. Accordingly, 

the Commission is proposing to treat 

that portion of a cross-currency swap 

that is a fixed exchange of principal in 

a manner that is consistent with the 

treatment of foreign exchange forwards 

and swaps. This treatment of crosscurrency swaps is limited to crosscurrency swaps and does not extend to 

any other swaps such as non-deliverable 

currency forwards. 

The Commission requests comment 

on the proposed treatment of products. 

In particular, commenters are invited to 

discuss the costs and benefits of the 

proposed approach. Commenters are 

urged to quantify the costs and benefits, 

if practicable. Commenters also may 

suggest alternatives to the proposed 

approach where the commenters believe 

that the alternatives would be 

appropriate under the CEA. 

C. Market Participants 

1. SDs and MSPs 

As noted above, section 4s(e)(2)(B) of 

the CEA directs the Commission to 

impose margin requirements on SDs and 

MSPs for which there is no Prudential 

Regulator (‘‘covered swap entities’’ or 

‘‘CSEs’’).22 This provision further states 

that the requirement shall apply to ‘‘all 

swaps that are not cleared.’’ Section 

4s(e)(3)(A)(2) states that the 

requirements must be ‘‘appropriate to 

the risks associated with’’ the swaps. 

Because different types of 

counterparties can pose different levels 

of risk, the Commission’s proposed 

requirements would differ depending on 

the category of counterparty. The 

proposed rules would establish three 

categories of counterparty: (i) SDs and 

MSPs, (ii) financial end users,23 and (iii) 

non-financial end users.24 As discussed 

below, the nature of an SD/MSP’s 

obligations under the rules would differ 

depending on whether the counterparty 

was a covered counterparty or a nonfinancial end user. 

2. Financial End Users 

a. Definition 

Financial end users would include 

any entity that (i) is specified in the 

definition, and (ii) is not an SD or MSP. 

The definition lists numerous entities 

whose business is financial in nature. 

The proposed rule also would permit 

the Commission to designate additional 

entities as financial end users if it 

identified additional entities whose 

activities and risk profile would warrant 

inclusion. As contemplated by the 2013 

international framework, the CFTC 

proposal, which is the same as the 

Prudential Regulator’s proposal, 

contains greater detail in defining 

financial end users than the 

international standards.25

In developing the definition, the 

Commission and the Prudential 

Regulators sought to provide clarity 

about whether particular counterparties 

would be subject to the margin 

requirements of the proposed rule. The 

definition is an attempt to strike a 

balance between the need to capture all 

financial counterparties that pose 

significant risk to the financial system 

and the danger of being overly 

inclusive. 

The Commission believes that 

financial firms generally present a 

higher level of risk than other types of 

counterparties because the profitability 

and viability of financial firms is more 

tightly linked to the health of the 

financial system than other types of 

counterparties. Because financial 

counterparties are more likely to default 

during a period of financial stress, they 

pose greater systemic risk and risk to the 

safety and soundness of the CSE. 

The list of financial entities is based 

to a significant extent on Federal 

statutes that impose registration or 

chartering requirements on entities that 

engage in specified financial activities. 

Such activities include deposit taking 

and lending, securities and swaps 

dealing, investment advisory activities, 

and asset management. 

Because Federal law largely looks to 

the States for the regulation of the 

business of insurance, the proposed 

definition broadly includes entities 

organized as insurance companies or 

supervised as such by a State insurance 

regulator. This element of the proposed 

definition would extend to reinsurance 

and monoline insurance firms, as well 

as insurance firms supervised by a 

foreign insurance regulator. 

The proposal also would cover a 

broad variety and number of nonbank 

lending and retail payment firms that 

operate in the market. To this end, the 

proposal would include State-licensed 

or registered credit or lending entities 

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26The Commission expects that financial 

cooperatives that provide financial services to their 

members, such as lending to their members and 

entering into swaps in connection with those loans, 

would be treated as financial end users, pursuant 

to this aspect of the proposed rule’s coverage of 

credit or lending entities. 

27Under the proposed rule, the financing 

subsidiaries or affiliates of producer or consumer 

cooperatives would be non-financial end users. 

28Section 2(h)(7)(c)(ii) of the CEA and section 

3C(g)(4) of the Securities Exchange Act of 1934 

authorize the CFTC and the SEC, respectively, to 

exempt small depository institutions, small Farm 

Credit System institutions, and small credit unions 

with total assets of $10 billion or less from the 

mandatory clearing requirements for swaps and 

security-based swaps. Additionally, the CFTC, 

pursuant to its authority under section 2(h)(1)(A) of 

the CEA, enacted 17 CFR 50.51, which allows 

cooperative financial entities, including those with 

total assets in excess of $10 billion, to elect an 

exemption from mandatory clearing of swaps that: 

(1) They enter into in connection with originating 

loans for their members; or (2) hedge or mitigate 

commercial risk related to loans or swaps with their 

members. 

29See e.g., Definitions of ‘‘Predominantly 

Engaged In Financial Activities’’ and ‘‘Significant 

Nonbank Financial Company and Bank Holding 

Company’’, 68 FR 20756 (April 5, 2013). 

30Proposed Regulation § 23.151. 

31A captive finance company is an entity that is 

excluded from the definition of financial entity 

under section 2(h)(7)(c)(iii) of the CEA for purposes 

of the requirement to submit certain swaps for 

clearing. That section describes it as ‘‘an entity 

whose primary business is providing financing, and 

uses derivatives for the purpose of hedging 

underlying commercial risks related to interest rate 

and foreign currency exposures, 90 percent or more 

of which arise from financing that facilitates the 

purchase or lease of products, 90 percent or more 

of which are manufactured by the parent company 

or another subsidiary of the parent company.’’ 

32An agent affiliate is an entity that is an affiliate 

of a person that qualifies for an exception from the 

requirement to submit certain trades for clearing. 

Under section 2(h)(7)(D) of the CEA, ‘‘an affiliate of 

a person that qualifies for an exception under 

subparagraph (A) (including affiliate entities 

predominantly engaged in providing financing for 

the purchase of the merchandise or manufactured 

goods of the person) may qualify for the exception 

only if the affiliate, acting on behalf of the person 

and as an agent, uses the swap to hedge or mitigate 

the commercial risk of the person or other affiliate 

of the person that is not a financial entity.’’ 

and money services businesses, under 

proposed regulatory language 

incorporating an inclusive list of the 

types of firms subject to State law.26

However, the Commission recognizes 

that the licensing of nonbank lenders in 

some states extends to commercial firms 

that provide credit to the firm’s 

customers in the ordinary course of 

business. Accordingly, the Commission 

is proposing to exclude an entity 

registered or licensed solely because it 

finances the entity’s direct sales of 

goods or services to customers. The 

Commission requests comment on 

whether this aspect of the proposed rule 

adequately maintains a distinction 

between financial end users and 

commercial end users. 

In addition, real estate investment 

companies would be financial end 

users, as they are entities that would be 

investment companies under section 3 

of the Investment Company Act but for 

section 3(c)(5)(C). Furthermore, other 

securitization vehicles would be 

financial end users in cases where those 

vehicles are entities that are deemed not 

to be investment companies under 

section 3 of the Investment Company 

Act pursuant to Rule 3a–7. The 

Commission also notes that the category 

of investment companies registered with 

the SEC under the Investment Company 

Act would include registered 

investment companies as well as 

business development companies. 

Under the proposed rule, those 

cooperatives that are financial 

institutions, such as credit unions, Farm 

Credit System banks and associations, 

and the National Rural Utilities 

Cooperative Finance Corporation would 

be financial end users because their sole 

business is lending and providing other 

financial services to their members, 

including engaging in swaps in 

connection with such loans.27

Cooperatives that are financial end users 

may qualify for an exemption from 

clearing,28 and therefore, they may enter 

into non-cleared swaps with covered 

swap entities that are subject to the 

proposed rule. 

The Commission remains concerned, 

however, that one or more types of 

financial entities might escape 

classification under the specific Federal 

or State regulatory regimes included in 

the proposed definition of a financial 

end user. Accordingly, the definition 

includes two additional prongs. First, 

the definition would cover an entity that 

is, or holds itself out as being, an entity 

or arrangement that raises money from 

investors primarily for the purpose of 

investing in loans, securities, swaps, 

funds or other assets for resale or other 

disposition or otherwise trading in 

loans, securities, swaps, funds or other 

assets. The Commission requests 

comment on the extent to which there 

are (or may be in the future) pooled 

investment vehicles that are not 

captured by the other prongs of the 

definition (such as the provisions 

covering private funds under the 

Investment Advisers Act or commodity 

pools under the CEA). The Commission 

also requests comment on whether this 

aspect of the definition of financial end 

user provides sufficiently clear guidance 

to covered swap entities and market 

participants as to its intended scope, 

and whether it adequately maintains a 

distinction between financial end users 

and commercial end users. 

Second, the proposal would allow the 

Commission to require a swap dealer 

and major swap participant (‘‘covered 

swap entity’’) to treat an entity as a 

financial end user for margin purposes, 

even if the person is not specifically 

listed within the definition of ‘‘financial 

end user’’ or if the entity is excluded 

from the definition of financial end user 

as described below. This provision was 

included out of an abundance of caution 

to act as a safety mechanism in the 

event that an entity didn’t fall squarely 

within one of the listed categories but 

was effectively acting as a financial end 

user. 

To address the classification of 

foreign entities as financial end users, 

the proposal would require the covered 

swap entity to determine whether a 

foreign counterparty would fall within 

another prong of the financial end user 

definition if the foreign entity was 

organized under the laws of the United 

States or any State. The Commission 

recognizes that this approach would 

impose upon covered swap entities the 

difficulties associated with analyzing a 

foreign counterparty’s business 

activities in light of a broad array of U.S. 

regulatory requirements. The 

alternative, however, would require 

covered swap entities to gather a foreign 

counterparty’s financial reporting data 

and determine the relative amount of 

enumerated financial activities in which 

the counterparty is engaged over a 

rolling period.29 The Commission 

requests comment on whether some 

other method or approach would 

adequately assure that the rule’s 

objectives with respect to dealer safety 

and soundness and reductions of 

systemic risk can be achieved, in a 

fashion that can be more readily 

operationalized by covered swap 

entities. For example, would it be 

appropriate to have foreign 

counterparties certify to CSEs whether 

they are financial end users or not? This 

could be operationally simpler for the 

CSEs and would avoid the circumstance 

where one CSE, in good faith, deemed 

a foreign counterparty to be a financial 

end user and another CSE, in good faith, 

did not. 

The definition of financial entities 30

would exclude the government of any 

country, central banks, multilateral 

development banks, the Bank for 

International Settlements, captive 

finance companies,31 and agent 

affiliates.32 The exclusion for sovereign 

entities, multilateral development banks 

and the Bank for International 

Settlements is consistent with the 2013 

international framework and the 

proposal of the Prudential Regulators. 

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59904 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

33See Commission Regulations §§ 50.50(d)(small 

banks), 50.51 (cooperatives), 50.52 (inter-affiliate 

trades), and CFTC Ltr. No. 13–22 (June 4, 2013) 

(treasury affiliates). 

34 12 U.S.C. 371c–1(a). 

35Proposed Regulation § 23.152 applies to 

‘‘covered counterparties.’’ Proposed Regulation 

§ 23.151 defines that term to include financial 

entities with material swaps exposure. 

36The 2013 international framework states that 

all uncleared derivatives, ‘‘including physically 

settled FX forwards and swaps’’ should be included 

in determining whether a covered entity should be 

subject to margin requirements. BCBS/IOSCO 

Report Paragraph 8.8. Although these products 

would not themselves be subject to margin 

requirements, they are uncleared derivatives that 

pose risks. It was the judgment of BCBS/IOSCO that 

they should be included in identifying significant 

market participants in the uncleared space. 

Consistent with international standards and with 

the Prudential Regulators’ proposal, the 

Commission is proposing to include them for 

purposes of this calculation. 

37Proposed Regulation § 23.151. 

Captive finance companies and agent 

affiliates were excluded by the DoddFrank Act from the definition of 

financial entity subject to mandatory 

clearing. 

The Commission notes that States 

would not be excluded from the 

definition of financial end user, as the 

term ‘‘sovereign entity’’ includes only 

central governments. The categorization 

of a State or particular part of a State as 

a financial end user depends on 

whether that part of the State is 

otherwise captured by the definition of 

financial end user. For example, a State 

entity that is a ‘‘governmental plan’’ 

under ERISA would meet the definition 

of financial end user. 

For a foreign entity that was not a 

central government, a foreign regulator 

could request a determination whether 

the entity was a financial end user. Such 

a determination could extend to other 

similarly situated entities in that 

jurisdiction. 

The Commission seeks comment on 

all aspects of the financial end user 

definition, including whether the 

definition has succeeded in capturing 

all entities that should be included. The 

Commission requests comment on 

whether there are additional entities 

that should be included as financial end 

users and, if so, how those entities 

should be defined. Further, the 

Commission also requests comment on 

whether there are additional entities 

that should be excluded from the 

definition of financial end user and why 

those particular entities should be 

excluded. The Commission also 

requests comment on whether another 

approach to defining financial end user 

(e.g., basing the financial end user 

definition on the financial entity 

definition as in the 2011 proposal) 

would provide more appropriate 

coverage and clarity, and whether 

covered swap entities could 

operationalize such an approach as part 

of their regular procedures for taking on 

new counterparties. 

The Commission requests comment 

on the costs and benefits of the 

proposed definition of financial end 

user. Commenters are urged to quantify 

the costs and benefits, if practicable. 

Commenters also may suggest 

alternatives to the proposed approach 

where the commenters believe that the 

alternatives would be appropriate under 

the CEA. 

b. Small Banks 

As noted above, banks would be 

financial end users under the proposal. 

They would be subject to initial margin 

requirements if they entered into 

uncleared swaps with CSEs and, as 

discussed below, had material swaps 

exposure. Staff of the Prudential 

Regulators have indicated that they 

expect that the proposed rule likely will 

have minimal impact on small banks. 

Staff of the Prudential Regulators 

believe that the vast majority of small 

banks do not engage in swaps at or near 

that level of activity that would meet the 

material swaps exposure threshold. If, 

however, a small bank did exceed the 

threshold level, the Prudential 

Regulators believe it would be 

appropriate for the protection of both 

the CSE and the small bank for two-way 

initial margin to be posted. The 

Commission notes that, as discussed in 

more detail below, initial margin would 

only need to be posted to the extent it 

exceeded $65 million. 

The proposed rule would require a 

CSE to exchange daily variation margin 

with a small bank, regardless of whether 

the institution had material swap 

exposure. However, the covered swap 

entity would only be required to collect 

variation margin from a small bank 

when the amount of both initial margin 

and variation margin required to be 

collected exceeded $650,000. The 

Prudential Regulators have indicated 

that they expect that the vast majority of 

small banks will have a daily margin 

requirement that is below this amount. 

The Commission requests comment 

on all aspects of the proposed treatment 

of small banks. In particular, the 

Commission requests comment on the 

interaction of this proposal with 

clearing exemptions that have been 

granted.33

c. Affiliates of CSEs 

The proposal generally would cover 

swaps between CSEs and their affiliates 

that are financial end users. The 

Commission notes that other applicable 

laws require transactions between banks 

and their affiliates to be on an arm’s 

length basis. For example, section 23B 

of the Federal Reserve Act provides that 

many transactions between a bank and 

its affiliates must be on terms and under 

circumstances, including credit 

standards, that are substantially the 

same or at least as favorable to the bank 

as those prevailing at the time for 

comparable transactions with or 

involving nonaffiliated companies.34

Consistent with that treatment, the 

Prudential Regulators and the 

Commission are proposing to apply the 

margin requirements to swaps between 

CSEs and their affiliates. 

The Commission requests comment 

on all aspects of the proposed treatment 

of transactions with affiliates. In 

particular, the Commission requests 

comment on the interaction of this 

proposal with clearing exemptions that 

have been granted. 

d. Multilateral Development Banks 

The proposed definition of the term 

‘‘multilateral development bank,’’ 

includes a provision encompassing 

‘‘[a]ny other entity that provides 

financing for national or regional 

development in which the U.S. 

government is a shareholder or 

contributing member or which the 

Commission determines poses 

comparable credit risk.’’ The 

Commission seeks comment regarding 

this definition. In particular, is the 

criterion of comparability of credit risk 

appropriate for this definition? Should 

the Commission look to other 

characteristics of the entity in 

determining whether it should be 

within the definition of ‘‘multilateral 

development bank’’? 

e. Material Swaps Exposure 

A CSE would not be required to 

exchange initial margin with a financial 

end user if the financial end user did 

not have ‘‘material swaps exposure.’’ 35

Material swaps exposure would be 

computed using the average daily 

aggregate notional amount of uncleared 

swaps, security-based swaps, foreign 

exchange forwards, and foreign 

exchange swaps36 with all 

counterparties for June, July, and 

August of the previous calendar year. 

Essentially, a financial end user would 

have material swaps exposure if it held 

an aggregate gross notional amount of 

these products of more than $3 billion.37

This provision recognizes that a 

financial end user that has relatively 

smaller positions does not pose the 

same risks as a financial end user with 

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38BCBS/IOSCO Report at 9. 

larger positions. By reducing the 

number of market participants subject to 

certain margin requirements, it also 

addresses the concerns that have been 

expressed about the availability of 

sufficient collateral to meet these 

requirements. 

While adoption of a material swaps 

exposure threshold is consistent with 

the 2013 international framework,38 the 

Commission and the Prudential 

Regulators, are proposing to set the 

materiality standard lower than the 

international standard. However, the 

lower standard was chosen in order to 

be consistent with the intent of the 

international standards, which was to 

require collection of margin only when 

the amount exceeds $65 million, as 

explained below. 

The 2013 international framework 

defines smaller financial end users as 

those counterparties that have a gross 

aggregate amount of covered swaps 

below Ö8 billion, which, at current 

exchange rates, is approximately equal 

to $11 billion. The preliminary view of 

the Commission and the Prudential 

Regulators is that defining material 

swaps exposure as a gross notional 

exposure of $3 billion, rather than $11 

billion, is appropriate because it reduces 

systemic risk without imposing undue 

burdens on covered swap entities, and 

therefore, is consistent with the 

objectives of the Dodd-Frank Act. This 

view is based on data and analyses that 

have been conducted since the 

publication of the 2013 international 

framework. 

Specifically, the Commission and the 

Prudential Regulators have reviewed 

actual initial margin requirements for a 

sample of cleared swaps. These analyses 

indicate that there are a significant 

number of cases in which a financial 

end user would have a material swaps 

exposure level below $11 billion but 

would have a swap portfolio with an 

initial margin collection amount that 

significantly exceeds the proposed 

permitted initial margin threshold 

amount of $65 million. The intent of 

both the Commission and the 2013 

international framework is that the 

initial margin threshold provide smaller 

counterparties with relief from the 

operational burden of measuring and 

tracking initial margin collection 

amounts that are expected to be below 

$65 million. Setting the material swaps 

exposure threshold at $11 billion 

appears to be inconsistent with this 

intent, based on the recent analyses. 

The table below summarizes actual 

initial margin requirements for 4,686 

counterparties engaged in cleared 

interest rate swaps. Each counterparty 

represents a particular portfolio of 

cleared interest rate swaps. Each 

counterparty had a swap portfolio with 

a total gross notional amount less than 

$11 billion and each is a customer of a 

CCP’s clearing member. Column (1) 

displays the initial margin amount as a 

percentage of the gross notional amount. 

Column (2) reports the initial margin, in 

millions of dollars that would be 

required on a portfolio with a gross 

notional amount of $11 billion. 

INITIAL MARGIN AMOUNTS ON 4,686 CLEARED INTEREST RATE SWAP PORTFOLIOS

Column (1) initial margin 

amount as percentage 

of gross notional amount 

(%) 

Column (2) initial margin 

amount on an $11 

billion gross notional 

portfolio ($MM) 

Average .................................................................................................................................... 2.1 231 

25th Percentile ......................................................................................................................... 0.6 66 

50th Percentile ......................................................................................................................... 1.4 154 

75th Percentile ......................................................................................................................... 2.7 297 

As shown in the table above, the 

average initial margin rate across all 

4,686 counterparties, reported in 

Column (1), is 2.1 percent, which would 

equate to an initial margin collection 

amount, reported in Column (2), of $231 

million on an interest rate swap 

portfolio with a gross notional amount 

of $11 billion. This average initial 

margin collection amount significantly 

exceeds the proposed permitted 

threshold amount of $65 million. 

Seventy-five percent of the 4,686 

cleared interest rate swap portfolios 

exhibit an initial margin rate in excess 

of 0.6 percent, which equates to an 

initial margin amount on a cleared 

interest rate swap portfolio of $66 

million (approximately equal to the 

proposed permitted threshold amount). 

The data above represent actual 

margin requirements on a sample of 

interest rate swap portfolios that are 

cleared by a single CCP. Some CCPs also 

provide information on the initial 

margin requirements on specific and 

representative swaps that they clear. 

The Chicago Mercantile Exchange 

(‘‘CME’’), for example, provides 

information on the initial margin 

requirements for cleared interest rate 

swaps and credit default swaps that it 

clears. This information does not 

represent actual margin requirements on 

actual swap portfolios that are cleared 

by the CME but does represent the 

initial margin that would be required on 

specific swaps if they were cleared at 

the CME. The table below presents the 

initial margin requirements for two 

swaps that are cleared by the CME. 

INITIAL MARGIN AMOUNTS ON CME CLEARED INTEREST RATE AND CREDIT DEFAULT SWAPS

Column (1) initial margin 

amount as percentage 

of gross notional amount 

(%) 

Column (2) initial margin 

amount on an $11 

billion gross notional 

portfolio ($MM) 

5 year, receive fixed and pay floating rate interest rate swap ................................................ 2.0 216 

5 year, sold CDS protection on the CDX IG Series 20 Version 22 Index .............................. 1.9 213 

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59906 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

39Proposed Regulation § 23.160. 

40Letter 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). 

41See section 2(h)(7) of the CEA. 

42BCBS/IOSCO Report at pp. 7–8. 

43Proposed Regulation § 23.158. 

According to the CME, the initial 

margin requirement on the interest rate 

swap and the credit default swap are 

both roughly two percent of the gross 

notional amount. This initial margin 

rate translates to an initial margin 

amount of roughly $216 million on a 

swap portfolio with a gross notional 

amount of $11 billion. Accordingly, this 

data also indicates that the initial 

margin collection amount on a swap 

portfolio with a gross notional size of 

$11 billion could be significantly larger 

than the proposed permitted initial 

margin threshold of $65 million. 

In addition to the information 

provided in the tables above, the 

Commission’s preliminary view is that 

additional considerations suggest that 

the initial margin collection amounts 

associated with uncleared swaps could 

be even greater than those reported in 

the tables above. The tables above 

represent initial margin requirements on 

cleared interest rate and credit default 

index swaps. Uncleared swaps in other 

asset classes, such as single name equity 

or single name credit default swaps, are 

likely to be riskier and hence would 

require even more initial margin. In 

addition, uncleared swaps often contain 

complex features, such as 

nonlinearities, that make them even 

riskier and would hence require more 

initial margin. Finally, uncleared swaps 

are generally expected to be less liquid 

than cleared swaps and must be 

margined, under the proposed rule, 

according to a ten-day close-out period 

rather than the five-day period required 

for cleared swaps. The data presented 

above pertains to cleared swaps that are 

margined according to a five-day and 

not a ten-day close-out period. The 

requirement to use a ten-day close-out 

period would further increase the initial 

margin requirements of uncleared 

versus cleared swaps. 

In light of the data and considerations 

noted above, the Commission’s 

preliminary view is that it is appropriate 

and consistent with the intent of the 

2013 international framework to 

identify a material swaps exposure with 

a gross notional amount of $3 billion 

rather than $11 billion (Ö8 billion) as is 

suggested by the 2013 international 

framework. Identifying a material swaps 

exposure with a gross notional amount 

of $3 billion is more likely to result in 

an outcome in which entities with a 

gross notional exposure below the 

material swaps exposure amount would 

be likely to have an initial margin 

collection amount below the proposed 

permitted initial margin threshold of 

$65 million. The Commission does 

recognize, however, that even at the 

lower amount of $3 billion, there are 

likely to be some cases in which the 

initial margin collection amount of a 

portfolio that is below the material 

swaps exposure amount will exceed the 

proposed permitted initial margin 

threshold amount of $65 million. The 

Commission’s preliminary view is that 

such instances should be relatively rare 

and that the operational benefits of 

using a simple and transparent gross 

notional measure to define the material 

swaps exposure amount are substantial. 

The Commission notes that under the 

implementation schedule set out below, 

this requirement would not take effect 

until January 1, 2019.39 Parties with 

gross notional exposures around this 

amount would have several years notice 

before the requirements took effect. 

The Commission requests comment 

on all aspects of the material swaps 

exposure provision. In particular, the 

Commission requests comment on the 

proposal to establish a level that is 

lower than the level set forth in the 2013 

international framework. Are there 

alternative measurement methodologies 

that do not rely on gross notional 

amounts that should be used? Does the 

proposed rule’s use and definition of the 

material swaps exposure raise any 

competitive equity issues that should be 

considered? Are there any other aspects 

of the material swaps exposure that 

should be considered by the 

Commission? 

The Commission requests comment 

on the costs and benefits of the 

proposed definition of material swaps 

exposure. Commenters are urged to 

quantify the costs and benefits, if 

practicable. Commenters also may 

suggest alternatives to the proposed 

approach where the commenters believe 

that the alternatives would be 

appropriate under the CEA. 

3. Non-Financial End Users 

Non-financial end users would 

include any entity that was not an SD, 

an MSP, or a financial end user. The 

proposal would not require CSEs to 

exchange margin with non-financial end 

users. The Commission believes that 

such entities, which generally are using 

swaps to hedge commercial risk, pose 

less risk to CSEs than financial entities. 

Therefore, under section 4s(e)(3)(A)(ii) 

of the CEA, applying a different 

standard to trades by CSEs with nonfinancial entities than to trades by CSEs 

with covered counterparties would be 

‘‘appropriate to the risk.’’ 

This approach is consistent with 

Congressional intent. Senior 

Congressional leaders have stated that 

they do not believe that non-financial 

end users should be required to post 

margin for uncleared swaps.40 In 

addition, the Dodd-Frank Act generally 

exempted non-financial end users from 

the requirement that they submit trades 

to clearing.41 If the Commission 

required them to post margin for 

uncleared trades, the clearing 

exemption could be weakened because 

the costs of clearing are likely to be less 

than the costs of margining an uncleared 

position. This approach is also 

consistent with international 

standards.42

The Commission’s proposal is 

generally consistent with the proposal 

of the Prudential Regulators but differs 

in some particulars. The Prudential 

Regulators’ proposal contains the 

following provision: 

A covered swap entity is not required to 

collect initial margin with respect to any 

non-cleared swap or non-cleared securitybased swap with a counterparty that is 

neither a financial end user with material 

swaps exposure nor a swap entity but shall 

collect initial margin at such times and in 

such forms (if any) that the covered swap 

entity determines appropriately address the 

credit risk posed by the counterparty and the 

risks of such non-cleared swaps and noncleared security-based swaps. 

The Commission’s proposal does not 

contain this provision. 

The Commission’s proposal contains 

other provisions designed to address the 

mandate under section 4s(e)(3)(A)(i) that 

Commission rules ‘‘help ensure the 

safety and soundness’’ of SDs and 

MSPs. First, as discussed further below, 

the rules would require CSEs to enter 

into certain documentation with all 

counterparties, including non-financial 

entities, to provide clarity about the 

parties’ respective rights and 

obligations.43 CSEs and non-financial 

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44Proposed Regulations §§ 23.154(a)(6) and 

23.155(a)(3). 

45This is consistent with the requirement set 

forth in section 4s(h)(3)(B)(iii)(II) of the CEA that 

SDs and MSPs must disclose to counterparties who 

are not SDs or MSPs a daily mark for uncleared 

swaps. 

46Commission Regulation § 23.200(e) defines 

execution to mean, ‘‘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.’’ 

17 CFR 23.200(e). 

47Proposed Regulation § 23.152(a). 

48Proposed Regulation § 23.152(b). 

49Proposed Regulation § 23.152(c). 

50See Commission Regulation § 23.504(b)(4). 

51Proposed Regulation § 23.153(a). 

52Proposed Regulation § 23.153(b). 

53See The Financial Crisis Inquiry Commission, 

The Financial Crisis Inquiry Report: Final Report of 

the National Commission on the Causes of the 

Financial and Economic Crisis in the United States 

(Official Government Edition) at 265–268 (2011), 

available at http://fcic-static.law.stanford.edu/cdn_

media/fcic-reports/fcic_final_report_full.pdf. 

entities would be free to set initial 

margin and variation margin 

requirements, if any, in their discretion 

and any thresholds agreed upon by the 

parties would be permitted. 

Second, the proposal would require 

each CSE to calculate hypothetical 

initial and variation margin amounts 

each day for positions held by nonfinancial entities that have material 

swaps exposure to the covered 

counterparty.44 That is, the CSE must 

calculate what the margin amounts 

would be if the counterparty were 

another SD or MSP and compare them 

to any actual margin requirements for 

the positions.45 These calculations 

would serve as risk management tools to 

assist the CSE in measuring its exposure 

and to assist the Commission in 

conducting oversight of the CSE. 

D. Nature and Timing of Margin 

Requirements 

1. Initial Margin 

Subject to thresholds discussed 

below, the proposal would require each 

CSE to collect initial margin from, and 

to post initial margin with, each covered 

counterparty on or before the business 

day after execution 46 for every swap 

with that counterparty.47 The proposal 

would require the CSEs to continue to 

post and to collect initial margin until 

the swap is terminated or expires.48

Recognizing that SDs and MSPs pose 

greater risk to the markets and the 

financial system than other swap market 

participants, Congress established a 

comprehensive regulatory scheme for 

them including registration, 

recordkeeping, reporting, margin, 

capital, and business conduct 

requirements. Accordingly, under the 

mandate of section 4s(e)(3)(C) to 

preserve the financial integrity of 

markets trading swaps and to preserve 

the stability of the United States 

financial system, the Commission is 

proposing to require SDs and MSPs to 

collect initial margin from, and to post 

initial margin with, one another. 

Similarly, as discussed above, the 

Commission believes that financial end 

users with material swaps exposure 

potentially pose greater risk to CSEs and 

to the financial system than nonfinancial end users or financial end 

users with smaller aggregate exposures. 

Accordingly, under the mandate of 

section 4s(e)(3)(A) to help ensure the 

safety and soundness of SDs and MSPs, 

the Commission is proposing to require 

SDs and MSPs to collect initial margin 

from, and to post initial margin with, 

financial end users. 

Notably, the proposal would require 

both collecting and posting of initial 

margin by CSEs (‘‘two-way margin’’). 

Two-way margin helps to ensure the 

safety and soundness of CSEs. Daily 

collection of initial margin increases the 

safety and soundness of the CSE by 

providing collateral to cover potential 

future exposure from each counterparty. 

That is, if a counterparty fails to meet 

an obligation, the CSE can liquidate the 

initial margin that it holds to cover 

some or all of the loss. But daily posting 

of initial margin also helps to ensure the 

safety and soundness of a CSE by 

making it more difficult for the CSE to 

build up exposures that it cannot fulfill. 

That is, the requirement that a CSE post 

initial margin acts as a discipline on its 

risk taking. The requirement also would 

make it more difficult for a rogue trader 

to hide his positions. 

In the wake of clearing mandates, 

uncleared swaps are likely to be more 

customized and consequently trade in a 

less liquid market than cleared swaps. 

As a result, uncleared swaps potentially 

might take a longer time and require a 

greater price premium to be liquidated 

than cleared swaps, particularly in 

distressed market conditions. Initial 

margin is designed to address these 

risks. 

The proposal contains a provision 

stating that a CSE would not be deemed 

to have violated its obligation to collect 

initial margin if it took certain steps.49

Specifically, if a counterparty failed to 

pay the required initial margin to the 

CSE, the CSE would be required to make 

the necessary efforts to attempt to 

collect the initial margin, including the 

timely initiation and continued pursuit 

of formal dispute resolution 

mechanisms,50 or otherwise 

demonstrate upon request to the 

satisfaction of the Commission that it 

has made appropriate efforts to collect 

the required initial margin or 

commenced termination of the swap. 

The Commission requests comment 

on all aspects of the proposal relating to 

the nature and timing of initial margin. 

In particular, the Commission requests 

comment on two-way initial margin. 

The Commission requests comment 

on the costs and benefits of the 

proposed approach. Commenters are 

urged to quantify the costs and benefits, 

if practicable. Commenters also may 

suggest alternatives to the proposed 

approach where the commenters believe 

that the alternatives would be 

appropriate under the CEA. 

2. Variation Margin 

Subject to a minimum transfer 

amount discussed below, the proposal 

would require each CSE to collect 

variation margin from, and to pay 

variation margin to, each counterparty 

that is a swap entity or a financial end 

user, on or before the end of the 

business day after execution for each 

swap with that counterparty.51 The 

proposed rule would require the CSEs to 

continue to pay or collect variation 

margin each business day until the swap 

is terminated or expires.52

Two-way variation margin would 

protect the safety and soundness of 

CSEs for the same reasons discussed 

above in connection with initial margin. 

Two-way variation margin has been a 

keystone of the ability of DCOs to 

manage risk. Each day, starting on the 

day after execution, current exposure is 

removed from the market through the 

payment and collection of variation 

margin. 

If two-way variation margin were not 

required for uncleared swaps between 

CSEs and counterparties that are swap 

entities or financial end users, current 

exposures might accumulate beyond the 

financial capacity of a counterparty. 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.53 As 

with initial margin, the Commission 

believes that requiring covered swap 

entities both to collect and pay margin 

with these counterparties effectively 

reduces systemic risk by protecting both 

the covered swap entity and its 

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54BCBS/IOSCO Report at 9. 

55Proposed Regulation § 23.153(c). 

56Proposed Regulation § 23.151, definition of 

‘‘eligible master netting agreement.’’ 

57 Id. 

58Proposed Regulation § 23.153(d). 

59Proposed Regulation § 23.154. 

60Proposed Regulation § 23.151, definition of 

‘‘initial margin threshold amount.’’ 

61Proposed Regulation § 23.154(a)(4). 

62Proposed Regulation § 23.152(a). 

63Proposed Regulation § 23.154(b). 

64Proposed Regulation § 23.151, definition of 

‘‘initial margin threshold amount.’’ 

65BCBS/IOSCO Report at 9. 

66Proposed Regulation § 23.154(a)(3). 

67BCBS/IOSCO Report at 9. 

counterparty from the effects of a 

default. 

In contrast to the initial margin 

requirement, which would only apply to 

financial end users with material swaps 

exposure, the proposed variation margin 

requirement would apply to all financial 

end users regardless of whether the 

entity had material swaps exposure. 

This is consistent with international 

standards.54 It reflects the Commission’s 

view that variation margin is an 

important risk mitigant that (i) reduces 

the build-up of risk that may ultimately 

pose systemic risk and (ii) imposes a 

lesser liquidity burden than does initial 

margin. Moreover, this approach is 

consistent with current market practice. 

The proposal would permit netting of 

variation margin across swaps.55 Any 

netting would have to be done pursuant 

to an eligible master netting 

agreement.56 The agreement would 

create a single legal obligation for all 

individual transactions covered by the 

agreement upon an event of default. It 

would specify the rights and obligations 

of the parties under various 

circumstances.57

As is the case for initial margin, 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.58 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, including 

pursuant to Commission Regulation 

23.504(b)(4), if applicable, 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. 

The Commission requests comment 

on all aspects of the proposal relating to 

the nature and timing of variation 

margin. 

The Commission requests comment 

on the costs and benefits of the 

proposed approach. Commenters are 

urged to quantify the costs and benefits, 

if practicable. Commenters also may 

suggest alternatives to the proposed 

approach where the commenters believe 

that the alternatives would be 

appropriate under the CEA. 

E. Calculation of Initial Margin 

1. Overview 

Under the proposed rules, a CSE 

could calculate initial margin using 

either a model-based method or a 

standardized table-based method.59 The 

required amount of initial margin would 

be the amount computed pursuant to 

the model or the table minus a threshold 

amount of $65 million.60 This amount 

could not be less than zero.61 The initial 

margin specified under the rule would 

be a minimum requirement, and the 

parties would be free to require more 

initial margin. 

When a CSE entered into a swap with 

a counterparty that was either another 

CSE or an SD/MSP subject to a 

Prudential Regulator, each party would 

bear the responsibility for calculating 

the amount that it would collect.62

Thus, for such trades, the amount a 

party posted could differ from the 

amount it collected either because of 

differences in their respective 

methodologies or because the product 

has asymmetric risk. As a practical 

matter, the Commission understands 

that the industry is working to develop 

common standards that would minimize 

this for methodologies. 

When, however, a CSE entered into a 

swap with a financial entity, the CSE 

would have responsibility for 

calculating both the amount it collected 

and the amount it posted.63 This is 

because the statute does not directly 

impose margin requirements on 

financial entities. They only come 

within the scope of section 4s when 

they trade with SDs or MSPs. 

As noted, the rules would permit 

CSEs and their covered counterparties 

to establish margin thresholds of up to 

$65 million. This means that the parties 

could agree not to post and/or to collect 

any margin amount falling below this 

threshold level. For covered entities that 

were part of a consolidated group, a 

single threshold would be applied 

across the consolidated group, not 

individually to each entity.64 This 

threshold is consistent with the 50 

million Euro threshold set forth in the 

international standards as is the 

consolidated group requirement.65 The 

Prudential Regulators proposed the 

same treatment in this regard. 

Concern has been expressed by some 

in the industry about the potential 

expense of two-way margin. The $65 

million threshold is designed to mitigate 

that expense while continuing to protect 

the financial integrity of CSEs and the 

financial system. Smaller exposures 

would be permitted to go 

uncollateralized, but a significant 

percentage of all large exposures would 

be supported by collateral. 

For example, if the initial margin 

calculated for a particular trade were 

$55 million, the CSE would not be 

required to post or to collect initial 

margin because the amount would be 

below the $65 million threshold. If the 

margin amount were $75 million, the 

CSE would only be required to post and 

to collect $10 million, the amount the 

margin calculation exceeded the $65 

million threshold. 

In order to reduce transaction costs, 

the proposal would establish a 

‘‘minimum transfer amount’’ of 

$650,000.66 Initial and variation margin 

payments would not be required to be 

made if the payment were below that 

amount. This amount is consistent with 

international standards.67 It represents 

an amount sufficiently small that the 

level of risk reduction might not be 

worth the transaction costs of 

transferring the money. It would affect 

only the timing of collection; it would 

not change the amount of margin that 

must be collected once the $650,000 

level was exceeded. 

For example, if a party posted $80 

million as initial margin on Monday and 

the requirement increased to 

$80,400,000 on Tuesday, the party 

would not be required to post additional 

funds on Tuesday because the $400,000 

increase would be less than the 

minimum transfer amount. If, however, 

on Wednesday, the requirement 

increased by another $400,000 to 

$80,800,000, the party would be 

required to post the entire $800,000 

additional amount. 

The Commission requests comment 

on the $65 million threshold and the 

$650,000 minimum transfer amount. 

The Commission requests comment on 

the costs and benefits of the proposed 

approach. Commenters are urged to 

quantify the costs and benefits, if 

practicable. Commenters also may 

suggest alternatives to the proposed 

approach where the commenters believe 

that the alternatives would be 

appropriate under the CEA. 

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68Proposed Regulation § 23.154(b)(1). See BCBS/ 

IOSCO Report at 12: ‘‘any quantitative model that 

is used for initial margin purposes must be 

approved by the relevant supervisory authority.’’ 

69 Id. 

70 Id. 

71 Id. 

72This term is defined in Proposed Regulation 

§ 23.151. 

73Proposed Regulation § 23.154(b)(2). 

74 Id. 75Proposed Regulation § 23.154(b)(3). 

2. Models 

a. Commission Approval 

Consistent with international 

standards, the proposal would require 

CSEs to obtain the written approval of 

the Commission before using a model to 

calculate initial margin.68 Further, the 

CSE would have to demonstrate that the 

model satisfied all of the requirements 

of this section on an ongoing basis.69 In 

addition, a CSE would have to notify the 

Commission in writing before extending 

the use of a model that has been 

approved to an additional product type, 

making any change to any initial margin 

model that has been approved that 

would result in a material change in the 

CSE’s assessment of initial margin 

requirements; or making any material 

change to assumptions used in the 

model.70 The Commission could rescind 

its approval of a model if the 

Commission determined that the model 

no longer complied with this section.71

Given the central place of modeling in 

most margin systems and the 

complexity of the process, the 

Commission believes that these 

oversight provisions are necessary. The 

resources that would be needed, 

however, to initially review and to 

periodically assess margin models 

present a significant challenge to the 

Commission. To address this issue, the 

Commission would seek to coordinate 

with both domestic and foreign 

authorities in the review of models. 

In many instances, CSEs whose 

margin models would be subject to 

Commission review would be affiliates 

of entities whose margin models would 

be subject to review by one of the 

Prudential Regulators. In such 

situations, the Commission would 

coordinate with the Prudential 

Regulators in order to avoid duplicative 

efforts and to provide expedited 

approval of models that a Prudential 

Regulator had already approved. For 

example, if a Prudential Regulator had 

approved the model of a depository 

institution registered as an SD, 

Commission review of a comparable 

model used by a non-bank affiliate of 

that SD would be greatly facilitated. 

Similarly, the Commission would 

coordinate with the SEC for CSEs that 

are dually registered and would 

coordinate with foreign regulators that 

had approved margin models for foreign 

CSEs. For CSEs that that wished to use 

models that were not reviewed by a 

Prudential Regulator, the SEC, or a 

foreign regulator, the Commission 

would coordinate, if possible, with the 

National Futures Association (‘‘NFA’’) 

as each CSE would be required to be a 

member of the NFA. 

The Commission requests comment 

on all aspects of the proposed margin 

approval process. Specifically, the 

Commission requests comment on the 

appropriateness and feasibility of 

coordinating with the Prudential 

Regulators, the SEC, foreign regulators, 

and the NFA in this regard. 

The Commission is also considering 

whether it would be appropriate to 

provide for provisional approval upon 

the filing of an application pending 

review. The Commission requests 

comment on the appropriateness of such 

an approach. 

In order to expedite the review of 

models further, the Commission is 

proposing to delegate authority to staff 

to perform the functions described 

above. As is the case with existing 

delegations to staff, the Commission 

would continue to reserve the right to 

perform these functions itself at any 

time. 

The Commission requests comment 

on whether additional procedural detail 

is appropriate. For example, should 

time frames be specified for completion 

of any of the functions? 

b. Applicability to Multiple Swaps 

To the extent that more than one 

uncleared swap is executed pursuant to 

an eligible master netting agreement 

(‘‘EMNA’’) 72 between a CSE and a 

covered counterparty, the CSE would be 

permitted to calculate initial margin on 

an aggregate basis with respect to all 

uncleared swaps governed by such 

agreement.73 As explained below, 

however, only exposures in certain asset 

classes could be offset. If the agreement 

covered uncleared swaps entered into 

before the applicable compliance date, 

those swaps would have to be included 

in the calculation.74

The proposal defines EMNA as any 

written, legally enforceable netting 

agreement that creates a single legal 

obligation for all individual transactions 

covered by the agreement upon an event 

of default (including receivership, 

insolvency, liquidation, or similar 

proceeding) provided that certain 

conditions are met. These conditions 

include requirements with respect to the 

covered swap entity’s right to terminate 

the contract and to liquidate collateral 

and certain standards with respect to 

legal review of the agreement to ensure 

that it meets the criteria in the 

definition. 

The Commission requests comment 

on all aspects of the proposed definition 

of EMNA. In particular, the Commission 

requests comment on whether the 

proposal provides sufficient clarity 

regarding the laws of foreign 

jurisdictions that provide for limited 

stays to facilitate the orderly resolution 

of financial institutions. The 

Commission also seeks comment 

regarding whether the provision for a 

contractual agreement subject by its 

terms to limited stays under resolution 

regimes adequately encompasses 

potential contractual agreements of this 

nature or whether this provision needs 

to be broadened, limited, clarified, or 

modified in some manner. 

c. Elements of a Model 

The proposal specifies a number of 

conditions that a model would have to 

meet to receive Commission approval.75

They include, among others, the 

following. 

(i) Ten-Day Close-Out Period 

The model must calculate potential 

future exposure using a one-tailed 99 

percent confidence interval for an 

increase in the value of the uncleared 

swap or netting set of uncleared swaps 

due to an instantaneous price shock that 

is equivalent to a movement in all 

material underlying risk factors, 

including prices, rates, and spreads, 

over a holding period equal to the 

shorter of ten business days or the 

maturity of the swap. 

The required 10-day close-out period 

assumption is consistent with 

counterparty credit risk capital 

requirements for banks. The calculation 

must be performed directly over a 10- 

day period. In the context of bank 

regulatory capital rules, a long horizon 

calculation (such as 10 days), under 

certain circumstances, may be indirectly 

computed by making a calculation over 

a shorter horizon (such as 1 day) and 

then scaling the result of the shorter 

horizon calculation to be consistent 

with the longer horizon. The proposed 

rule does not provide this option to 

covered swap entities using an 

approved initial margin model. The 

Commission’s understanding is that the 

rationale for allowing such indirect 

calculations that rely on scaling shorter 

horizon calculations has largely been 

based on computational and cost 

considerations that were material in the 

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past but are much less so in light of 

advances in computational speeds and 

reduced computing costs. The 

Commission seeks comment on whether 

the option to make use of such indirect 

calculations has a material effect on the 

burden of complying with the proposed 

rule, and whether such indirect 

methods are appropriate in light of 

current computing methods and costs. 

(ii) Portfolio Offsets 

The model may reflect offsetting 

exposures, diversification, and other 

hedging benefits for uncleared swaps 

that are governed by the same EMNA by 

incorporating empirical correlations 

within the broad risk categories, 

provided the covered swap entity 

validates and demonstrates the 

reasonableness of its process for 

modeling and measuring hedging 

benefits. The categories are agriculture, 

credit, energy, equity, foreign exchange/ 

interest rate, metals, and other. 

Empirical correlations under an eligible 

master netting agreement may be 

recognized by the model within each 

broad risk category, but not across broad 

risk categories. The sum of the initial 

margins calculated for each broad risk 

category must be used to determine the 

aggregate initial margin due from the 

counterparty. 

For example, if a CSE entered into 

two credit swaps and two energy swaps 

with a single counterparty, the CSE 

could use an approved initial margin 

model to perform two separate 

calculations: the initial margin 

calculation for the credit swaps and the 

initial margin calculation for the energy 

commodity swaps. Each calculation 

could recognize offsetting and 

diversification within the credit swaps 

and within the energy commodity 

swaps. The result of the two separate 

calculations would then be summed 

together to arrive at the total initial 

margin amount for the four swaps (two 

credit swaps and two energy commodity 

swaps). 

The Commission believes that the 

correlations of exposures across 

unrelated asset categories, such as credit 

and energy commodities, are not stable 

enough over time, and, in particular, 

during periods of financial stress, to be 

recognized in a regulatory margin model 

requirement. The Commission further 

believes that a single commodity asset 

class is too broad and that the 

relationship between disparate 

commodity types, such as aluminum 

and corn, are not stable enough to 

warrant hedging benefits within the 

initial margin model. The Commission 

seeks comment on this specific 

treatment of asset classes for initial 

margin purposes and whether fewer or 

more distinctions should be made. 

The Commission is aware that some 

swaps may be difficult to classify into 

one and only one asset class because 

some swaps may have characteristics 

that relate to more than one asset class. 

Under the proposal, the Commission 

expects that the CSE would make a 

determination as to which asset class 

best represents the swap based on a 

holistic view of the underlying swap. As 

a specific example, many swaps may 

have some sensitivity to interest rates 

even though most of the swap’s 

sensitivity relates to another asset class 

such as equity or credit. The 

Commission seeks comment on whether 

or not this approach is reasonable and 

whether or not instances in which the 

classification of a swap into one of the 

broad asset classes described above is 

problematic and material. If such 

instances are material, the Commission 

seeks comment on alternative 

approaches to dealing with such swaps. 

(iii) Stress Calibration 

The proposed rule requires the initial 

margin model to be calibrated to a 

period of financial stress. In particular, 

the initial margin model must employ a 

stress period calibration for each broad 

asset class (agricultural commodity, 

energy commodity, metal commodity, 

other commodity, credit, equity, and 

interest rate and foreign exchange). The 

stress period calibration employed for 

each broad asset class must be 

appropriate to the specific asset class in 

question. While a common stress period 

calibration may be appropriate for some 

asset classes, a common stress period 

calibration for all asset classes would 

only be considered appropriate if it is 

appropriate for each specific underlying 

asset class. Also, the time period used 

to inform the stress period calibration 

must include at least one year, but no 

more than five years, of equallyweighted historical data. 

This proposed requirement is 

intended to balance the tradeoff 

between shorter and longer data spans. 

Shorter data spans are sensitive to 

evolving market conditions but may also 

overreact to short-term and 

idiosyncratic spikes in volatility. Longer 

data spans are less sensitive to shortterm market developments but may also 

place too little emphasis on periods of 

financial stress, resulting in 

requirements that are too low. The 

requirement that the data be equally 

weighted is intended to establish a 

degree of consistency in model 

calibration while also ensuring that 

particular weighting schemes do not 

result in excessive margin requirements 

during short-term bouts of heightened 

volatility. 

The model must use risk factors 

sufficient to measure all material price 

risks inherent in the transactions for 

which initial margin is being calculated. 

The risk categories must include, but 

should not be limited to, foreign 

exchange or interest rate risk, credit 

risk, equity risk, agricultural commodity 

risk, energy commodity risk, metal 

commodity risk, and other commodity 

risk, as appropriate. For material 

exposures in significant currencies and 

markets, modeling techniques must 

capture spread and basis risk and 

incorporate a sufficient number of 

segments of the yield curve to capture 

differences in volatility and imperfect 

correlation of rates along the yield 

curve. 

The initial margin model must 

include all material risks arising from 

the nonlinear price characteristics of 

option positions or positions with 

embedded optionality and the 

sensitivity of the market value of the 

positions to changes in the volatility of 

the underlying rates, prices, or other 

material risk factors. 

(iv) Frequency of Margin Calculation 

The proposed rule requires daily 

calculation of initial margin. The use of 

an approved initial margin model may 

result in changes to the initial margin 

amount on a daily basis for a number of 

reasons. 

First, the characteristics of the swaps 

that have a material effect on their risk 

may change over time. As an example, 

the credit quality of a corporate 

reference entity upon which a credit 

default swap contract is written may 

undergo a measurable decline. 

Second, any change to the 

composition of the swap portfolio that 

results in the addition or deletion of 

swaps from the portfolio would result in 

a change in the initial margin amount. 

Third, the underlying parameters and 

data that are used in the model may 

change over time as underlying 

conditions change. For example, a new 

period of financial stress may be 

encountered in one or more asset 

classes. While the stress period 

calibration is intended to reduce the 

extent to which small or moderate 

changes in the risk environment 

influence the initial margin model’s risk 

assessment, a significant change in the 

risk environment that affects the 

required stress period calibration could 

influence the margin model’s overall 

assessment of the risk of a swap. 

Fourth, quantitative initial margin 

models are expected to be maintained 

and refined on a continuous basis to 

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76Proposed Regulation § 23.154(b)(5). 

77Proposed Regulation § 23.154(b)(5). 

78Commission Regulation § 23.600 requires each 

registered SD/MSP to establish a risk management 

program that identifies the risks implicated by the 

SD/MSP’s activities along with the risk tolerance 

limits set by the SD/MSP. The SD/MSP should take 

into account a variety of risks, including market, 

credit, liquidity, foreign currency, legal, 

operational, settlement, and other applicable risks. 

The risks would also include risks posed by 

affiliates. See 17 CFR 23.600. 

79Proposed Regulation § 23.154(c). 

80BCBS/IOSCO Report at Appendix A. 

81This calculation is set forth in proposed 

Regulation § 23.154(c)(2). 

82Note that in this example, whether or not the 

counterparties have agreed to exchange variation 

margin has no effect on the net-to-gross ratio 

calculation, i.e., the calculation is performed 

without considering any variation margin 

payments. This is intended to ensure that the netto-gross ratio calculation reflects the extent to 

which the uncleared swaps generally offset each 

other and not whether the counterparties have 

agreed to exchange variation margin. As an 

example, if a swap dealer engaged in a single sold 

credit derivative with a counterparty, then the netto-gross calculation would be 1.0 whether or not the 

dealer received variation margin from its 

counterparty. 

reflect the most accurate risk assessment 

possible with available best practices 

and methods. As best practice risk 

management models and methods 

change, so too may the risk assessments 

of initial margin models. 

(v) Benchmarking 

The proposed rule requires that a 

model used for calculating initial 

margin requirements be benchmarked 

periodically against observable margin 

standards to ensure that the initial 

margin required is not less than what a 

CCP would require for similar 

transactions.76 This benchmarking 

requirement is intended to ensure that 

any initial margin amount produced by 

a model is subject to a readily 

observable minimum. It will also have 

the effect of limiting the extent to which 

the use of models might disadvantage 

the movement of certain types of swaps 

to DCOs by setting lower initial margin 

amounts for uncleared transactions than 

for similar cleared transactions. 

d. Control Mechanisms 

The proposal would require CSEs to 

implement certain control 

mechanisms.77 They include, among 

others, the following. 

The CSE must maintain a risk 

management unit in accordance with 

existing Commission Regulation 

23.600(c)(4)(i) that reports directly to 

senior management and is independent 

from the business trading units.78 The 

unit must validate its model before 

implementation and on an ongoing 

basis. The validation process must 

include an evaluation of the conceptual 

soundness of the model, an ongoing 

monitoring process to ensure that the 

initial margin is not less than what a 

DCO would require for similar cleared 

products, and back testing. 

If the validation process revealed any 

material problems with the model, the 

CSE would be required to notify the 

Commission of the problems, describe 

to the Commission any remedial actions 

being taken, and adjust the model to 

insure an appropriate amount of initial 

margin is being calculated. 

The CSE must have an internal audit 

function independent of the business 

trading unit that at least annually 

assesses the effectiveness of the controls 

supporting the model. The internal 

audit function must report its findings 

to the CSE’s governing body, senior 

management, and chief compliance 

officer at least annually. 

Given the complexity of margin 

models and the incentives to calculate 

lower margin amounts, the Commission 

believes that rigorous internal oversight 

is necessary to ensure proper 

functioning. 

The Commission seeks comment on 

all aspects of the proposed standards for 

models and the proposed levels of 

regulatory review. 

The Commission requests comment 

on the costs and benefits of the 

proposed approach. Commenters are 

urged to quantify the costs and benefits, 

if practicable. Commenters also may 

suggest alternatives to the proposed 

approach where the commenters believe 

that the alternatives would be 

appropriate under the CEA. 

3. Table-Based Method 

a. Method of Calculation 

Some CSEs might not have the 

internal technical resources to develop 

initial margin models or have simple 

portfolios for which they want to avoid 

the complexity of modeling. The tablebased method would allow a CSE to 

calculate its initial margin requirements 

using a standardized table.79 The table 

specifies the minimum initial margin 

amount that must be collected as a 

percentage of a swap’s notional amount. 

This percentage varies depending on the 

asset class of the swap. Except as 

described below, a CSE would be 

required to calculate a minimum initial 

margin amount for each swap and sum 

up all the minimum initial margin 

amounts calculated under this section to 

arrive at the total amount of initial 

margin. The table is consistent with 

international standards.80

b. Net-to-Gross Ratio Adjustment 

The Commission recognizes that 

using a notional amount measure of 

initial margin without any adjustment 

for offsetting exposures, diversification, 

and other hedging benefits might not 

accurately reflect the size or risks of a 

CSE’s swap-based positions in many 

situations. Moreover, not adequately 

recognizing the benefits of offsets, 

diversification, and hedging might lead 

to large disparities between modelbased and table-based initial margin 

requirements. These disparities might 

give rise to inequities between CSEs that 

elect to use an approved model and 

CSEs that rely on the table for 

computing their respective initial 

margin requirements. 

To address these potential inequities, 

the Commission is proposing an 

adjustment to the table-based initial 

margin requirement. Specifically, the 

Commission would allow a CSE to 

calculate a net-to-gross ratio 

adjustment.81

The net-to-gross ratio compares the 

net current replacement cost of the 

uncleared portfolio (in the numerator) 

with the gross current replacement cost 

of the uncleared portfolio (in the 

denominator). The net current 

replacement cost is the cost of replacing 

the entire portfolio of swaps that is 

covered under an eligible master netting 

agreement. The gross current 

replacement cost is the cost of replacing 

those swaps that have a strictly positive 

replacement cost. 

For example, consider a portfolio that 

consists of two uncleared swaps in 

which the mark-to-market value of the 

first swap is $10 (i.e., the CSE is owed 

$10 from its counterparty) and the markto-market value of the second swap is 

–$5 (i.e., the CSE owes $5 to its 

counterparty). The net current 

replacement cost is $5 ($10–$5), the 

gross current replacement cost is $10, 

and the net-to-gross ratio would be 5/10 

or 0.5.82

The net-to-gross ratio and gross 

standardized initial margin amounts 

provided in the table are used in 

conjunction with the notional amount of 

the transactions in the underlying swap 

portfolio to arrive at the total initial 

margin requirement as follows: 

Standardized Initial Margin = 0.4 × 

Gross Initial Margin + 0.6 × NGR × Gross 

Initial Margin 

where: 

Gross Initial Margin = the sum of the 

notional value multiplied by the 

applicable initial margin requirement 

percentage from the table A for each 

uncleared swap in the portfolio 

and 

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59912 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

83BCBS/IOSCO Report at 13. 

84See the Basel Committee on Banking 

Supervision, ‘‘The standardized approach for 

measuring counterparty credit risk exposures,’’ 

(March 31, 2014), available at http://www.bis.org/

publ/bcbs279.pdf. 

85Proposed Regulation § 23.155(a)(1) and 

Commission Regulation § 23.504(b)(4). 

86Proposed Regulation § 23.155(a)(2). 

87Proposed Regulation § 23.155(b). 

88BCBS/IOSCO Report at 14–15. 

89For example, in May 2000, a clearing member 

defaulted to the New York Clearing Corporation. A 

significant contributing factor was the lack of a 

rigorous settlement price procedure which allowed 

prices in an illiquid market to be mismarked and 

unrealized losses to accumulate. See Report on 

Lessons Learned from the Failure of Klein & Co, 

Division of Trading and Markets, Commodity 

Futures Trading Commission (July 2001). 

90See BCBS/IOSCO Report at 16. 

91Proposed Regulation § 23.156(a)(1). 

92Major currencies are defined in Proposed 

Regulation § 23.151. 

NGR = Net-to-Gross Ratio 

The Commission notes that the 

calculation of the net-to-gross ratio for 

margin purposes must be applied only 

to swaps subject to the same EMNA and 

that the calculation is performed across 

transactions in disparate asset classes 

within a single netting agreement. 

(Thus, all non-cleared swaps subject to 

the same EMNA can be netted against 

each other in the calculation of the netto-gross ratio. By contrast, under a 

model, netting is only permitted within 

each asset class). This approach is 

consistent with the standardized 

counterparty credit risk capital 

requirements. 

The Commission also notes that if a 

counterparty maintains multiple swap 

portfolios under multiple EMNAs, the 

standardized initial margin amounts 

would be calculated separately for each 

portfolio with each calculation using the 

gross initial margin and net-to-gross 

ratio that is relevant to each portfolio. 

The total standardized initial margin 

would be the sum of the standardized 

initial margin amounts for each 

portfolio. 

The proposed net-to-gross ratio 

adjustment is consistent with 

international standards.83 The proposed 

table and adjustment are the same as the 

Prudential Regulators’ proposal. 

The Commission seeks comment on 

all aspects of the proposed table-based 

approach. The Commission notes that 

the BCBS has recently adopted a new 

method for the purpose of capitalizing 

counterparty credit risk.84 The 

Commission seeks comment on whether 

the BCBS’s recently adopted 

standardized approach would represent 

a material improvement relative to the 

proposed method that employs the netto-gross ratio. 

The Commission requests comment 

on the costs and benefits of the 

proposed approach. Commenters are 

urged to quantify the costs and benefits, 

if practicable. Commenters also may 

suggest alternatives to the proposed 

approach where the commenters believe 

that the alternatives would be 

appropriate under the CEA. 

F. Calculation of Variation Margin 

1. Means of Calculation 

Under the proposal, each CSE would 

be required to calculate variation margin 

for itself and for each covered 

counterparty using a methodology and 

inputs that to the maximum extent 

practicable and in accordance with 

existing Regulation 23.504(b)(4) rely on 

recently-executed transactions, 

valuations provided by independent 

third parties, or other objective 

criteria.85 In addition, each CSE would 

have to have in place alternative 

methods for determining the value of an 

uncleared swap in the event of the 

unavailability or other failure of any 

input required to value a swap.86

2. Control Mechanisms 

The proposal would also set forth 

several control mechanisms.87 Each CSE 

would be required to create and 

maintain documentation setting forth 

the variation margin methodology with 

sufficient specificity to allow the 

counterparty, the Commission, and any 

applicable Prudential Regulator to 

calculate a reasonable approximation of 

the margin requirement independently. 

Each CSE would be required to evaluate 

the reliability of its data sources at least 

annually, and make adjustments, as 

appropriate. The proposal would permit 

the Commission to require a CSE to 

provide further data or analysis 

concerning the methodology or a data 

source. 

These provisions are consistent with 

international standards 88 and the 

Prudential Regulators’ proposed rules. 

The Commission’s proposal, however, 

sets forth more detailed requirements. 

These requirements are consistent with 

an approach currently under 

consideration by an IOSCO working 

group. 

The Commission believes that the 

accurate valuation of positions and the 

daily payment of variation margin to 

remove accrued risk is a critical element 

in assuring the safety and soundness of 

CSEs and in preserving the financial 

integrity of the markets. The 

Commission believes that its experience 

with cleared markets 89 coupled with 

the problems in the uncleared markets 

noted in section II.A. demonstrates this. 

The Commission believes that the 

proposed provisions avoid potential 

miscalculations and would allow the 

variation margin calculations to be 

monitored and, thereby, forestall 

potential problems that could 

exacerbate a crisis. These measures are 

designed to be prudent safeguards to be 

used to address weaknesses that may 

only become apparent over time. 

The Commission seeks comment on 

all aspects of the proposed requirements 

for calculating variation margin. 

The Commission requests comment 

on the costs and benefits of the 

proposed approach. Commenters are 

urged to quantify the costs and benefits, 

if practicable. Commenters also may 

suggest alternatives to the proposed 

approach where the commenters believe 

that the alternatives would be 

appropriate under the CEA. 

G. Forms of Margin 

1. Initial Margin 

In general, the Commission believes 

that margin assets should share the 

following fundamental characteristics. 

The assets should be liquid and, with 

haircuts, hold their value in times of 

financial stress. The value of the assets 

should not exhibit a significant 

correlation with the creditworthiness of 

the counterparty or the value of the 

swap portfolio.90

Guided by these principles, the 

Commission is proposing that CSEs may 

only post or accept certain assets to 

meet initial margin requirements to or 

from covered counterparties.91 These 

include: U.S. dollars; cash in a currency 

in which payment obligations under the 

swap are required to be settled; U.S. 

Treasury securities; certain securities 

guaranteed by the U.S.; certain 

securities issued or guaranteed by the 

European Central bank, a sovereign 

entity, or the BIS; certain corporate debt 

securities; certain equity securities 

contained in major indices; major 

currencies,92 and gold. 

These are assets for which there are 

deep and liquid markets and, therefore, 

assets that can be readily valued and 

easily liquidated. This list includes a 

number of assets that were not included 

in the 2011 proposal. This is responsive 

to a number of commenters who 

expressed concern about the narrowness 

of that list and the potential that there 

would be insufficient available 

collateral. 

The Commission notes that any debt 

security issued by a U.S. Governmentsponsored enterprise that is not 

operating with capital support or 

another form of direct financial 

assistance from the U.S. government 

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Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 59913 

93Proposed Regulation § 23.156(a)(1)(ix). 

94Proposed Regulation § 23.156(a)(2). 

95Proposed Regulation § 23.156(a)(4). 

96Proposed Regulation § 23.156(b). 97 76 FR 23732 at 23747. 

would be eligible collateral only if the 

security met the requirements for 

corporate debt securities. 

The Commission also notes that 

eligible collateral would include other 

publicly-traded debt that has been 

deemed acceptable as initial margin by 

a Prudential Regulator.93 The Prudential 

Regulators have indicated that this 

would include securities that meet the 

terms of 12 CFR 1.2(d). That provision 

states that the issuer of a security must 

have adequate capacity to meet financial 

commitments under the security for the 

projected life of the asset or exposure. 

It further states an issuer has adequate 

capacity to meet financial commitments 

if the risk of default by the obligor is low 

and the full and timely payment of 

principal and interest is expected. For 

example, municipal bonds that meet 

this standard, as determined by a 

Prudential Regulator, would be eligible 

collateral. 

Under the proposal, certain assets 

would be prohibited from use as initial 

margin.94 These include any asset that 

is an obligation of the party providing 

such asset or an affiliate of that party. 

These also include instruments issued 

by bank holding companies, depository 

institutions and market intermediaries. 

The use of such assets as initial margin 

could compound risk. These restrictions 

reflect the Commission’s view that the 

price and liquidity of securities issued 

by the foregoing entities are very likely 

to come under significant pressure 

during a period of financial stress when 

a CSE may be resolving a counterparty’s 

defaulted swap position and present an 

additional source of risk. 

The Commission requests comment 

on the securities subject to this 

restriction, and, in particular, on 

whether securities issued by other 

entities, such as non-bank systemically 

important financial institutions 

designated by the Financial Stability 

Oversight Council, also should be 

excluded from the list of eligible 

collateral. 

Counterparties that wished to rely on 

assets that do not qualify as eligible 

collateral under the proposed rule still 

would be able to pledge those assets 

with a lender in a separate arrangement, 

such as collateral transformation 

arrangements, using the cash or other 

eligible collateral received from that 

separate arrangement to meet the 

minimum margin requirements. 

Moreover, the Commission notes that 

the proposal would not restrict the types 

of collateral that could be collected or 

posted to satisfy margin terms that are 

bilaterally negotiated above required 

amounts. For example, if, 

notwithstanding the $65 million 

threshold, a CSE decided to collect 

initial margin to protect itself against 

the credit risk of a particular 

counterparty, the CSE could accept any 

form of collateral. 

Except for U.S. dollars and the 

currency in which the payment 

obligations of the swap is required, 

assets posted as required initial margin 

would be subject to haircuts in order to 

address the possibility that the value of 

the collateral could decline during the 

period that it took to liquidate a swap 

position in default. The proposed 

collateral haircuts have been calibrated 

to be broadly consistent with valuation 

changes observed during periods of 

financial stress. 

Because the value of noncash 

collateral and foreign currency may 

change over time, the proposal would 

require a CSE to monitor the value of 

such collateral previously collected to 

satisfy initial margin requirements and, 

to the extent the value of such collateral 

has decreased, to collect additional 

collateral with a sufficient value to 

ensure that all applicable initial margin 

requirements remain satisfied.95

The Commission seeks comment on 

all aspects of the proposed requirements 

for eligible collateral for initial margin. 

In particular, the Commission requests 

comments on whether the list should be 

expanded or contracted in any way. If 

so, subject to what terms and 

conditions? 

The Commission requests comment 

on the costs and benefits of the 

proposed approach. Commenters are 

urged to quantify the costs and benefits, 

if practicable. Commenters also may 

suggest alternatives to the proposed 

approach where the commenters believe 

that the alternatives would be 

appropriate under the CEA. 

2. Variation Margin 

The proposal would require that 

variation margin be paid in U.S. dollars, 

or a currency in which payment 

obligations under the swap are required 

to be settled.96 When determining the 

currency in which payment obligations 

under the swap are required to be 

settled, a covered swap entity must 

consider the entirety of the contractual 

obligation. As an example, in cases 

where a number of swaps, each 

potentially denominated in a different 

currency, are subject to a single master 

agreement that requires all swap cash 

flows to be settled in a single currency, 

such as the Euro, then that currency 

(Euro) may be considered the currency 

in which payment obligations are 

required to be settled. 

The proposal is narrower than the 

2011 proposal which also permitted 

U.S. Treasury securities.97 This change 

is designed to reinforce the concept that 

variation margin is paid and to reduce 

the potential for disputes to arise over 

the value of assets being used to meet 

this margin requirement. This proposed 

change is consistent with regulatory and 

industry initiatives to improve 

standardization and efficiency in the 

OTC derivatives market. For example, in 

June of 2013, ISDA published the 2013 

Standard Credit Support Annex 

(‘‘SCSA’’). The SCSA provides for the 

sole use of cash as eligible collateral for 

variation margin. The Commission 

supports this and other ongoing 

regulatory and industry efforts at 

standardization that improve 

operational efficiency and reduce the 

differences between the bilateral and 

cleared OTC derivatives markets. 

In this regard, the Commission notes 

that central counterparties generally 

require that variation margin be paid in 

cash. U.S. law applicable to cleared 

swaps is consistent with this practice. 

Section 5b(c)(2)(E) of the CEA requires 

derivatives clearing organizations to 

‘‘complete money settlements on a 

timely basis (but not less frequently 

than once each business day).’’ CFTC 

Regulation 39.14(a)(1) defines 

‘‘settlement’’ as, among other things, 

‘‘payment and receipt of variation 

margin for futures, options, and swaps.’’ 

CFTC Regulation 39.14(b) requires that 

‘‘except as otherwise provided by 

Commission order, derivatives clearing 

organizations shall effect a settlement 

with each clearing member at least once 

each business day.’’ 

The Commission believes that this 

change from the 2011 proposal is 

appropriate because it better reflects 

that counterparties to swap transactions 

generally view variation margin 

payments as the daily settlement of their 

exposure(s) to one another. 

Additionally, limiting variation margin 

to cash should sharply reduce the 

potential for disputes over the value of 

variation margin. 

Under this proposed rule, the value of 

cash paid to satisfy variation margin 

requirements is not subject to a haircut. 

Variation margin payments reflect gains 

and losses on a swap transaction, and 

payment or receipt of variation margin 

generally represents a transfer of 

ownership. Therefore, haircuts are not a 

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59914 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

98BCBS/IOSCO Report at 14–15. The 

international standards do not distinguish between 

initial margin and variation margin in discussing 

eligible assets. 

99Proposed Regulation § 23.157. 

100BCBS/IOSCO Report at 19–20. 

101See ‘‘Draft Regulatory Technical Standards on 

Risk-mitigation Techniques for OTC-derivative 

Contracts Not Cleared by a CCP under Article 

11(15) of Regulation (EU) No. 648/2012,’’ pp. 11, 

42–43 (April 14, 2014). 102Section 4d(f) of the CEA. 

103Protection of Collateral of Counterparties to 

Uncleared Swaps; Treatment of Securities in a 

Portfolio Margining Account in a Commodity 

Broker Bankruptcy, 78 FR 66621 (Nov. 6, 2013). 

104Proposed Regulation § 23.158. 

necessary component of the regulatory 

requirements for cash variation margin. 

The proposal is stricter than 

international standards which do not 

require that variation margin be in 

cash.98 It is the same as the Prudential 

Regulators’ proposal. 

The Commission seeks comment on 

all aspects of the proposed requirements 

for forms of variation margin. 

The Commission requests comment 

on the costs and benefits of the 

proposed approach. Commenters are 

urged to quantify the costs and benefits, 

if practicable. Commenters also may 

suggest alternatives to the proposed 

approach where the commenters believe 

that the alternatives would be 

appropriate under the CEA. 

H. Custodial Arrangements 

The proposal sets forth requirements 

for the custodial arrangements for initial 

margin posted for transactions between 

CSEs and covered counterparties.99

Each CSE that posts initial margin with 

respect to an uncleared swap would be 

mandated to require that all funds or 

other property that it provided as initial 

margin be held by one or more 

custodians that were not affiliates of the 

CSE or the counterparty. Each CSE that 

collects initial margin with respect to an 

uncleared swap would be mandated to 

require that such initial margin be held 

at one or more custodians that were not 

affiliates of the CSE or the counterparty. 

Each CSE would be required to enter 

into custodial agreements containing 

specified terms. These would include a 

prohibition on rehypothecating the 

margin assets and standards for the 

substitution of assets. 

The proposed rules are consistent 

with international standards except that 

international standards would allow 

rehypothecation under certain 

circumstances.100 The proposal is the 

same as the Prudential Regulators’ 

proposal. The Commission also notes 

that the European Supervisory 

Authorities have proposed to prohibit 

rehypothecation.101

The proposed approach is grounded 

in several provisions of section 4s(e) of 

the CEA. First, section 4s(e)(3)(A)(i) 

mandates that margin rules ‘‘help 

ensure the safety and soundness of 

[SDs] and [MSPs].’’ Maintaining margin 

collateral at an independent custodian 

subject to specified terms protects both 

parties to a transaction by preventing 

assets from being lost or misused. In 

particular, a prohibition on 

rehypothecation enhances safety by 

avoiding the possibility that a margin 

asset will be lost because of the failure 

of a third party who was not a party to 

the original transaction. 

Second, section 4s(e)(3)(C) mandates 

that margin rules preserve ‘‘the financial 

integrity of the markets trading swaps’’ 

and ‘‘the stability of the United States 

financial system.’’ Maintaining margin 

collateral at an independent custodian 

preserves financial integrity and 

financial stability by preventing the 

same asset from supporting multiple 

positions. If an SD could take collateral 

posted by a counterparty for one swap 

and reuse it to margin a second swap 

with another SD, and that SD could, in 

turn, do the same, this would increase 

leverage in the system and create the 

possibility of a cascade of defaults if one 

of these firms failed. 

Third, section 4s(e)(3)(A) refers to the 

‘‘greater risk’’ to SDs, MSPs, and the 

financial system ‘‘arising from the use of 

swaps that are not cleared.’’ It mandates 

rules ‘‘appropriate for the risk’’ 

associated with uncleared swaps. 

Margin posted by customers to futures 

commission merchants (‘‘FCMs’’) and 

by FCMs to DCOs for cleared swaps is 

subject to segregation requirements.102 It 

would be inappropriate to address the 

greater risk of uncleared swaps with a 

lesser standard. 

The proposed rules can be 

harmonized with section 4s(l) of the 

CEA which authorizes counterparties of 

an SD or an MSP to request that margin 

be segregated. As discussed above, 

covered counterparties pose risk to the 

financial system. The primary purpose 

of the proposed custodial arrangements 

is preservation of the financial integrity 

of the markets and the U.S. financial 

system although the arrangements will 

also have the effect of protecting 

individual market participants. Section 

4s(l) is not made superfluous by the 

proposed rules because it would still be 

available for financial end users with 

less than material swaps exposure, for 

financial end users that post initial 

margin in excess of the required 

amount, and for non-financial end users 

that post initial margin. Such entities 

would be posting margin, by agreement, 

with SDs or MSPs. Section 4s(l) would 

provide them with an opportunity to 

obtain additional protection if they 

desired. 

The Commission previously adopted 

rules implementing section 4s(l).103 The 

Commission is now proposing to amend 

those rules to reflect the approach 

described above where segregation of 

initial margin would be mandatory 

under certain circumstances. The 

Commission is proposing three changes. 

First, the proposal would amend 

§ 23.701(a)(1) to read as follows: Notify 

each counterparty to such transaction 

that the counterparty has the right to 

require that any Initial Margin the 

counterparty provides in connection 

with such transaction be segregated in 

accordance with §§ 23.702 and 23.703 

except in those circumstances where 

segregation is mandatory pursuant to 

§ 23.157. (New language in italics.) 

Second, the proposal would amend 

§ 23.701(d) to read as follows: Prior to 

confirming the terms of any such swap, 

the swap dealer or major swap 

participant shall obtain from the 

counterparty confirmation of receipt by 

the person specified in paragraph (c) of 

this section of the notification specified 

in paragraph (a) of this section, and an 

election, if applicable, to require such 

segregation or not. The swap dealer or 

major swap participant shall maintain 

such confirmation and such election as 

business records pursuant to § 1.31 of 

this chapter. (New language in italics.) 

Third, the proposal would amend 

§ 23.701(f) to read as follows: A 

counterparty’s election, if applicable, to 

require segregation of Initial Margin or 

not to require such segregation, may be 

changed at the discretion of the 

counterparty upon written notice 

delivered to the swap dealer or major 

swap participant, which changed 

election shall be applicable to all swaps 

entered into between the parties after 

such delivery. (New language in italics.) 

The Commission seeks comment on 

all aspects of the proposed requirements 

regarding custodial arrangements. 

The Commission requests comment 

on the costs and benefits of the 

proposed approach. Commenters are 

urged to quantify the costs and benefits, 

if practicable. Commenters also may 

suggest alternatives to the proposed 

approach where the commenters believe 

that the alternatives would be 

appropriate under the CEA. 

I. Documentation 

The proposal sets forth 

documentation requirements for 

CSEs.104 For uncleared swaps between a 

CSE and a covered counterparty, the 

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Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 59915 

105Commission Regulation § 23.504. 

106Proposed Regulation § 23.160. 

107BCBS/IOSCO Report at 23–24. 

108 7 U.S.C. 2(i). 

documentation would be required to 

provide the CSE with the contractual 

right and obligation to exchange initial 

margin and variation margin in such 

amounts, in such form, and under such 

circumstances as are required by 

§ 23.150 through § 23.160 of this part. 

For uncleared swaps between a CSE and 

a non-financial entity, the 

documentation would be required to 

specify whether initial and/or variation 

margin will be exchanged and, if so, to 

include the information set forth in the 

rule. That information would include 

the methodology and data sources to be 

used to value positions and to calculate 

initial margin and variation margin, 

dispute resolution procedures, and any 

margin thresholds. 

The international standards do not 

contain a specific requirement for 

documentation. The requirements in the 

Prudential Regulators’ proposal are 

consistent with the Commission 

proposal but the Commission proposal 

contains additional elements. 

The Commission proposal contains a 

cross-reference to an existing 

Commission rule which already 

imposes documentation requirements 

on SDs and MSPs.105 Consistent with 

that rule, the proposal would apply 

documentation requirements not only to 

covered counterparties but also to nonfinancial end users. 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 during times of financial 

turmoil. This would benefit not only the 

CSE but the non-financial end user as 

well. 

The Commission seeks comment on 

all aspects of the proposed requirements 

for documentation. 

The Commission requests comment 

on the costs and benefits of the 

proposed approach. Commenters are 

urged to quantify the costs and benefits, 

if practicable. Commenters also may 

suggest alternatives to the proposed 

approach where the commenters believe 

that the alternatives would be 

appropriate under the CEA. 

J. Implementation Schedule 

The proposed rules establish the 

following implementation schedule: 106

December 1, 2015 for the 

requirements in § 23.153 for variation 

margin; 

December 1, 2015 for the 

requirements in § 23.152 for initial 

margin for any uncleared swaps where 

both (i) the CSE combined with all its 

affiliates and (ii) its counterparty 

combined with all its affiliates, have an 

average daily aggregate notional amount 

of uncleared swaps, uncleared securitybased swaps, foreign exchange forwards, 

and foreign exchange swaps in June, 

July, and August 2015 that exceeds $4 

trillion, where such amounts are 

calculated only for business days; 

December 1, 2016 for the 

requirements in § 23.152 for initial 

margin for any uncleared swaps where 

both (i) the CSE combined with all its 

affiliates and (ii) its counterparty 

combined with all its affiliates, have an 

average daily aggregate notional amount 

of uncleared swaps, uncleared securitybased swaps, foreign exchange forwards, 

and foreign exchange swaps in June, 

July and August 2016 that exceeds $3 

trillion, where such amounts are 

calculated only for business days; 

December 1, 2017 for the 

requirements in § 23.152 for initial 

margin for any uncleared swaps where 

both (i) the CSE combined with all its 

affiliates and (ii) its counterparty 

combined with all its affiliates have an 

average daily aggregate notional amount 

of uncleared swaps, uncleared securitybased swaps, foreign exchange forwards, 

and foreign exchange swaps in June, 

July and August 2017 that exceeds $2 

trillion, where such amounts are 

calculated only for business days; 

December 1, 2018 for the 

requirements in § 23.152 for initial 

margin for any uncleared swaps where 

both (i) the CSE combined with all its 

affiliates and (ii) its counterparty 

combined with all its affiliates have an 

average daily aggregate notional amount 

of uncleared swaps, uncleared securitybased swaps, foreign exchange forwards, 

and foreign exchange swaps in June, 

July and August 2018 that exceeds $1 

trillion, where such amounts are 

calculated only for business days; 

December 1, 2019 for the 

requirements in § 23.152 for initial 

margin for any other CSE with respect 

to uncleared swaps entered into with 

any other counterparty. 

This extended schedule is designed to 

give market participants ample time to 

develop the systems and procedures 

necessary to exchange margin and to 

make arrangements to have sufficient 

assets available for margin purposes. 

The requirements would be phased-in 

in steps from the largest covered parties 

to the smallest. 

Variation margin would be 

implemented on the first date for two 

reasons. First, a significant part of the 

market currently pays variation margin 

so full implementation would be less 

disruptive. Second, the elimination of 

current exposures through the daily use 

of variation margin would be an 

effective first step in enhancing the 

safety and soundness of market 

participants and the financial integrity 

of the markets. 

The proposal is consistent with 

international standards except for the 8 

billion euro threshold, discussed above, 

that would apply starting Dec. 1, 2019 

under the international standards.107

The proposal is the same as the proposal 

of the Prudential Regulators. 

The Commission requests comment 

on the costs and benefits of the 

proposed approach. Commenters are 

urged to quantify the costs and benefits, 

if practicable. Commenters also may 

suggest alternatives to the proposed 

approach where the commenters believe 

that the alternatives would be 

appropriate under the CEA. 

K. Request for Comment 

The Commission requests comment 

on all aspects of the proposed rules. In 

particular, as noted above, the 

Commission invites comments on the 

potential costs and benefits of each 

provision. Commenters are urged to 

quantify the costs and benefits, if 

practicable. Commenters also may 

suggest alternatives to the proposed 

approach where the commenters believe 

that the alternatives would be 

appropriate under the CEA. 

III. Advance Notice of Proposed 

Rulemaking on the Cross-Border 

Application of the Proposed Margin 

Rules 

A. Alternative Options 

Section 2(i) of the CEA 108 provides 

that the provisions of the CEA relating 

to swaps that were enacted by the Wall 

Street Transparency and Accountability 

Act of 2010 (including any rule 

prescribed or regulation promulgated 

under that Act, shall not apply to 

activities outside the United States 

unless those activities (1) have a direct 

and significant connection with 

activities in, or effect on, commerce of 

the United States or (2) contravene such 

rules or regulations as the Commission 

may prescribe or promulgate as are 

necessary or appropriate to prevent the 

evasion of any provision of this chapter 

that was enacted by the Wall Street 

Transparency and Accountability Act of 

2010. 

Section 2(i) provides the Commission 

with express authority over activities 

outside the United States relating to 

swaps when certain conditions are met. 

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59916 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

109 Interpretative Guidance and Policy Statement 

Regarding Compliance with Certain Swap 

Regulations, 78 FR 45292 (July 26, 2013) 

(‘‘Guidance’’). The Commission addressed, among 

other things, how the swap provisions in the DoddFrank Act (including the margin requirement for 

uncleared swaps) would apply on a cross-border 

basis. In this regard, the Commission stated that as 

a general policy matter it would apply the margin 

requirement as a transaction-level requirement. 

110The scope of the term ‘‘U.S. person’’ as used 

in the Cross-Border Guidance Approach and the 

Entity-Level Approach would be the same as under 

the Guidance. See Guidance at 45316–45317 for a 

summary of the Commission’s interpretation of the 

term ‘‘U.S. person.’’ 

111Under the Guidance, id. at 45318, the term 

‘‘guaranteed affiliate’’ refers to a non-U.S. person 

that is an affiliate of a U.S. person and that is 

guaranteed by a U.S. person. The scope of the term 

‘‘guarantee’’ under the Cross-Border Guidance 

Approach and the Entity-Level Approach would be 

the same as under note 267 of the Guidance and 

accompanying text. 

112Under the Guidance, id. at 45359, the factors 

that are relevant to the consideration of whether a 

person is an ‘‘affiliate conduit’’ include whether: (i) 

The non-U.S. person is majority-owned, directly or 

indirectly, by a U.S. person; (ii) the non-U.S. person 

controls, is controlled by, or is under common 

control with the U.S. person; (iii) the non-U.S. 

person, in the regular course of business, engages 

in swaps with non-U.S. third party(ies) for the 

purpose of hedging or mitigating risks faced by, or 

to take positions on behalf of, its U.S. affiliate(s), 

and enters into offsetting swaps or other 

arrangements with such U.S. affiliate(s) in order to 

transfer the risks and benefits of such swaps with 

third-party(ies) to its U.S. affiliates; and (iv) the 

financial results of the non-U.S. person are 

included in the consolidated financial statements of 

the U.S. person. Other facts and circumstances also 

may be relevant. 

113Under a limited exception, where a swap 

between the foreign branch of a U.S. SD/MSP and 

a non-U.S. person (that is not a guaranteed or 

conduit affiliate) takes place in a foreign 

jurisdiction other than Australia, Canada, the 

European Union, Hong Kong, Japan, or Switzerland, 

the counterparties generally may comply only with 

the transaction-level requirements in the foreign 

jurisdiction where the foreign branch is located if 

the aggregate notional value of all the swaps of the 

U.S. SD’s foreign branches in such countries does 

not exceed 5% of the aggregate notional value of all 

of the swaps of the U.S. SD, and the U.S. person 

maintains records with supporting information for 

the 5% limit and can identify, define, and address 

any significant risk that may arise from the nonapplication of the Transaction-Level Requirements. 

As discussed in part I.A. above, the 

primary purpose of the margin 

provision in section 4s(e) is to address 

risk to SDs, MSPs, and the financial 

system arising from uncleared swaps. 

Given the risk-mitigation function of the 

margin rules for uncleared swaps, the 

Commission believes that the rules 

should apply on a cross-border basis in 

a manner that effectively addresses risks 

to the registered SD or MSP. At the same 

time, it may be appropriate, consistent 

with principles of international comity 

and statutory objectives underlying the 

margin requirements, to allow SDs and 

MSPs to satisfy the margin requirements 

by complying with a comparable regime 

in the relevant foreign jurisdiction, or to 

not apply the margin requirements 

under certain circumstances. 

In this Advance Notice of Proposed 

Rulemaking, the Commission is 

considering three approaches to 

applying the margin requirements to 

Commission-registered SDs and MSPs, 

consistent with section 2(i): (1) A 

transaction-level approach that is 

consistent with the Commission’s crossborder guidance (‘‘Guidance 

Approach’’); 109 (2) the Prudential 

Regulators’ approach; and (3) an entitylevel approach (‘‘Entity-Level 

Approach’’). The general framework for 

each of these approaches is described 

below. The Commission is not 

endorsing at this time any particular 

approach and invites comments on all 

aspects of the three approaches and 

welcomes any suggestions on other 

possible approaches. The Commission 

may propose and ultimately adopt one 

of the three approaches with 

modifications. 

1. The Cross-Border Guidance Approach 

Under the first option, the 

Commission would apply the margin 

requirements consistent with the CrossBorder Guidance. The Commission 

stated in the Guidance that it would 

generally treat the margin requirements 

(for uncleared swaps) as a transactionlevel requirement. Consistent with the 

rationale stated in the Guidance, under 

this approach, the proposed margin 

requirements would apply to a U.S. SD/ 

MSP (other than a foreign branch of a 

U.S. bank that is a SD/MSP) for all of 

their uncleared swaps (as applicable), 

irrespective of whether the counterparty 

is a U.S. person 110 or not, without 

substituted compliance. 

On the other hand, under this 

approach, the proposed margin 

requirements would apply to a non-U.S. 

SD/MSP (whether or not it is a 

‘‘guaranteed affiliate’’ 111 or an ‘‘affiliate 

conduit’’ 112) only with respect to its 

uncleared swaps with a U.S. person 

counterparty (including a foreign branch 

of U.S. bank that is a SD/MSP) and a 

non-U.S. counterparty that is guaranteed 

by a U.S. person or is an affiliate 

conduit. Where the counterparty is a 

guaranteed affiliate or is an affiliate 

conduit, the Commission would allow 

substituted compliance (i.e., the nonU.S. SD/MSP would be permitted to 

comply with the margin requirements of 

its home country’s regulator if the 

Commission determines that such 

requirements are comparable to the 

Commission’s margin requirements). 

For trades between a non-U.S. SD/

MSP (whether or not it is a guaranteed 

affiliate or an affiliate conduit) and a 

non-U.S. counterparty that is not a 

guaranteed affiliate or affiliate conduit, 

the Commission would not apply the 

margin requirements to such swaps. 

In the case of a foreign branch of a 

U.S. bank that is a SD/MSP, the 

proposed margin requirements would 

apply with respect to all of its uncleared 

swaps, regardless of the counterparty. 

However, where the counterparty to the 

trade is another foreign branch of a U.S. 

bank that is a SD/MSP or is a non-U.S. 

person counterparty (whether or not it 

is a guaranteed affiliate or an affiliate 

conduit), the Commission would allow 

substituted compliance (i.e., the foreign 

branch of a U.S. bank that is a SD/MSP 

would be permitted to comply with the 

margin requirements of the regulator in 

the foreign jurisdiction where the 

foreign branch is located if the 

Commission determines that such 

requirements are comparable to the 

Commission’s margin requirements).113

Below is a summary of how the 

margin requirements would apply under 

the Cross-Border Guidance Approach. 

U.S. person (other 

than Foreign Branch 

of U.S. Bank that is a 

Swap Dealer or MSP) 

Foreign Branch of 

U.S. Bank that is a 

Swap Dealer or MSP 

Non-U.S. person 

guaranteed by, or 

affiliate conduit of, a 

U.S. person 

Non-U.S. person not 

guaranteed by, and 

not an affiliate conduit 

of, a U.S. person 

U.S. Swap Dealer or MSP (including an affiliate of a non-U.S. person).Apply .......................... Apply .......................... Apply .......................... Apply 

Foreign Branch of U.S. Bank that is a Swap 

Dealer or MSP.

Apply .......................... Substituted Compliance.Substituted Compliance.Substituted Compliance 

Non-U.S. Swap Dealer or MSP (including an 

affiliate of a U.S. person).

Apply .......................... Substituted Compliance.Substituted Compliance.Do Not Apply 

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Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 59917 

114See Section 9 of Margin and Capital 

Requirements for Covered Swap Entities, 12 CFR 

Part 237 (Sept. 3, 2014), available at http://www.

federalreserve.gov/newsevents/press/bcreg/bcreg

20140903c1.pdf. 

115Under the Prudential Regulators’ approach, if 

an SD/MSP is under the control of a U.S. person, 

it would not be considered a non-U.S. SD/MSP. 

116However, substituted compliance may be 

available under certain circumstances, as described 

in the Guidance for entity-level requirements. 

2. Prudential Regulators’ Approach 

Under the second option, the 

Commission would adopt the Prudential 

Regulators’ approach to cross-border 

application of the margin 

requirements.114 Under the Prudential 

Regulators’ proposal, the Prudential 

Regulators would not assert authority 

over trades between a non-U.S. SD/

MSP 115 that is not guaranteed by a U.S. 

person and either a (i) non-U.S. SD/MSP 

that is not guaranteed by a U.S. person 

or (ii) a non-U.S. person that is not 

guaranteed by a U.S. person. The 

Prudential Regulators’ approach is 

generally consistent with the EntityLevel Approach described below, with 

the exception of the application of the 

margin requirements to certain non-U.S. 

SD/MSPs. 

However, the Prudential Regulators’ 

proposal in this regard would be 

consistent with the Commission’s CrossBorder Guidance Approach to margin 

requirements with respect to a trade 

between a non-U.S. SD/MSP and a nonU.S. person that is not guaranteed by a 

U.S. person. But under the definition of 

‘‘foreign covered swap entity’’ in the 

Prudential Regulators’ approach, a nonU.S. SD/MSP controlled by a U.S. 

person would not be a foreign covered 

swap entity, and thus, would not qualify 

for the exclusion from the margin 

requirement. In addition, the Prudential 

Regulators’ proposal incorporates a 

‘‘control’’ test for purposes of 

determining whether a registered SD/

MSP (or in the Prudential Regulators’ 

proposal, a ‘‘covered swap entity’’) is 

not a ‘‘foreign’’ entity. 

3. Entity-Level Approach 

Under the third option, the 

Commission would treat the margin 

requirements as an entity-level 

requirement. Under this Entity-Level 

Approach, the Commission would apply 

its cross-border rules on margin on a 

firm-wide level, irrespective of whether 

the counterparty is a U.S. person.116 At 

the same time, in recognition of 

international comity, the Commission is 

considering, where appropriate, to allow 

SDs/MSPs to satisfy the margin 

requirements by complying with a 

comparable regime in the relevant 

foreign jurisdiction, as described in the 

table below. This approach would be 

intended to address the concern that the 

source of the risk to a firm—given that 

the non-U.S. SD/MSP has sufficient 

contact with the United States to require 

registration as an SD/MSP—is not 

confined to its uncleared swaps with 

U.S. counterparties or to its uncleared 

swaps executed within the United 

States. A firm’s losses in uncleared 

swaps with non-U.S. counterparties, for 

example, could have a direct and 

significant impact on the firm’s 

financial integrity and on the U.S. 

financial system. 

Counterparty A Counterparty B Applicable requirements 

1. U.S. SD/MSP ....................................... U.S. person ........................................................... U.S. (All). 

2. U.S. SD/MSP ....................................... Non U.S. person guaranteed by a U.S. person ... U.S. (All). 

3. Non-U.S. SD/MSP guaranteed by a 

U.S. person.

U.S. person not registered as an SD/MSP ........... U.S. (All). 

4. Non-U.S. SD/MSP guaranteed by a 

U.S. person.

Non-U.S. person guaranteed by a U.S. person ... U.S. (All). 

5. U.S. SD/MSP ....................................... Non-U.S. person not guaranteed by a U.S. person.U.S. (Initial Margin collected by U.S. SD/MSP). 

Substituted Compliance (Initial Margin collected 

by non-U.S. person not guaranteed by a U.S. 

person). 

U.S. (Variation Margin). 

6. Non-U.S. SD/MSP guaranteed by a 

U.S. person.

Non-U.S. person not guaranteed by a U.S. person.U.S. (Initial Margin collected by non-U.S. SD/

MSP guaranteed by a U.S. person). 

Substituted Compliance (Initial Margin collected 

by non-U.S. person not guaranteed by a U.S. 

person). 

U.S. (Variation Margin). 

7. Non-U.S. SD/MSP not guaranteed by 

a U.S. person.

U.S. person not registered as an SD/MSP ........... Substituted Compliance (All). 

8 Non-U.S. SD/MSP not guaranteed by a 

U.S. person.

Non-U.S. person guaranteed by a U.S. person ... Substituted Compliance (All). 

9. Non-U.S. SD/MSP not guaranteed by 

a U.S. person.

Non-U.S. SD/MSP not guaranteed by a U.S. person.Substituted Compliance (All). 

10. Non-U.S. SD/MSP not guaranteed by 

a U.S. person.

Non-U.S. person not registered as an SD/MSP 

and not guaranteed by a U.S. person.

Substituted Compliance (All). 

B. Questions 

In this Advance Notice of Proposed 

Rulemaking, the Commission requests 

comment on all aspects of these options 

to the cross-border application of the 

margin requirements. In particular, the 

Commission is interested in comments 

relating to the costs and benefits of the 

various approaches so that it can take 

that into consideration when developing 

proposed rules relating to the crossborder application of the margin rules. 

Commenters are encouraged to address, 

among other things, the following 

questions: 

1. Under the Guidance Approach and 

Prudential Regulators Approach, certain 

trades involving a non-U.S. SD/MSP 

would be excluded from the 

Commission’s margin rules. The 

Commission seeks comment on whether 

this exclusion is over- or underinclusive, and if so, please explain why. 

2. Each of the options provides for 

substituted compliance under certain 

situations. In light of the equal or greater 

supervisory interest of the foreign 

regulator in certain circumstances, the 

Commission is seeking comment on 

whether the scope of substituted 

compliance under each option is 

appropriate. 

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59918 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

117 5 U.S.C. 601 et seq. 

118 47 FR 18618 (Apr. 30, 1982). 

119See 77 FR 30596, 30701 (May 23, 2012). 

120See 66 FR 20740, 20743 (April 25, 2001). 

121 44 U.S.C. 3501 et seq. 

3. The Commission is seeking 

comments on whether, in defining a 

non-U.S. covered swap entity, it should 

use the concept of ‘‘control,’’ in 

determining whether a covered swap 

entity is (or should be treated as) a nonU.S. covered swap entity. If the 

Commission uses a concept of control, 

should it be the same as that used by the 

Prudential Regulators, or should it be 

different? 

4. In the Commission’s view, it is the 

substance, rather than the form, of an 

agreement, arrangement or structure that 

should determine whether it should be 

considered a ‘‘guarantee.’’ The 

Commission invites comment on how 

the term ‘‘guarantee’’ should be 

construed or defined in the context of 

these margin rules. For example, should 

the definition cover the multitude of 

different agreements, arrangements and 

structures that transfer risk directly back 

to the United States with respect to 

financial obligations arising out of a 

swap? Should the definition cover such 

agreements, arrangements and 

structures even if they do not 

specifically reference the relevant swap 

or affirmatively state that it does not 

apply to such swap? Should the 

definition cover agreements, 

arrangements and structures even if the 

other party to the swap terminates, 

waives, or revokes the benefit of such 

agreements, arrangements or structures? 

5. The Commission seeks comments 

on the costs and benefits of 

harmonization with the Prudential 

Regulators’ proposal. 

6. The Commission invites 

commenters to comment in particular 

on the benefits of each of the 

approaches with respect to the statutory 

goal of protecting the financial system 

against the risks associated with 

uncleared swaps. 

7. Given that some foreign 

jurisdictions may not adopt comparable 

margin requirements, the Commission 

seeks comment on the costs and benefits 

of not requiring substituted compliance 

in emerging markets with respect to 

certain transactions and what might be 

an appropriate threshold percentage of a 

swap portfolio of participants or other 

standard for a de minimis level. In 

particular, the Commission is seeking 

comment on potential competitive 

impacts. Commenters are encouraged to 

quantify, if practical. 

8. The Commission seeks comment, 

including quantitative estimates in 

terms of notional volumes of swap 

activity, about how the different crossborder alternatives may impact the 

competitive landscape between U.S. 

entities and non-U.S. entities 

participating in swap markets. 

Specifically, the Commission seeks 

quantitative estimates of costs of 

transacting uncleared swaps with each 

category of counterparties, and/or access 

specific geographical markets, under 

each of the different alternatives. 

Commission seeks quantitative 

estimates of such impact on the ability 

of the affected market participants (who 

might be unable to access specific 

markets or counterparties) to hedge their 

risks using uncleared swaps. As the 

proposed margins on uncleared swaps 

are designed to strengthen market 

integrity, the Commission seeks 

comments on potential impact of each 

of these alternatives on market 

participants’ business models and 

trading strategies that could potentially 

compromise this policy goal. 

Commenters are encouraged to quantify 

and provide institutional details. 

9. The Commission is seeking 

comments on how the different 

alternatives impact price discovery? 

Commenters are encouraged to quantify, 

if practical. For instance, will different 

cross-border alternatives impact the 

ability of different categories of market 

participants, as contemplated in these 

alternatives, to transact uncleared swaps 

with each other? The Commission seeks 

quantitative estimates of such impact on 

transacted volumes and the pricing of 

uncleared swaps. 

10. The Commission is seeking 

comments on the relative costs and 

difficulty of compliance associated with 

each of the three approaches. Is one of 

the approaches preferable to the others 

in this regard? 

11. The Commission is seeking 

comments on the impact of each of the 

three approaches on a SD/MSP’s risk 

management practices. 

IV. 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.117 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.118

The proposed regulations would affect 

SDs and MSPs and their counterparties 

to uncleared swaps. As the only 

counterparties of SDs and MSPs to 

uncleared swaps can be other SDs, 

MSPs or ECPs, the following RFA will 

only discuss these entities. 

The Commission previously has 

determined that SDs and MSPs are not 

small entities for purposes of the 

RFA.119 The Commission also 

previously has determined that ECPs are 

not small entities for RFA purposes.120

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 of 1995 

(‘‘PRA’’) 121 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 proposed 

rulemaking contains collections of 

information for which the Commission 

has previously received control 

numbers from OMB. The titles for these 

collections of information are 

‘‘Regulations and Forms Pertaining to 

Financial Integrity of the Market Place, 

OMB control number 3038–0024’’ and 

‘‘Swap Trading Relationship 

Documentation Requirements for Swap 

Dealers and Major Swap Participants, 

OMB control number 3038–0088.’’ 

The collections of information that are 

proposed by this rulemaking are 

necessary to implement section 4s(e) of 

the CEA, which expressly requires the 

Commission to adopt rules governing 

margin requirements for SDs and MSPs. 

If adopted, responses to this collection 

of information would be mandatory. An 

agency may not conduct or sponsor, and 

a person is not required to respond to, 

a collection of information unless it 

displays a currently valid control 

number. 

1. Clarification of Collection 3038–0088 

This proposed rulemaking clarifies 

the existing collection of information 

found in OMB Control Number 3038– 

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Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 59919 

122See OMB Control No. 3038–0088, available at 

http://www.reginfo.gov/public/do/PRAOMBHistory

?ombControlNumber=3038-0088. 123 77 FR 55904 (Sept. 12, 2012). 

124The Commission previously proposed to adopt 

regulations governing standards and other 

requirements for initial margin models that would 

be used by SDs and MSPs to margin uncleared swap 

transactions. See Capital Requirements of Swap 

Dealers and Major Swap Participants, 76 FR 27,802 

(May 12, 2011). As part of the proposal, the 

Commission submitted proposed revisions to 

collection 3038–0024 for the estimated burdens 

associated with the margin model to OMB. The 

Commission is resubmitting new estimated burden 

as part of this re-proposal of the regulations. 

0088.122 Regulation 23.151 defines 

terms used in the proposed rule, 

including the definition of ‘‘eligible 

master netting agreement,’’ which 

provides that a CSE that relies on the 

agreement for purpose of calculating the 

required margin must (1) conduct 

sufficient legal review of the agreement 

to conclude with a well-founded basis 

that the agreement meets specified 

criteria and (2) establish and maintain 

written procedures for monitoring 

relevant changes in the law and to 

ensure that the agreement continues to 

satisfy the requirements of this section. 

The term ‘‘eligible master netting 

agreement’’ is used elsewhere in the 

proposed rule to specify instances in 

which a CSE may (1) calculate variation 

margin on an aggregate basis across 

multiple non-cleared swaps and (2) 

calculate initial margin requirements 

under an initial margin model for one or 

more swaps. 

Proposed Regulations §§ 23.152(c) 

and 23.153(d) specify that a CSE shall 

not be deemed to have violated its 

obligation to collect or post initial and 

variation margin, respectively, from or 

to a counterparty if the CSE has made 

the necessary efforts to collect or post 

the required 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 

or post the required margin. 

Proposed Regulation § 23.154 

establishes standards for initial margin 

models. These standards include (1) a 

requirement that a CSE review its initial 

margin model annually (§ 23.154(b)(4)); 

(2) a requirement that the covered swap 

entity validate its initial margin model 

initially and on an ongoing basis, 

describe to the Commission any 

remedial actions being taken, and report 

internal audit findings regarding the 

effectiveness of the initial margin model 

to the CSE’s board of directors or a 

committee thereof (§§ 23.154(b)(5)(ii) 

through 23.154(b)(5)(iv)); (3) a 

requirement that the CSE adequately 

documents all material aspects of its 

initial margin model (§ 23.154(b)(6)); 

and (4) a requirement that the CSE 

adequately documents internal 

authorization procedures, including 

escalation procedures that require 

review and approval of any change to 

the initial margin calculation under the 

initial margin model, demonstrable 

analysis that any basis for any such 

change is consistent with the 

requirements of this section, and 

independent review of such 

demonstrable analysis and approval 

(§ 23.154(b)(7)). 

Proposed Regulation § 23.155(b) 

requires a covered swap entity to create 

and maintain documentation setting 

forth the variation margin methodology, 

evaluate the reliability of its data 

sources at least annually, and make 

adjustments, as appropriate, and 

provides that the Commission at any 

time may require a covered swap entity 

to provide further data or analysis 

concerning the methodology or a data 

source. 

Proposed Regulation § 23.158 requires 

a covered swap entity to execute trading 

documentation with each counterparty 

that is either a swap entity or financial 

end user regarding credit support 

arrangements that (1) provides the 

contractual right to collect and post 

initial margin and variation margin in 

such amounts, in such form, and under 

such circumstances as are required; and 

(2) specifies the methods, procedures, 

rules, and inputs for determining the 

value of each non-cleared swap or noncleared security-based swap for 

purposes of calculating variation margin 

requirements, and the procedures for 

resolving any disputes concerning 

valuation. The reporting and 

recordkeeping requirements of proposed 

Regulation § 23.158, proposed 

Regulations § 23.154(b)(4) through (7), 

and proposed Regulation § 23.155(b) are 

contained in the provisions of 

Commission Regulations 23.500 through 

23.506, which were adopted on 

September 11, 2012, and part of OMB 

Control No. 3038–0088.123 Thus, the 

requirements in this proposal that are 

subject to collection 3038–0088 were 

previously addressed by the 

Commission in adopting the swap 

documentation trading requirements 

and simply further clarified in this 

proposal. 

To be sure, Commission Regulation 

§ 23.504(b) requires an SD or MSP to 

maintain written swap trading 

relationship documentation that must 

include all terms governing the trading 

relationship between the SD or MSP and 

its counterparty, and Commission 

Regulation § 23.504(d) requires that 

each SD and MSP maintain all 

documents required to be created 

pursuant to Commission Regulation 

23.504. Also, Commission Regulation 

§ 23.502(c) requires each SD and MSP to 

notify the Commission and any 

applicable Prudential Regulator of any 

swap valuation dispute in excess of $20 

million if not resolved in specified 

timeframes. Accordingly, this proposed 

rulemaking, specifically the 

requirements found in proposed 

Regulation § 23.154(b)(4) through (7), 

proposed Regulations §§ 23.155(b) and 

23.158, would not impact the burden 

estimates currently provided for in OMB 

Control No. 3038–0088. 

2. Revisions to Collection 3038–0024 

Collection 3038–0024 is currently in 

force with its control number having 

been provided by OMB. The proposal 

would revise collection 3038–0024 as 

discussed below. 

Proposed Regulation § 23.154(b)(1) 

requires CSEs that wish to use initial 

margin models to obtain the 

Commission’s approval, and to 

demonstrate to the Commission that the 

models satisfy standards established in 

§ 23.154.124 These standards include (1) 

a requirement that a CSE receive 

approval from the Commission based on 

a demonstration that the initial margin 

model meets specific requirements 

(§ 23.154(b)(1)); (2) a requirement that a 

CSE notify the Commission in writing 

60 days before extending the use of the 

model to additional product types, 

making certain changes to the initial 

margin model, or making material 

changes to modeling assumptions 

(§ 23.154(b)(1)); and (3) a variety of 

quantitative requirements, including 

requirements that the CSE validate and 

demonstrate the reasonableness of its 

process for modeling and measuring 

hedging benefits, demonstrate to the 

satisfaction of the Commission that the 

omission of any risk factor from the 

calculation of its initial margin is 

appropriate, demonstrate to the 

satisfaction of the Commission that 

incorporation of any proxy or 

approximation used to capture the risks 

of the covered swap entity’s non-cleared 

swaps or non-cleared security-based 

swaps is appropriate, periodically 

review and, as necessary, revise the data 

used to calibrate the initial margin 

model to ensure that the data 

incorporate an appropriate period of 

significant financial stress 

(§ 23.154(b)(3)). 

The requirement of proposed 

Regulation § 23.154(b)(1) that a CSE 

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59920 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

125 7 U.S.C. 19(a). 

126Posting collateral for swap transactions may 

result in other changes in the relationship between 

the CSE and counterparty instead of just pricing 

terms of swap contracts. For instance, bank CSEs 

might lower the required minimum balance on 

checking accounts that counterparty maintain with 

the bank, instead. 

127See 76 FR 23732 (April 28, 2011). 

128Margin requirements for non-centrally cleared 

derivatives at http://www.bis.org/publ/bcbs261.pdf, 

September 2013. The proposed rule establishes 

minimum standards for margin requirements for 

non-centrally cleared derivatives as agreed by BIS 

and IOSCO. 

must obtain the Commission’s approval 

to use an initial margin model by 

submitting documentation 

demonstrating that the initial margin 

model meets the standards set forth in 

§ 23.154, and the requirement that a CSE 

must provide the Commission with 

written notice 60 days prior to 

extending the use of the initial margin 

model to additional product types or 

making material changes to the model 

would result in revisions to the 

collection. 

Currently, there are approximately 

100 SDs and MSPs provisionally 

registered with the Commission. The 

Commission further estimates that 

approximately 60 of the SDs and MSPs 

will be subject to the Commission’s 

margin rules as they are not subject to 

a Prudential Regulator. The Commission 

further estimates that all SDs and MSPs 

will seek to obtain Commission 

approval to use models for computing 

initial margin requirements. The 

Commission estimates that the initial 

margin model requirements will impose 

an average of 240 burden hours per 

registrant. 

Based upon the above, the estimated 

additional hour burden for collection 

3038–0024 was calculated as follows: 

Number of registrants: 60. 

Frequency of collection: Initial 

submission and periodic updates. 

Estimated annual responses per 

registrant: 1. 

Estimated aggregate number of 

annual responses: 60. 

Estimated annual hour burden per 

registrant: 240 hours. 

Estimated aggregate annual hour 

burden: 14,400 hours [60 registrants × 

240 hours per registrant]. 

3. Information Collection Comments 

The Commission invites the public 

and other Federal agencies to comment 

on any aspect of the reporting burdens 

discussed above. Pursuant to 44 U.S.C. 

3506(c)(2)(B), the Commission solicits 

comments in order to: (1) Evaluate 

whether the proposed collection of 

information is necessary for the proper 

performance of the functions of the 

Commission, including the information 

will have practical utility; (2) evaluate 

the accuracy of the Commission’s 

estimate of the burden of the proposed 

collection of information; (3) determine 

whether there are ways to enhance the 

quality, utility, and clarity of the 

information to be collected; and (4) 

minimize the burden of the collection of 

information on those who are to 

respond, including through the use of 

automated collection techniques or 

other forms of information technology. 

Comments may be submitted directly 

to the Office of Information and 

Regulatory Affairs, by fax at (202) 395– 

6566 or by email at OIRAsubmissions@

omb.eop.gov. Please provide the 

Commission with a copy of submitted 

comments so that all comments can be 

summarized and addressed in the final 

rule preamble. Refer to the ADDRESSES

section of this notice of proposed 

rulemaking for comment submission 

instructions to the Commission. A copy 

of the supporting statements for the 

collections of information discussed 

above may be obtained by visiting 

RegInfo.gov. OMB is required to make a 

decision concerning the collection of 

information between 30 and 60 days 

after publication of this document in the 

Federal Register. Therefore, a comment 

is best assured of having its full effect 

if OMB receives it within 30 days of 

publication. 

C. Cost-Benefit Considerations 

1. Introduction 

Section 15(a) of the CEA requires the 

Commission to consider the costs and 

benefits of its actions before 

promulgating a regulation under the 

CEA or issuing certain orders.125

Section 15(a) further 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 

financial integrity of futures markets; (3) 

price discovery; (4) sound risk 

management practices; and (5) other 

public interest considerations. The 

Commission considers the costs and 

benefits resulting from its discretionary 

determinations with respect to the 

section 15(a) factors. 

The Commission recognizes that there 

is an inherent trade-off involved in 

setting minimum collateral standards. 

Such standards could increase margin 

requirements, which in turn would 

require market participants to post 

additional collateral. Posting additional 

collateral may result in opportunity 

costs in terms of lost returns from 

investing the funds in collateral, or in 

interest expenses incurred to raise 

additional funds. Such costs may reduce 

the investment returns for market 

participants posting collateral. On the 

other hand, minimum collateral 

standards help to mitigate counterparty 

credit risk. This is achieved by requiring 

market participants to post collateral 

that is sufficient to cover potential 

losses from default most of the time. 

The potential reduction in investment 

returns for market participants posting 

collateral might also be offset to some 

degree by improvements in pricing as a 

result of the reduction in risk of the 

swap. The reduction in counterparty 

credit risk from the posting of collateral 

may result in tighter spreads quoted by 

liquidity providers.126 From a regulatory 

perspective, minimum collateral 

standards introduce a trade-off between 

potentially lowering anticipated returns 

for market participants and lowering 

systemic risk from counterparty 

defaults. A substantial loss from a 

default might induce a cascade of 

defaults in a financial network, and 

perhaps, induce a liquidity crisis and 

the seizing up of parts of the financial 

system. In developing this proposal, the 

Commission has sought to reduce the 

potential lowering of investment returns 

of market participants by allowing them 

to use approved models to set margin 

collateral for certain swap transactions 

while still guarding against the dangers 

of systemic risk from counterparty 

defaults, along with other parts of the 

rule. 

2. Rule Summary 

This proposed rulemaking is a reproposal of prior CFTC proposed 

rulemaking.127 It is the result of a 

working group consultation paper 

issued by BCBS–IOSCO on margin for 

OTC-derivative contracts not cleared by 

a CCP (uncleared derivatives).128 This 

proposed rulemaking would implement 

the new statutory framework of section 

4s(e) of the 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 SDs and MSPs. 

Generally, the proposed rule would 

require the exchange (collection, 

posting, and payment) of margin by SDs 

and MSPs for trades with other SDs, 

MSPs and financial end-users. Initial 

margin is required to be held at thirdparty custodians with no 

rehypothecation. These CSEs would not 

be required to collect margin from or 

post margin to commercial end-users. 

Generally, the CFTC’s margin rules 

will apply to a SD or MSP whenever 

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Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 59921 

129For this rulemaking, a swap entity is either a 

swap dealer or a major swap participant. 

there is no Prudential Regulator for that 

covered swap entity.129 The CFTC’s 

margin rules will apply to swaps that 

are not cleared and that are executed 

subsequent to applicable compliance 

dates set out below, based on an entity’s 

level of uncleared swaps activity during 

a particular period. 

Generally, a CSE must collect IM from 

a counterparty that is (i) a swap entity, 

or (ii) a financial end-user with material 

swaps exposure ($3 billion notional 

during June, July and August of the 

previous year) in an amount that is no 

less than the greater of: (i) Zero (0) or 

(ii) the IM collection amount for such 

swap less the IM threshold amount ($65 

million—not including any portion of 

the IM threshold amount already 

applied by the covered swap entity or 

its affiliates to other swaps with the 

counterparty or its affiliates). 

Generally, a CSE must post IM for any 

swap with a counterparty that is a 

financial end-user with material swaps 

exposure (see above). A CSE is not 

required to collect IM from or post IM 

to commercial end-users. 

There are two general methods for 

calculating initial margin, the 

standardized approach and the modelbased approach. Under the standardized 

approach, the CSE must calculate IM 

collection amounts using a table/grid 

that is set out in the proposed rule. 

The model-based approach calculates 

an amount of IM that is equal to the 

potential future exposure (‘‘PFE’’) of a 

swap or a netting set of swaps. PFE is 

an estimate of the one-tailed 99% 

confidence interval for an increase in 

the value of the swap over a 10 day 

period (i.e., VaR model for a 10 day 

period). The model-based approach 

must meet the following requirements: 

(1) The model must have prior written 

approval by the Commission; (2) a CSE 

must demonstrate that the initial margin 

model continuously satisfies the rule’s 

requirements; (3) a covered swap entity 

must notify the Commission in writing 

prior to making material changes to the 

model, such as: (a) Extending the use of 

the model to an additional product type; 

(b) making any change that results in 

material changes to the amount of IM; 

or (c) making any material changes to 

the assumptions of the model. The 

Commission may rescind its approval in 

whole or in part of an entity’s margin 

model at any time. 

The rules for variation margin are as 

follows: (1) On or before the business 

day after execution of an uncleared 

swap between a covered swap entity 

and a counterparty that is a swap entity 

or a financial end user, the covered 

swap entity must collect variation 

margin from or pay variation margin to 

the counterparty; (2) a CSE is not 

required to collect or pay variation from 

commercial end-users; and (3) a CSE is 

not required to collect, post, or pay 

margin unless and until the total 

amount of margin transfer to be 

collected or posted for an individual 

counterparty exceeds the minimum 

transfer amount. 

The eligible collateral for variation 

margin is cash funds denominated in (a) 

USD, or (b) a currency in which 

payment under the swap contracts is 

required. The eligible collateral for 

initial margin includes (subject to 

haircuts on value) financial instruments 

in various categories, including cash, 

Treasury securities, and various 

publicly traded debt and equity 

instruments. A CSE may not collect or 

post as initial margin any asset that is 

a security issued by (i) the party 

providing such asset or an affiliate of 

that party; (ii) various banking entities 

as listed in the proposed rule; or (iii) 

certain government-sponsored 

enterprises unless an exception applies. 

As defined in the rule, a financial 

end-user is any counterparty that is not 

a covered swap entity and includes, 

among others: (i) A commodity pool, 

commodity trading advisor and 

commodity pool operator (all defined in 

the CEA); (ii) a private fund (defined in 

Investment Advisers Act); (iii) an 

employee benefit plan, as defined in 

ERISA section 3; (iv) a person 

predominantly engaged in activities that 

are in the business of banking, or in 

activities that are financial in nature 

(defined in section 4(k) of the BHCA); 

(v) a person defined in (a)–(d), if that 

person organized under the laws of the 

U.S.; and (vi) any other entity that in the 

Commission’s discretion is a financial 

end-user. A non-financial end-user is 

any entity that is not a financial enduser or an SD/MSP. 

Generally, a CSE entering into a swap 

with a swap entity or a financial enduser with material swap exposure who 

posts initial margin to the counterparty 

must comply with the following 

conditions: (1) All funds posted as 

initial margin must be held by a thirdparty custodian (unaffiliated with either 

party in the swap); (2) the third-party 

custodian is prohibited from rehypothecating (or otherwise 

transferring) the initial margin; (3) the 

third-party custodian is prohibited from 

reinvesting the initial margin in any 

asset that would not qualify as eligible 

collateral; and (4) the custodial 

agreement is legal, valid, binding and 

enforceable in the event of bankruptcy, 

insolvency, or similar proceedings. 

Generally, a CSE entering into a swap 

with a swap entity or a financial enduser with a material swap exposure that 

collects initial margin from the 

counterparty must require the same 

conditions listed above for initial 

margin posted. 

Generally, CSEs must comply with 

the minimum margin requirements for 

uncleared swaps on or before the 

following dates. For variation margin, 

covered swap entities must comply by 

December 1, 2015. Initial margin is 

subject to a phased-in period. The 

compliance date is December 1, 2015 

when both (i) the CSE and its affiliates 

and (ii) its counterparty and its 

affiliates, have an average daily 

aggregate notional amount of uncleared 

swaps, uncleared security-based swaps, 

foreign exchange forwards and foreign 

exchange swaps for each business day 

in June, July and August 2015 that 

exceeds $4 trillion. The compliance date 

is December 1, 2016 when both (i) the 

CSE and its affiliates and (ii) its 

counterparty and its affiliates, have an 

average daily aggregate notional amount 

of uncleared swaps, uncleared securitybased swaps, foreign exchange forwards 

and foreign exchange swaps for each 

business day in June, July and August 

2016 that exceeds $3 trillion. The 

compliance date is December 1, 2017 

when both (i) the CSE and its affiliates 

and (ii) its counterparty and its 

affiliates, have an average daily 

aggregate notional amount of uncleared 

swaps, uncleared security-based swaps, 

foreign exchange forwards and foreign 

exchange swaps for each business day 

in June, July and August 2017 that 

exceeds $2 trillion. The compliance date 

is December 1, 2018 when both (i) the 

CSE and its affiliates and (ii) its 

counterparty and its affiliates, have an 

average daily aggregate notional amount 

of uncleared swaps, uncleared securitybased swaps, foreign exchange forwards 

and foreign exchange swaps for each 

business day in June, July and August 

2018 that exceeds $1 trillion. The 

compliance date is December 1, 2019 for 

any other covered swap entity with 

respect to uncleared swaps and 

uncleared security-based swaps entered 

into with any other counterparty. 

3. Status Quo Baseline 

The baseline against which this 

proposed rule will be compared is the 

status quo. This requires the 

Commission to assess what is the 

current practice within the swaps 

industry. At present, swap market 

participants are not legally required to 

post either initial or variation margin 

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59922 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

130See http://www2.isda.org/functional-areas/

research/surveys/margin-surveys. 

131Bank for International Settlements, February 

2013, page 31, see http://www.bis.org/publ/

bcbs242.pdf. 

132Bank for International Settlements, February 

2013, page 31. See http://www.bis.org/publ/

bcbs242.pdf. 

133See http://www.cftc.gov/MarketReports/

SwapsReports/index.htm. 

when engaging in uncleared swaps. 

Nevertheless, for risk management 

purposes, many market participants 

currently undertake this practice. 

In determining the current market 

practices, the Commission utilized 

several sources of swaps market data. 

These sources include (i) the ISDA 

Margin Survey 2014 (‘‘ISDA Survey’’), 

(ii) BIS’s Quantitative impact study on 

margin requirements for non-centrallycleared OTC derivatives (‘‘BCBS/IOSCO 

Quantitative Impact Study’’), and (iii) 

Swap Data Repository data (‘‘SDR 

Data’’). Although the data the 

Commission is considering might not be 

complete, the Commission requests 

comments regarding whether there is 

additional data that it should consider 

when developing its baseline. 

a. ISDA Margin Survey 

A resource containing current market 

practice for uncleared swaps is the ISDA 

Survey.130 The use of collateral 

agreements (those with exposure and/or 

collateral balances) is substantial. The 

ISDA Survey estimates that roughly 

90% of all global uncleared OTC 

derivatives trades have collateral 

agreements. 97% and 86% of global 

bilateral transactions involving credit 

and fixed income, respectively, are 

subject to collateral agreements or credit 

support annexes. The survey reports 

that the use of cash and government 

securities accounts for roughly 90% of 

uncleared global OTC derivative 

collateral, as has been the case in prior 

years. The total global collateral related 

to uncleared derivatives has decreased 

14% from $3.7 trillion at the end of 

2012 to $3.2 trillion at the end of 2013. 

The survey asserts that this decrease can 

be largely attributed to mandatory 

clearing requirements. 

b. BCBS/IOSCO’s Quantitative Impact 

Study 

Another source containing current 

market practices for uncleared swaps is 

the BCBS/IOSCO Quantitative Impact 

Study.131 According to the Study, 

BCBS/IOSCO Quantitative Impact Study 

respondents have roughly Ö319 trillion 

(approximately $415 trillion) in total 

outstanding notional derivative 

positions, are collecting a total of 

roughly Ö95 billion (approximately $124 

billion) in initial margin and are posting 

roughly Ö6 billion (approximately $7.8 

billion) in initial margin. Hence, average 

margin represents about 0.03% of the 

gross notional exposure.’’ 132 The large 

difference between collected and posted 

margin reflects the fact that the BCBS/ 

IOSCO Quantitative Impact Study 

respondents tend to be large derivative 

dealers with large swap portfolios with 

transactions that on aggregate mostly 

offset, have substantial capital, and who 

have high credit ratings, this generally 

leads to lower margins. 

In light of the definition of potential 

future exposure in this proposal, it is 

useful to examine current practice. The 

table below, reproduced from the BCBS/ 

IOSCO Quantitative Impact Study 

provides some statistics on potential 

future exposure, and related industry 

practices. 

TABLE 4b—CURRENT MARGIN PRACTICES FOR UNCLEARED SWAPS

Average Median Number of 

respondents 

Margin period of risk (or risk horizon) in days ............................................................................ 8.1 10.0 15 

Confidence level (%) used .......................................................................................................... 96.2% 96.3% 14 

Length of the look-back period (in years) used in calibration of model ...................................... 2.9 2.0 13 

Level of initial margin as a percentage of potential future exposure .......................................... 97.5% 100.0% 10 

Margin frequency (in days) Variation margin .............................................................................. 2.3 1.0 31 

Initial margin ................................................................................................................................ 1.0 1.0 21 

Respondents have provided information on initial margin frequency. Eight (8) of these respondents collect initial margin at deal inception. One 

(1) of them collects initial margin on an event-driven basis. The remaining 12 respondents collect initial margin daily. 

The Commission seeks comment on 

the representativeness of the BCBS/

IOSCO’s Quantitative Impact Study. 

How do the calculations in the BCBS/ 

IOSCO’s Quantitative Impact Study 

compare to the experience of financial 

institutions? Commenters are 

encouraged to quantify when possible. 

c. Estimates Using SDR Data 

Finally, the Commission reports 

aggregated data derived from data 

submitted to swap data repositories in a 

weekly swaps market report.133 Open 

swap positions in credit and interest 

rates as of June 27, 2014 for CFTC 

regulated CSEs (59 entities) are 

presented below. The table also 

includes total notional amount of swaps 

transacted by these entities in credit and 

interest rates during the period January 

to June 2014: 

OPEN SWAPS AS OF JUNE 27, 2014 

[Notional amount in US$ billions (double count)] 

Uncleared Cleared 

Interest Rates .......................................................................................................................................................... 253,434 223,744 

Credit ....................................................................................................................................................................... 10,039 879 

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Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 59923 

134See http://www.regulations.gov/

#!documentDetail;D=OCC-2011-0008-0131. 

AGGREGATE NOTIONAL SWAPS TRANSACTION (JANUARY TO JUNE 2014) 

[Notional amount in US$ billions (double count)] 

Uncleared Cleared 

Interest Rates .......................................................................................................................................................... 12,630 39,816 

Credit ....................................................................................................................................................................... 1,362 5,717 

The Commission notes that OCC’s 

Economic Impact Analysis for Swaps 

Margin Proposed Rule 134 has estimated 

that in year one, OCC-supervised 

institutions will have to post total initial 

margin of approximately $331 billion 

with approximately $283 billion in 

interest rate and credit swaps. Using 

annualized notional swaps activity for 

just interest rate and credit, and 

adopting a similar methodology to the 

OCC’s Economic Impact Analysis, the 

Commission estimates that the 59 CFTC 

regulated CSEs will have to post initial 

margin in year one of approximately 

$340 billion or possibly less as noted 

below. The OCC’s estimate and the 

Commission’s estimate are not based on 

the same data. The OCC’s estimates are 

based on transactions activity implied 

by the open swaps positions from Call 

Report schedule RC–L. The 

Commission’s estimates are based on 

transaction data reported to SDRs. To 

the extent SDR data includes financial 

end users without material swaps 

exposure, nonfinancial end users, 

sovereigns, and multilateral 

development banks who do not have to 

post collateral, the amount of required 

initial margin would be less than the 

Commission’s estimate of approximately 

$340 billion. Further, the amount of 

required initial margin will be lower as 

a result of the $65 million threshold, 

too. While the OCC has made certain 

assumptions regarding coverage of the 

swaps activity by its regulated entities 

during the different compliance dates, 

the Commission does not have access to 

relevant data to make similar estimates. 

The Commission’s initial margin 

estimates assume that uncleared swaps 

activities by CFTC regulated CSEs in 

these two asset classes will remain the 

same. These differences in approaches 

and the data sources means that the 

Commission’s estimates will likely have 

overstated the actual margins that will 

be posted in year one after enactment. 

The Commission points out that 

prudentially regulated CSEs, CFTC 

regulated CSEs, and SEC regulated CSEs 

will trade with each other. Thus, one 

cannot simply add the margin estimates 

by various regulators as this will double 

count the amount of initial margin 

collateral for swap transactions between 

differently regulated CSEs. The 

Commission seeks comment on how it 

should consider or allocate the common 

costs and benefits of the margin 

collateral that is required by more than 

one CSE regulator. Further, the 

Commission seeks comments on all 

aspects of its initial margin estimates 

and methods. Commenters are 

encouraged to quantify, if practical. 

4. Section 15(a) Factors 

a. Protection of Market Participants and 

the Public 

Margin helps to protect market 

participants from counterparty credit 

risk. It also helps to protect the public 

by lowering the probability of a 

financial crisis, because margin helps to 

impede or contain the risk of a cascade 

of defaults occurring. A cascade occurs 

when one participant defaulting causes 

subsequent defaults by its 

counterparties, and so on, resulting in a 

domino effect and a potential financial 

crisis. 

The derivatives positions of swap 

market participants are limited by their 

ability to post margin. If the ability to 

post margin is binding, then required 

margin may reduce swap market 

exposures for some participants. In 

many cases, reduced swap market 

exposure for a participant may lower 

their probability of default, all else 

equal. Further, when a swap participant 

defaults, the margin can be used to 

absorb the losses to the counterparty. 

This facilitates the non-defaulting party 

reestablishing a similar position with a 

new counterparty. 

In requiring daily variation margin 

payments, the proposed rule would 

require counterparties to mark-to-market 

all open swap positions. The process of 

marking swap contracts to market or 

model, forces participants to recognize 

losses promptly and to adjust collateral 

accordingly. This helps to prevent the 

accumulation of large unrecognized 

losses and exposures. Consequently, 

this frequent settling up may reduce the 

probability of default of the party who 

has been experiencing losses on the 

contract. The proposed rule however, 

requires a minimum payment amount of 

$650,000, which provides 

counterparties with operational relief. 

This minimum payment does not lower 

the amount owed, but permits deferral 

of margin exchanges until it is 

operationally efficient. In providing this 

relief the Commission believes that it 

will lower the overall burden on the 

financial system, but as a result of this 

amount being relatively small the 

Commission believes this deferral 

would not noticeably increase the 

overall risk to the financial system and 

the general public. 

The proposed rule also provides that 

initial margin must be held at a thirdparty custodian. The margin amount 

held there cannot be rehypothecated 

with both parties having access to the 

collateral. This access is designed to 

prevent a liquidity event, inducing a 

cascading event. With rehypothecation, 

the collateral of some parties may be 

linked or used as collateral posted for 

other positions—the same collateral is 

posted for many positions for many 

different entities, resulting in a 

rehypothecation chain. When a default 

or liquidity event occurs at one link 

along the rehypothecation chain, it 

might induce further defaults or 

liquidity events for other links in the 

rehypothecation chain, because access 

to the collateral for other positions may 

be obstructed by a default along the 

chain, which may result in a liquidity 

event along the entire chain. 

The cost of providing initial margin 

collateral reflects the cost of obtaining 

the assets used as collateral, which is 

either the cost of raising external funds, 

or the foregone income that could been 

earned had the firm invested in a 

different asset (opportunity cost). The 

effective cost is the difference between 

the relevant cost of obtaining eligible 

assets and the return on the assets that 

can be pledged as collateral. The 

effective cost will likely differ between 

entities and even desks in the same 

entity as well as over time as conditions 

change. At one extreme, it may be that 

some entities providing initial margin, 

such as pension funds and asset 

managers, will provide assets as initial 

margin that they already own and 

would have owned even if no 

requirements were in place. In such 

cases the economic cost of providing 

initial margin collateral is anticipated to 

be low. In other cases, entities engaging 

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59924 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

135See, for instances, Singh (2010), ‘‘Undercollateralisation and rehypothecation in the OTC 

derivatives markets,’’ Banque de France Financial 

Stability Review (14); Sidanius and Zikes (2012), 

‘‘OTC derivatives reform and collateral demand 

impact,’’ Financial Stability Paper (18); and Duffie, 

Scheicher, and Vuillemey (2014), ‘‘Central Clearing 

and Collateral Demand,’’ working paper, Stanford 

University. 

136Committee on the Global Financial System, 

‘‘Asset encumbrance and the demand for collateral 

assets’’, CGFS Papers, no. 49, May 2013, http://

www.bis.org/publ/cgfs49.pdf. 

137Anderson and Joeveer (2014), ‘‘The Economics 

of Collateral,’’ working paper, London School of 

Economics. 

in uncleared swaps will have to raise 

additional funds to secure assets that 

can be pledged as initial margin. The 

greater the costs of their funding, 

relative to the rates of return on the 

initial margin collateral, the greater the 

cost of providing collateral assets. It is 

difficult, however, to estimate these 

costs due to differences in funding costs 

across different types of entities as well 

as differences in funding costs over 

time, and differences in the rate of 

return on different collateral assets that 

may be used to satisfy the initial margin 

requirements. In addition, as a result of 

the fact that posting margin reduces the 

risk of default, the posting party could 

receive a benefit in the form of 

improved pricing of the swap or other 

beneficial changes to the relationship 

between the CSE and the counterparty. 

To the extent any such benefit is 

realized, it would offset a portion of the 

cost incurred in posting collateral. 

The Commission seeks comment on 

the appropriate cost or a proxy for the 

costs to posting collateral for CFTC 

regulated entities, recognizing that 

CFTC entities may have different costs 

for pledging collateral. The Commission 

also seeks comments on the quantitative 

impact of these proposed rules on the 

pricing of swaps or other changes in the 

relationships between CSEs and 

counterparties. 

The proposal also requires that 

variation margin be exchanged between 

covered swap entities and other swap 

entities and financial end-users. The 

Commission preliminarily believes that 

the impact of such requirements are low 

in the aggregate because: (i) regular 

exchange of variation margin is already 

a well-established market practice 

among a large number of market 

participants, and (ii) exchange of 

variation margin simply redistributes 

resources from one entity to another in 

a manner that imposes no aggregate 

liquidity costs. An entity that suffers a 

reduction in liquidity from posting 

variation margin is offset by an increase 

in the liquidity enjoyed by the entity 

receiving the variation margin because 

variation margin is posted with cash. 

The Commission notes that if the 

margin payments are not instantaneous, 

however, there may be a slight loss in 

liquidity while payments are being 

posted. 

Posting margin may discourage some 

parties from hedging certain risks 

because it is no longer cost effective for 

them to do so. Consequently, this may 

reduce liquidity for some swap 

contracts. This concern is mitigated 

somewhat by exempting non-financial 

end users from having to post margin. 

Furthermore, not requiring parties to 

exchange variation margin when the 

change in valuation is small enough, 

$650,000, achieves additional cost 

savings. The proposed rule will create 

additional demand for eligible collateral 

to post as margin. Some advocates have 

expressed concern regarding the future 

availability of eligible assets for market 

participants to post as margin; 135

however, in developing this proposal, 

the Commission has added additional 

types of financial instruments to the list 

of eligible collateral in an attempt to 

mitigate this concern. That being said, it 

is too early to tell the extent to which 

eligible collateral will become more 

expensive to obtain. Even if higher 

demand for collateral does increase the 

price of certain existing assets, the 

Commission surmises that markets for 

various forms of collateral will clear. 

Higher prices may create incentives for 

creators of high quality assets to supply 

more in the future. For instance, 

sovereigns and credit worthy 

corporations may find it advantageous 

to issue more debt; as demand increases 

for their debt, prices will rise with 

corresponding borrowing rates 

decreasing. In addition, mutual funds 

and hedge funds may be willing for a fee 

to lend out assets that they hold in their 

portfolios to be pledged as initial 

margin. Some financial intermediaries 

may set up services to transform other 

financial instruments into eligible 

collateral, too. 

According to the Committee on the 

Global Financial System, there seems to 

be sufficient eligible collateral at present 

and in the near term, as they noted that 

‘‘Current estimates suggest that the 

combined impact of liquidity regulation 

and OTC derivatives reforms could 

generate additional collateral demand to 

the tune of $4 trillion. At the same time, 

the supply of collateral assets is known 

to have risen significantly since end2007. Outstanding amounts of AAAand AA-rated government securities 

alone—based on the market 

capitalization of widely used 

benchmark indices—increased by $10.8 

trillion between 2007 and 2012. Other 

measures suggest even greater increases 

in supply.’’ 136 As discussed above, 

there may be a reduction in the number 

of swap contracts due to the cost of 

posting margin. Indeed, this may be the 

case even if the cost of posting eligible 

collateral does not increase in price. 

Finally, the proposed margin rules will 

be phased in gradually. This gives 

regulators the ability to make 

adjustments, if necessary. 

b. The Efficiency, Competitiveness, and 

Integrity of Markets 

The proposed margin requirements 

make cleared swaps relatively more 

attractive. The Commission is requiring 

ten day initial margins for uncleared 

swaps and only five day margin for 

cleared swaps. In addition, the 

Commission is only allowing limited 

netting for uncleared swaps. All else 

equal, due to multilateral netting, less 

collateral may be required in a cleared 

environment relative to an uncleared 

environment.137

The Commission is allowing only 

limited netting for uncleared swaps. 

Limited netting may encourage 

participants to use a small number of 

counterparties for multiple swap 

transactions, because participants can 

only net swaps from those made with 

the same counterparty. This may 

encourage the concentration of risk 

among a few counterparties. However, 

these concerns may be mitigated 

somewhat by performing frequent 

portfolio compression exercises that 

facilitate multilateral netting. 

Another cost of the rules may be a 

reduction in the efficacy of hedging. 

Rules that make standardized swaps 

relatively less expensive may induce 

some entities to forego some customized 

swaps that may better match their 

exposures. However, before an entity 

decides to use a standardized swap over 

a customized uncleared swap, it must 

weigh the potentially lower margin 

costs from using standardized swaps 

against potentially losses from imperfect 

hedges. Consequently, market 

participants will still use customized 

swaps when they believe such swaps 

are superior for their hedging needs. 

All the market protection benefits 

discussed above may help to improve 

the integrity of markets, because they 

make it more likely that swap market 

participants will be able to perform on 

their contractual obligations. This 

comes with potential losses to 

participants who have to place their 

capital into margin and, hence 

potentially receive lower anticipated 

returns on their capital. 

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Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 59925 

The Commission has endeavored to 

harmonize this rulemaking with the 

domestic prudential regulators, as well 

as with foreign regulators. Two of the 

goals of harmonization are to satisfy the 

statute as well as to create a more level 

playing field thereby promoting fairer 

competition between entities regulated 

in different jurisdictions or by different 

regulators. Otherwise, regulatory 

arbitrage opportunities might be 

substantial. Price arbitrage occurs when 

an identical asset simultaneously has 

two different prices, so that an arbitrager 

may buy that asset where it is cheaper 

and sell it where it is more expensive to 

garner a risk free profit. Similarly, a 

regulatory arbitrager takes advantage of 

regulatory discrepancies by adapting 

activities so as to locate them in 

jurisdictions to increase the arbitrager’s 

regulatory profits (i.e., regulatory 

benefits minus regulatory burdens). 

The Commission is in discussion with 

domestic and foreign regulators on the 

material swap exposure threshold for 

financial end users to be required to 

post margin collateral. The Commission 

notes that some foreign regimes have 

proposed a higher threshold than $3 

billion. In addition, the Commission 

realizes that setting a threshold lower 

than another jurisdiction may result in 

some market participants conducting 

some swaps in the jurisdiction with a 

lower threshold. The Commission is 

required, to the maximum extent 

practicable, to harmonize with 

prudential regulators, and domestic 

regulators are endeavoring to harmonize 

with foreign regulators, as well. 

Therefore, the Commission expects to 

consider the relative benefits that might 

come from having consistent standards 

against those that might come from 

having different thresholds. The 

Commission is seeking comment on the 

costs and benefits of setting the 

threshold for material swap exposure for 

financial end users to be required to 

post margin collateral at various levels. 

In particular, commenters are 

encouraged to discuss competitive 

impacts and to quantify, if practical. In 

addition, the Commission is seeking 

comments on the costs and benefits of 

not fully harmonizing its rules with 

those of the prudential regulators. 

Commenters are encouraged to discuss 

the operational difficulties and to 

quantify, if practical. 

Inasmuch as larger banks tend to have 

a lower cost of capital than smaller 

banks, the posting of margin for 

uncleared swaps may result in a 

competitive advantage for larger banks 

when engaging in swaps, all else equal. 

Even though they are exempted from 

clearing as financial end users, small 

banks that have a material swaps 

exposure generally will have to post 

margin collateral when engaging in 

uncleared swaps with CFTC regulated 

CSEs. Thus, small banks may have to 

fund additional collateral to post as 

margin for uncleared swaps or engage in 

more cleared swaps that require 

relatively less collateral to post. The 

Commission is seeking comment on the 

costs and benefits of requiring small 

banks with material swaps exposures to 

post collateral with CFTC regulated 

CSEs. Commenters may choose to 

recognize that under the prudential 

regulators’ proposal, small banks that 

have a material swaps exposure and that 

engage in swaps with prudentially 

regulated CSEs would have to post 

margin collateral for uncleared swaps, 

too. Further, commenters may also 

choose to recognize that the 

Commission is required to harmonize 

this rulemaking, to the maximum extent 

practicable, with the prudential 

regulators. Comments are encouraged to 

quantify, if practical. 

c. Price Discovery 

The Commission is requiring ten day 

initial margins for uncleared swaps and 

only five day margin for cleared swaps. 

In addition, the Commission is only 

allowing limited netting for uncleared 

swaps. Consequently, these rules 

promote the use of more standardized 

cleared swaps at the expense of more 

customized and opaque swaps. 

To the extent traders increase the use 

of standardized cleared swaps in 

response to these rules, it may lead to 

greater transparency, overall, in the 

swaps markets. Compared to uncleared 

swaps, standardized swaps’ prices tend 

to be more transparent and the price 

discovery process for such swaps may 

improve with higher volumes. 

Conversely, lower volumes for 

uncleared swaps may negatively impact 

the price discovery process for such 

swaps. However, the Commission 

believes that the potential reduction in 

the efficacy of the price discovery 

process for uncleared swaps is less of a 

concern, because the price-setting 

process for uncleared swaps is not 

conducted on a regulated platform or 

pursuant to rules requiring transparency 

and is therefore relatively opaque in the 

current environment, anyway. 

The Commission recognizes that 

another way the rules may affect price 

discovery is by promoting confidence in 

the market. As such, the margin 

collateral rules may protect, 

prophylactically, the price discovery 

process of some swap contracts in some 

circumstances. The rules might protect 

price discovery by reducing the 

frequency of trading interruptions in 

segments of the swap market due to 

credit risk concerns. This rulemaking 

might improve price discovery in these 

instances, because the presence of 

collateral mitigates credit risk concerns, 

and thereby allows these swap contract 

markets to remain functioning. In turn, 

this permits market participants to 

continue to observe the prices of these 

swaps. 

The Commission requests comment 

on potential effects of the rule on price 

discovery as well as on the relative use 

of cleared and uncleared swaps, and on 

whether particular types of market 

participants, including intermediaries 

such as regulated trading platforms, will 

be impacted differently by the rule. 

Commenters are urged to quantify the 

costs and benefits, if practicable. 

d. Sound Risk Management Practices 

Margin helps to mitigate the credit 

risk exposure resulting from swap 

contracts. Further, it is a sound practice 

to regularly mark to market or model to 

prevent the accumulation of 

unrecognized losses and exposures 

(through the exchange of variation 

margin). At the same time, requiring 

margin may help deter traders from 

taking advantage of the inherent 

leverage in certain swap transactions. 

The Commission is requiring ten day 

initial margins for uncleared swaps and 

only five day initial margin for cleared 

swaps. Thus, the rule may result in the 

use of more standardized cleared swaps 

at the expense of more customized 

swaps which may be harder to evaluate 

and risk manage; however, this may 

result in market participants using nonoptimal hedging techniques, as noted 

above, which may increase overall risk 

at a firm. 

Prohibiting rehypothecation at thirdparty custodians when both parties have 

access to the collateral will be helpful 

in the time of default. Otherwise, a 

liquidity event might occur that induces 

a cascading event, in which the 

positions will be linked to other 

positions and counterparties. The policy 

of not allowing rehypothecation, 

however, requires that more collateral 

be available to post as margin. As 

discussed above, this does not seem to 

be a serious problem at present, but it 

might become one in the future. In 

addition, to protect parties against the 

circumstance when pledged collateral 

might be appropriated by the 

counterparty, margins must be held at 

third parties. Facilitating the use of 

more customized models might induce 

market participants to more thoroughly 

analyze the risks of their swap 

transactions, and may lead to better risk 

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59926 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

management practices overall. The 

Commission is allowing various 

methods to model the amount of 

collateral required as initial margin for 

uncleared swap transactions, including 

Commission-approved standard models 

or more customized ones. 

In this proposal, the Commission has 

added flexibility to what constitutes 

eligible collateral, allowing participants 

in uncleared swap transactions to 

‘optimize’ their collateral inasmuch as 

they may reduce their opportunity cost 

losses from pledging assets with lower 

anticipated returns. This may result in 

market participants focusing on 

improving their margin and risk 

management practices. 

e. Other Public Interest Considerations 

The Commission has not identified 

any other public interest considerations. 

List of Subjects 

17 CFR Part 23 

Swaps, Swap dealers, Major swap 

participants, Capital and margin 

requirements. 

17 CFR Part 140 

Authority delegations (Government 

agencies), Organization and functions 

(Government agencies). 

For the reasons discussed in the 

preamble, the Commodity Futures 

Trading Commission proposes to amend 

17 CFR chapter I as set forth below: 

PART 23—SWAP DEALERS AND 

MAJOR SWAP PARTICIPANTS 

■ 1. The authority citation for part 23 

continues to read as follows: 

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

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

18, 19, 21. 

■ 2. Add subpart E to part 23 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 Scope. 

23.151 Definitions applicable to margin 

requirements. 

23.152 Collection and posting of initial 

margin. 

23.153 Collection and payment of variation 

margin. 

23.154 Calculation of initial margin. 

23.155 Calculation of variation margin. 

23.156 Forms of margin. 

23.157 Custodial arrangements. 

23.158 Margin documentation. 

23.159 Compliance dates. 

23.160–23.199 [Reserved] 

§§ 23.100–23.149 [Reserved] 

§ 23.150 Scope. 

The margin requirements set forth in 

§ 23.150 through § 23.159 shall apply to 

uncleared swaps, as defined in § 23.151, 

that are executed after the applicable 

compliance dates set forth in § 23.159. 

§ 23.151 Definitions applicable to margin 

requirements. 

For the purposes of §§ 23.150 through 

23.159: 

Affiliate means any company that 

controls, is controlled by, or is under 

common control with another company. 

Bank holding company has the 

meaning specified in section 2 of the 

Bank Holding Company Act of 1956 (12 

U.S.C. 1841). 

Broker dealer means an entity 

registered with the Securities and 

Exchange Commission under section 15 

of the Securities Exchange Act of 1934 

(15 U.S.C. 78o). 

Control of another company means: 

(1) Ownership, control, or power to 

vote 25 percent or more of a class of 

voting securities of the company, 

directly or indirectly or acting through 

one or more other persons; 

(2) Ownership or control of 25 percent 

or more of the total equity of the 

company, directly or indirectly or acting 

through one or more other persons; or 

(3) Control in any manner of the 

election of a majority of the directors or 

trustees of the company. 

Counterparty means the other party to 

a swap to which a covered swap entity 

is a party. 

Covered counterparty means a 

financial end user with material swaps 

exposure, a swap dealer, or a major 

swap participant that enters into a swap 

with a covered swap entity. 

Covered swap entity means a swap 

dealer or major swap participant for 

which there is no prudential regulator. 

Cross-currency swap means a swap in 

which one party exchanges with another 

party principal and interest rate 

payments in one currency for principal 

and interest rate payments in another 

currency, and the exchange of principal 

occurs upon the inception of the swap, 

with reversal of the exchange of 

principal at a later date that is agreed 

upon at the inception of the swap. 

Data source means an entity and/or 

method from which or by which a 

covered swap entity obtains prices for 

swaps or values for other inputs used in 

a margin calculation. 

Depository institution has the 

meaning specified in section 3(c) of the 

Federal Deposit Insurance Act (12 

U.S.C. 1813(c)). 

Eligible collateral means collateral 

described in § 23.157. 

Eligible master netting agreement 

means a written, legally enforceable 

agreement provided that: 

(1) The agreement creates a single 

legal obligation for all individual 

transactions covered by the agreement 

upon an event of default, including 

upon an event of receivership, 

insolvency, liquidation, or similar 

proceeding, of the counterparty; 

(2) The agreement provides the 

covered swap entity the right to 

accelerate, terminate, and close out on 

a net basis all transactions under the 

agreement and to liquidate or set off 

collateral promptly upon an event of 

default, including upon an event of 

receivership, insolvency, liquidation, or 

similar proceeding, of the counterparty, 

provided that, in any such case, any 

exercise of rights under the agreement 

will not be stayed or avoided under 

applicable law in the relevant 

jurisdictions, other than in receivership, 

conservatorship, resolution under the 

Federal Deposit Insurance Act (12 

U.S.C. 1811 et seq.), Title II of the DoddFrank Act (12 U.S.C. 4617) or under any 

similar insolvency law applicable to 

U.S. Government-sponsored enterprises 

(12 U.S.C. 2183 and 2279cc); 

(3) The agreement does not contain a 

walkaway clause (that is, a provision 

that permits a non-defaulting 

counterparty to make a lower payment 

than it otherwise would make under the 

agreement, or no payment at all, to a 

defaulter or the estate of a defaulter, 

even if the defaulter or the estate of the 

defaulter is a net creditor under the 

agreement); and 

(4) A covered swap entity that relies 

on the agreement for purposes of 

calculating the margin required by this 

part: 

(i) Conducts sufficient legal review 

(and maintains sufficient written 

documentation of that legal review) to 

conclude with a well-founded basis 

that: 

(A) The agreement meets the 

requirements of paragraphs (1) through 

(3) of this definition; and 

(B) In the event of a legal challenge 

(including one resulting from default or 

from receivership, insolvency, 

liquidation, or similar proceeding) the 

relevant court and administrative 

authorities would find the agreement to 

be legal, valid, binding, and enforceable 

under the law of the relevant 

jurisdictions; and 

(ii) Establishes and maintains written 

procedures to monitor possible changes 

in relevant law and to ensure that the 

agreement continues to satisfy the 

requirements of this definition. 

Financial end user means 

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Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 59927 

(1) A counterparty that is not a swap 

entity and that is: 

(i) A bank holding company or an 

affiliate thereof; a savings and loan 

holding company; or a nonbank 

financial institution supervised by the 

Board of Governors of the Federal 

Reserve System under Title I of the 

Dodd-Frank Act (12 U.S.C. 5323); 

(ii) A depository institution; a foreign 

bank; a Federal credit union or State 

credit union as defined in section 2 of 

the Federal Credit Union Act (12 U.S.C. 

1752(1) and (6)); an institution that 

functions solely in a trust or fiduciary 

capacity as described in section 

2(c)(2)(D) of the Bank Holding Company 

Act (12 U.S.C. 1841(c)(2)(D)); an 

industrial loan company, an industrial 

bank, or other similar institution 

described in section 2(c)(2)(H) of the 

Bank Holding Company Act (12 U.S.C. 

1841(c)(2)(H)); 

(iii) An entity that is state-licensed or 

registered as: 

(A) A credit or lending entity, 

including a finance company; money 

lender; installment lender; consumer 

lender or lending company; mortgage 

lender, broker, or bank; motor vehicle 

title pledge lender; payday or deferred 

deposit lender; premium finance 

company; commercial finance or 

lending company; or commercial 

mortgage company; except entities 

registered or licensed solely on account 

of financing the entity’s direct sales of 

goods or services to customers; 

(B) A money services business, 

including a check casher; money 

transmitter; currency dealer or 

exchange; or money order or traveler’s 

check issuer; 

(iv) A regulated entity as defined in 

section 1303(20) of the Federal Housing 

Enterprises Financial Safety and 

Soundness Act of 1992 (12 U.S.C. 

4502(20)) and any entity for which the 

Federal Housing Finance Agency or its 

successor is the primary federal 

regulator; 

(v) Any institution chartered and 

regulated by the Farm Credit 

Administration in accordance with the 

Farm Credit Act of 1971, as amended, 

12 U.S.C. 2001 et seq.; 

(vi) A securities holding company; a 

broker or dealer; an investment adviser 

as defined in section 202(a) of the 

Investment Advisers Act of 1940 (15 

U.S.C. 80b–2(a)); an investment 

company registered with the Securities 

and Exchange Commission under the 

Investment Company Act of 1940 (15 

U.S.C. 80a–1 et seq.). 

(vii) A private fund as defined in 

section 202(a) of the Investment 

Advisers Act of 1940 (15 U.S.C. 80–b– 

2(a)); an entity that would be an 

investment company under section 3 of 

the Investment Company Act of 1940 

(15 U.S.C. 80a–3) but for section 

3(c)(5)(C); or an entity that is deemed 

not to be an investment company under 

section 3 of the Investment Company 

Act of 1940 pursuant to Investment 

Company Act Rule 3a–7 of the 

Securities and Exchange Commission 

(17 CFR 270.3a–7); 

(viii) A commodity pool, a commodity 

pool operator, a commodity trading 

advisor, or a futures commission 

merchant; 

(ix) An employee benefit plan as 

defined in paragraphs (3) and (32) of 

section 3 of the Employee Retirement 

Income and Security Act of 1974 (29 

U.S.C. 1002); 

(x) An entity that is organized as an 

insurance company, primarily engaged 

in writing insurance or reinsuring risks 

underwritten by insurance companies, 

or is subject to supervision as such by 

a State insurance regulator or foreign 

insurance regulator; 

(xi) An entity that is, or holds itself 

out as being, an entity or arrangement 

that raises money from investors 

primarily for the purpose of investing in 

loans, securities, swaps, funds or other 

assets for resale or other disposition or 

otherwise trading in loans, securities, 

swaps, funds or other assets; 

(xii) A person that would be a 

financial entity described in paragraphs 

(1)(i)–(xi) of this definition if it were 

organized under the laws of the United 

States or any State thereof; or 

(xiii) Notwithstanding paragraph (2) 

of this definition, any other entity that 

the Commission determines should be 

treated as a financial end user. 

(2) The term ‘‘financial end user’’ 

does not include any counterparty that 

is: 

(i) A sovereign entity; 

(ii) A multilateral development bank; 

(iii) The Bank for International 

Settlements; 

(iv) An entity that is exempt from the 

definition of financial entity pursuant to 

section 2(h)(7)(C)(iii) of the Act and 

implementing regulations; or 

(v) An affiliate that qualifies for the 

exemption from clearing pursuant to 

section 2(h)(7)(D) of the Act. 

Foreign bank has the meaning 

specified in section 1 of the 

International Banking Act of 1978 (12 

U.S.C. 3101). 

Foreign exchange forward and foreign 

exchange swap mean any foreign 

exchange forward, as that term is 

defined in section 1a(24) of the Act, and 

foreign exchange swap, as that term is 

defined in section 1a(25) of the Act. 

Initial margin means collateral 

collected or posted to secure potential 

future exposure under one or more 

uncleared swaps. 

Initial margin threshold amount 

means an aggregate credit exposure of 

$65 million resulting from all uncleared 

swaps and uncleared security-based 

swaps between a covered swap entity 

and its affiliates, and a covered 

counterparty and its affiliates. 

Major currencies means 

(1) United States Dollar (USD); 

(2) Canadian Dollar (CAD); 

(3) Euro (EUR); 

(4) United Kingdom Pound (GBP); 

(5) Japanese Yen (JPY); 

(6) Swiss Franc (CHF); 

(7) New Zealand Dollar (NZD); 

(8) Australian Dollar (AUD); 

(9) Swedish Kronor (SEK); 

(10) Danish Kroner (DKK); 

(11) Norwegian Krone (NOK); and 

(12) Any other currency designated by 

the Commission. 

Market intermediary means 

(1) A securities holding company; 

(2) A broker or dealer; 

(3) A futures commission merchant; 

(4) A swap dealer; or 

(5) A security-based swap dealer. 

Material swaps exposure for an entity 

means that the entity and its affiliates 

have an average daily aggregate notional 

amount of uncleared swaps, uncleared 

security-based swaps, foreign exchange 

forwards, and foreign exchange swaps 

with all counterparties for June, July 

and August of the previous calendar 

year that exceeds $3 billion, where such 

amount is calculated only for business 

days. 

Minimum transfer amount means an 

initial margin or variation margin 

amount under which no actual transfer 

of funds is required. The minimum 

transfer amount shall be $650,000 or 

such other amount as the Commission 

may establish by order. 

Multilateral development bank means 

(1) The International Bank for 

Reconstruction and Development; 

(2) The Multilateral Investment 

Guarantee Agency; 

(3) The International Finance 

Corporation; 

(4) The Inter-American Development 

Bank; 

(5) The Asian Development Bank; 

(6) The African Development Bank; 

(7) The European Bank for 

Reconstruction and Development; 

(8) The European Investment Bank; 

(9) The European Investment Fund; 

(10) The Nordic Investment Bank; 

(11) The Caribbean Development 

Bank; 

(12) The Islamic Development Bank; 

(13) The Council of Europe 

Development Bank; and 

(14) Any other entity that provides 

financing for national or regional 

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development in which the U.S. 

government is a shareholder or 

contributing member or which the 

Commission determines poses 

comparable credit risk. 

Non-financial end user means a 

counterparty that is not a swap dealer, 

a major swap participant, or a financial 

end user. 

Prudential regulator has the meaning 

specified in section 1a(39) of the Act. 

Savings and loan holding company 

has the meaning specified in section 

10(n) of the Home Owners’ Loan Act (12 

U.S.C. 1467a(n)). 

Securities holding company has the 

meaning specified in section 618 of the 

Dodd-Frank Act (12 U.S.C. 1850a). 

Security-based swap has the meaning 

specified in section 3(a)(68) of the 

Securities Exchange Act of 1934 (15 

U.S.C. 78c(a)(68)). 

Sovereign entity means a central 

government (including the U.S. 

government) or an agency, department, 

ministry, or central bank of a central 

government. 

State means any State, 

commonwealth, territory, or possession 

of the United States, the District of 

Columbia, the Commonwealth of Puerto 

Rico, the Commonwealth of the 

Northern Mariana Islands, American 

Samoa, Guam, or the United States 

Virgin Islands. 

Subsidiary means a company that is 

controlled by another company. 

Swap entity means a swap dealer or 

major swap participant. 

Uncleared security-based swap means 

a security-based swap that is not cleared 

by a clearing agency registered with the 

Securities and Exchange Commission. 

Uncleared swap means a swap that is 

not cleared by a registered derivatives 

clearing organization, or by a clearing 

organization that has received a noaction letter or other exemptive relief 

from the Commission permitting it to 

clear certain swaps for U.S. persons 

without being registered as a derivatives 

clearing organization. 

U.S. Government-sponsored 

enterprise means an entity established 

or chartered by the U.S. government to 

serve public purposes specified by 

federal statute but whose debt 

obligations are not explicitly guaranteed 

by the full faith and credit of the U.S. 

government. 

Variation margin means a payment by 

a party to its counterparty to meet an 

obligation under one or more swaps 

between the parties as a result of a 

change in value of such obligations 

since the trade was executed or the 

previous time such payment was made. 

§ 23.152 Collection and posting of initial 

margin. 

(a) Collection—(1) Initial obligation. 

On or before the business day after 

execution of an uncleared swap between 

a covered swap entity and a covered 

counterparty, the covered swap entity 

shall collect initial margin from the 

covered counterparty in an amount 

equal to or greater than an amount 

calculated pursuant to § 23.154, in a 

form that complies with § 23.156, and 

pursuant to custodial arrangements that 

comply with § 23.157. 

(2) Continuing obligation. The 

covered swap entity shall continue to 

hold initial margin from the covered 

counterparty in an amount equal to or 

greater than an amount calculated each 

business day pursuant to § 23.154, in a 

form that complies with § 23.156, and 

pursuant to custodial arrangements that 

comply with § 23.157, until such 

uncleared swap is terminated or expires. 

(b) Posting—(1) Initial obligation. On 

or before the business day after 

execution of an uncleared swap between 

a covered swap entity and a covered 

counterparty that is a financial end user, 

the covered swap entity shall post 

initial margin with the covered 

counterparty in an amount equal to or 

greater than an amount calculated 

pursuant to § 23.154, in a form that 

complies with § 23.156, and pursuant to 

custodial arrangements that comply 

with § 23.157. 

(2) Continuing obligation. The 

covered swap entity shall continue to 

post initial margin with the covered 

counterparty in an amount equal to or 

greater than an amount calculated each 

business day pursuant to § 23.154, in a 

form that complies with § 23.156, and 

pursuant to custodial arrangements that 

comply with § 23.157, until such 

uncleared swap is terminated or expires. 

(c) Satisfaction of collection and 

posting requirements. A covered swap 

entity shall not be deemed to have 

violated its obligation to collect or to 

post initial margin from a covered 

counterparty if: 

(1) The covered counterparty has 

refused or otherwise failed to provide, 

or to accept, the required initial margin 

to, or from, the covered swap entity; and 

(2) The covered swap entity has: 

(i) Made the necessary efforts to 

collect or to post the required initial 

margin, including the timely initiation 

and continued pursuit of formal dispute 

resolution mechanisms, including 

pursuant to § 23.504(b)(4), if applicable, 

or has otherwise demonstrated upon 

request to the satisfaction of the 

Commission that it has made 

appropriate efforts to collect or to post 

the required initial margin; or 

(ii) Commenced termination of the 

uncleared swap with the covered 

counterparty promptly following the 

applicable cure period and notification 

requirements. 

§ 23.153 Collection and payment of 

variation margin. 

(a) Initial obligation. On or before the 

business day after execution of an 

uncleared swap between a covered swap 

entity and a counterparty that is a swap 

entity or a financial end user, the 

covered swap entity shall collect 

variation margin from, or pay variation 

margin to, the counterparty as 

calculated pursuant to § 23.155 and in a 

form that complies with § 23.156. 

(b) Continuing obligation. The 

covered swap entity shall continue to 

collect variation margin from, or to pay 

variation margin to, the counterparty as 

calculated each business day pursuant 

to § 23.155 and in a form that complies 

with § 23.156 each business day until 

such uncleared swap is terminated or 

expires. 

(c) Netting. To the extent that more 

than one uncleared swap is executed 

pursuant to an eligible master netting 

agreement between a covered swap 

entity and a counterparty, a covered 

swap entity may calculate and comply 

with the variation margin requirements 

of this section on an aggregate basis 

with respect to all uncleared swaps 

governed by such agreement. If the 

agreement covers uncleared swaps 

entered into before the applicable 

compliance date set forth in § 23.159, 

those swaps must be included in the 

aggregate for the purposes of calculation 

and complying with the variation 

margin requirements of this section. 

(d) Satisfaction of collection and 

payment requirements. A covered swap 

entity shall not be deemed to have 

violated its obligation to collect or to 

pay variation margin from a 

counterparty if: 

(1) The counterparty has refused or 

otherwise failed to provide or to accept 

the required variation margin to or from 

the covered swap entity; and 

(2) The covered swap entity has: 

(i) Made the necessary efforts to 

collect or to pay 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 

or to pay the required variation margin; 

or 

(ii) Commenced termination of the 

uncleared swap with the counterparty 

promptly following the applicable cure 

period and notification requirements. 

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Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 59929 

§ 23.154 Calculation of initial margin. 

(a) Means of calculation. (1) Each 

business day each covered swap entity 

shall calculate an initial margin amount 

to be collected from each covered 

counterparty using: 

(i) A risk-based model that meets the 

requirements of paragraph (b) of this 

section; or 

(ii) The table-based method set forth 

in paragraph (c) of this section. 

(2) Each business day each covered 

swap entity shall calculate an initial 

margin amount to be posted with each 

covered counterparty that is a financial 

end user using: 

(i) A risk-based model that meets the 

requirements of paragraph (b) of this 

section; or 

(ii) The table-based method set forth 

in paragraph (c) of this section. 

(3) Each covered swap entity may 

reduce the amounts calculated pursuant 

to paragraphs (a)(1) and (2) of this 

section by the initial margin threshold 

amount provided that the reduction 

does not include any portion of the 

initial margin threshold amount already 

applied by the covered swap entity or 

its affiliates in connection with other 

uncleared swaps or uncleared securitybased swaps with the counterparty or its 

affiliates. 

(4) The amounts calculated pursuant 

to paragraph (a)(3) of this section shall 

not be less than zero. 

(5) A covered swap entity shall not be 

required to collect or to post an amount 

below the minimum transfer amount. 

(6) For risk management purposes, 

each business day each covered swap 

entity shall calculate a hypothetical 

initial margin requirement for each 

swap for which the counterparty is a 

non-financial end user that has material 

swaps exposure to the covered swap 

entity as if the counterparty were a 

covered counterparty and compare that 

amount to any initial margin required 

pursuant to the margin documentation. 

(b) Risk-based Models—(1) 

Commission approval. (i) A covered 

swap entity shall obtain the written 

approval of the Commission to use a 

model to calculate the initial margin 

required in this part. 

(ii) A covered swap entity shall 

demonstrate that the model satisfies all 

of the requirements of this section on an 

ongoing basis. 

(iii) A covered swap entity shall 

notify the Commission in writing 60 

days prior to: 

(A) Extending the use of an initial 

margin model that has been approved to 

an additional product type; 

(B) Making any change to any initial 

margin model that has been approved 

that would result in a material change 

in the covered swap entity’s assessment 

of initial margin requirements; or 

(C) Making any material change to 

modeling assumptions used by the 

initial margin model. 

(iv) The Commission may rescind its 

approval of the use of any initial margin 

model, in whole or in part, or may 

impose additional conditions or 

requirements if the Commission 

determines, in its sole discretion, that 

the model no longer complies with this 

section. 

(2) Applicability to multiple swaps. 

To the extent that more than one 

uncleared swap is executed pursuant to 

an eligible master netting agreement 

between a covered swap entity and a 

covered counterparty, a covered swap 

entity may use its initial margin model 

to calculate and comply with the initial 

margin requirements on an aggregate 

basis with respect to all uncleared 

swaps governed by such agreement. If 

the agreement covers uncleared swaps 

entered into before the applicable 

compliance date, those swaps must be 

included in the aggregate in the initial 

margin model for the purposes of 

calculating and complying with the 

initial margin requirements. 

(3) Elements of the model. (i) The 

model shall calculate an amount of 

initial margin that is equal to the 

potential future exposure of the 

uncleared swap or netting set of 

uncleared swaps covered by an eligible 

master netting agreement. Potential 

future exposure is an estimate of the 

one-tailed 99 percent confidence 

interval for an increase in the value of 

the uncleared swap or netting set of 

uncleared swaps due to an 

instantaneous price shock that is 

equivalent to a movement in all material 

underlying risk factors, including 

prices, rates, and spreads, over a 

holding period equal to the shorter of 

ten business days or the maturity of the 

swap. 

(ii) All data used to calibrate the 

model shall be based on an equally 

weighted historical observation period 

of at least one year and not more than 

five years and must incorporate a period 

of significant financial stress for each 

broad asset class that is appropriate to 

the uncleared swaps to which the initial 

margin model is applied. 

(iii) The model shall use risk factors 

sufficient to measure all material price 

risks inherent in the transactions for 

which initial margin is being calculated. 

The risk categories shall include, but 

should not be limited to, foreign 

exchange or interest rate risk, credit 

risk, equity risk, agricultural commodity 

risk, energy commodity risk, metal 

commodity risk, and other commodity 

risk, as appropriate. For material 

exposures in significant currencies and 

markets, modeling techniques shall 

capture spread and basis risk and shall 

incorporate a sufficient number of 

segments of the yield curve to capture 

differences in volatility and imperfect 

correlation of rates along the yield 

curve. 

(iv) In the case of an uncleared crosscurrency swap, the model need not 

recognize any risks or risk factors 

associated with the fixed, physicallysettled foreign exchange transactions 

associated with the exchange of 

principal embedded in the crosscurrency swap. The model shall 

recognize all material risks and risk 

factors associated with all other 

payments and cash flows that occur 

during the life of the uncleared crosscurrency swap. 

(v) The model may calculate initial 

margin for an uncleared swap or netting 

set of uncleared swaps covered by an 

eligible master netting agreement. It may 

reflect offsetting exposures, 

diversification, and other hedging 

benefits for uncleared swaps that are 

governed by the same eligible master 

netting agreement by incorporating 

empirical correlations within the 

following broad risk categories, 

provided the covered swap entity 

validates and demonstrates the 

reasonableness of its process for 

modeling and measuring hedging 

benefits: agriculture, credit, energy, 

equity, foreign exchange/interest rate, 

metals, and other. Empirical 

correlations under an eligible master 

netting agreement may be recognized by 

the model within each broad risk 

category, but not across broad risk 

categories. 

(vi) If the model does not explicitly 

reflect offsetting exposures, 

diversification, and hedging benefits 

between subsets of uncleared swaps 

within a broad risk category, the 

covered swap entity shall calculate an 

amount of initial margin separately for 

each subset of uncleared swaps for 

which offsetting exposures, 

diversification, and other hedging 

benefits are explicitly recognized by the 

model. The sum of the initial margin 

amounts calculated for each subset of 

uncleared swaps within a broad risk 

category shall be used to determine the 

aggregate initial margin due from the 

counterparty for the portfolio of 

uncleared swaps within the broad risk 

category. 

(vii) The sum of the initial margins 

calculated for each broad risk category 

shall be used to determine the aggregate 

initial margin due from the 

counterparty. 

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(viii) The model shall not permit the 

calculation of any initial margin amount 

to be offset by, or otherwise take into 

account, any initial margin that may be 

owed or otherwise payable by the 

covered swap entity to the counterparty. 

(ix) The model shall include all 

material risks arising from the nonlinear 

price characteristics of option positions 

or positions with embedded optionality 

and the sensitivity of the market value 

of the positions to changes in the 

volatility of the underlying rates, prices, 

or other material risk factors. 

(x) The covered swap entity shall not 

omit any risk factor from the calculation 

of its initial margin that the covered 

swap entity uses in its model unless it 

has first demonstrated to the satisfaction 

of the Commission that such omission is 

appropriate. 

(xi) The covered swap entity shall not 

incorporate any proxy or approximation 

used to capture the risks of the covered 

swap entity’s actual swaps unless it has 

first demonstrated to the satisfaction of 

the Commission that such proxy or 

approximation is appropriate. 

(xii) The covered swap entity shall 

have a rigorous and well-defined 

process for re-estimating, re-evaluating, 

and updating its internal models to 

ensure continued applicability and 

relevance. 

(xiii) The covered swap entity shall 

review and, as necessary, revise the data 

used to calibrate the model at least 

monthly, and more frequently as market 

conditions warrant, ensuring that the 

data incorporate a period of significant 

financial stress appropriate to the 

uncleared swaps to which the model is 

applied. 

(xiv) The level of sophistication of the 

initial margin model shall be 

commensurate with the complexity of 

the swaps to which it is applied. In 

calculating an initial margin amount, 

the model may make use of any of the 

generally accepted approaches for 

modeling the risk of a single instrument 

or portfolio of instruments. 

(xv) The Commission may in its sole 

discretion require a covered swap entity 

using a model to collect a greater 

amount of initial margin than that 

determined by the covered swap entity’s 

model if the Commission determines 

that the additional collateral is 

appropriate due to the nature, structure, 

or characteristics of the covered swap 

entity’s transactions or is commensurate 

with the risks associated with the 

transaction. 

(4) Periodic review. A covered swap 

entity shall periodically, but no less 

frequently than annually, review its 

model in light of developments in 

financial markets and modeling 

technologies, and enhance the model as 

appropriate to ensure that it continues 

to meet the requirements for approval in 

this section. 

(5) Control, oversight, and validation 

mechanisms. (i) The covered swap 

entity shall maintain a risk management 

unit in accordance with § 23.600(c)(4)(i) 

that is independent from the business 

trading unit (as defined in § 23.600). 

(ii) The covered swap entity’s risk 

control unit shall validate its model 

prior to implementation and on an 

ongoing basis. The covered swap 

entity’s validation process shall be 

independent of the development, 

implementation, and operation of the 

model, or the validation process shall be 

subject to an independent review of its 

adequacy and effectiveness. The 

validation process shall include: 

(A) An evaluation of the conceptual 

soundness of (including developmental 

evidence supporting) the model; 

(B) An ongoing monitoring process 

that includes verification of processes 

and benchmarking by comparing the 

covered swap entity’s model outputs 

(estimation of initial margin) with 

relevant alternative internal and 

external data sources or estimation 

techniques including benchmarking 

against observable margin standards to 

ensure that the initial margin is not less 

than what a derivatives clearing 

organization would require for similar 

cleared transactions; and 

(C) An outcomes analysis process that 

includes back testing the model. 

(iii) If the validation process reveals 

any material problems with the model, 

the covered swap entity shall notify the 

Commission of the problems, describe 

to the Commission any remedial actions 

being taken, and adjust the model to 

insure an appropriately conservative 

amount of required initial margin is 

being calculated. 

(iv) In accordance with § 23.600(e)(2), 

the covered swap entity shall have an 

internal audit function independent of 

the business trading unit and the risk 

management unit that at least annually 

assesses the effectiveness of the controls 

supporting the model measurement 

systems, including the activities of the 

business trading units and risk control 

unit, compliance with policies and 

procedures, and calculation of the 

covered swap entity’s initial margin 

requirements under this part. At least 

annually, the internal audit function 

shall report its findings to the covered 

swap entity’s governing body, senior 

management, and chief compliance 

officer. 

(6) Documentation. The covered swap 

entity shall adequately document all 

material aspects of its model, including 

management and valuation of uncleared 

swaps to which it applies, the control, 

oversight, and validation of the model, 

any review processes and the results of 

such processes. 

(7) Escalation procedures. The 

covered swap entity must adequately 

document authorization procedures, 

including escalation procedures that 

require review and approval of any 

change to the initial margin calculation 

under the model, demonstrable analysis 

that any basis for any such change is 

consistent with the requirements of this 

section, and independent review of such 

demonstrable analysis and approval. 

(c) Table-based 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) Standardized initial margin 

schedule. 

Asset class 

Initial margin 

requirement 

(% of notional 

exposure) 

Credit: 0–2 year duration ...... 2 

Credit: 2–5 year duration ...... 5 

Credit: 5+ year duration ....... 10 

Commodity ............................ 15 

Equity .................................... 15 

Foreign Exchange/Currency 6 

Cross Currency Swaps: 0–2 

year duration ..................... 1 

Cross Currency Swaps: 2–5 

year duration ..................... 2 

Cross currency Swaps: 5+ 

year duration ..................... 4 

Interest Rate: 0–2 year duration .................................... 1 

Interest Rate: 2–5 year duration .................................... 2 

Interest Rate: 5+ year duration .................................... 4 

Other ..................................... 15 

(2) Net to gross ratio adjustment. (i) 

For multiple uncleared swaps subject to 

an eligible master netting agreement, the 

initial margin amount under the 

standardized table shall be computed 

according to this paragraph. 

(ii) Initial Margin = 0.4 × Gross Initial 

Margin + 0.6 × Net-to-Gross Ratio × 

Gross Initial Margin, where 

(A) Gross Initial Margin = the sum of 

the product of each uncleared swap’s 

effective notional amount and the gross 

initial margin requirement for all 

uncleared swaps subject to the eligible 

master netting agreement; 

(B) Net-to-Gross Ratio = the ratio of 

the net current replacement cost to the 

gross current replacement cost; 

(C) Gross Current Replacement cost = 

the sum of the replacement cost for each 

uncleared swap subject to the eligible 

master netting agreement for which the 

cost is positive; and 

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(D) Net Current Replacement Cost = 

the total replacement cost for all 

uncleared swaps subject to the eligible 

master netting agreement. 

§ 23.155 Calculation of variation margin. 

(a) Means of calculation. (1) Each 

business day each covered swap entity 

shall calculate variation margin for itself 

and for each counterparty that is a swap 

entity or a financial end user using a 

methodology and inputs that to the 

maximum extent practicable rely on 

recently-executed transactions, 

valuations provided by independent 

third parties, or other objective criteria. 

(2) Each covered swap entity shall 

have in place alternative methods for 

determining the value of an uncleared 

swap in the event of the unavailability 

or other failure of any input required to 

value a swap. 

(3) For risk management purposes, 

each business day each covered swap 

entity shall calculate a hypothetical 

variation margin requirement for each 

swap for which the counterparty is a 

non-financial end user that has material 

swaps exposure to the covered 

counterparty as if the counterparty were 

a covered swap entity and compare that 

amount to any variation margin required 

pursuant to the margin documentation. 

(b) Control mechanisms. (1) Each 

covered swap entity shall create and 

maintain documentation setting forth 

the variation methodology with 

sufficient specificity to allow the 

counterparty, the Commission, and any 

applicable prudential regulator to 

calculate a reasonable approximation of 

the margin requirement independently. 

(2) Each covered swap entity shall 

evaluate the reliability of its data 

sources at least annually, and make 

adjustments, as appropriate. 

(3) The Commission at any time may 

require a covered swap entity to provide 

further data or analysis concerning the 

methodology or a data source, 

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; 

(iv) The empirical support for the 

methodology; and 

(v) The empirical support for the 

assessment of the data sources. 

§ 23.156 Forms of margin. 

(a) Initial margin—(1) Eligible 

collateral. A covered swap entity shall 

collect and post as initial margin for 

trades with a covered counterparty only 

the following assets: 

(i) U.S. dollars; 

(ii) A major currency; 

(iii) A currency in which payment 

obligations under the swap are required 

to be settled; 

(iv) A security that is issued by, or 

unconditionally guaranteed as to the 

timely payment of principal and interest 

by, the U.S. Department of Treasury; 

(v) A security that is issued by, or 

unconditionally guaranteed as to the 

timely payment of principal and interest 

by, a U.S. government agency (other 

than the U.S. Department of Treasury) 

whose obligations are fully guaranteed 

by the full faith and credit of the U.S. 

government; 

(vi) A publicly traded debt security 

issued by, or an asset-backed security 

fully guaranteed as to the timely 

payment of principal and interest by, a 

U.S. government-sponsored enterprise 

that is operating with capital support or 

another form of direct financial 

assistance received from the U.S. 

government that enables the repayments 

of the government-sponsored 

enterprise’s eligible securities; or 

(vii) A security that is issued by, or 

fully guaranteed as to the payment of 

principal and interest by, the European 

Central Bank or a sovereign entity that 

is assigned no higher than a 20 percent 

risk weight under the capital rules 

applicable to swap dealers subject to 

regulation by a prudential regulator; 

(viii) A security that is issued by, or 

fully guaranteed as to the payment of 

principal and interest by, the Bank for 

International Settlements, the 

International Monetary Fund, or a 

multilateral development bank; 

(ix) Other publicly-traded debt that 

has been deemed acceptable as initial 

margin by a prudential regulator; or 

(x) A publicly traded common equity 

security that is included in: 

(A) The Standard & Poor’s Composite 

1500 Index or any other similar index of 

liquid and readily marketable equity 

securities as determined by the 

Commission; or 

(B) An index that a covered swap 

entity’s supervisor in a foreign 

jurisdiction recognizes for purposes of 

including publicly traded common 

equity as initial margin under 

applicable regulatory policy, if held in 

that foreign jurisdiction; or 

(xi) Gold. 

(2) Prohibition of certain assets. A 

covered swap entity may not collect or 

post as initial margin any asset that is 

a security issued by: 

(i) The party providing such asset or 

an affiliate of that party, 

(ii) A bank holding company, a 

savings and loan holding company, a 

foreign bank, a depository institution, a 

market intermediary, a company that 

would be any of the foregoing if it were 

organized under the laws of the United 

States or any State, or an affiliate of any 

of the foregoing institutions, or 

(iii) A U.S. government-sponsored 

enterprise after the termination of 

capital support or another form of direct 

financial assistance received from the 

U.S. government that enables the 

repayments of the governmentsponsored enterprise’s eligible securities 

unless: 

(A) The security meets the 

requirements of paragraph (a)(1)(iv) of 

this section; 

(B) The security meets the 

requirements of paragraph (a)(1)(vii) of 

this section; or 

(C) The security meets the 

requirements of paragraph (a)(1)(viii) of 

this section. 

(3) Haircuts. (i) Each covered swap 

entity shall apply haircuts to any asset 

posted or received as initial margin 

under this section that reflect the credit 

and liquidity characteristics of the asset. 

(ii) At a minimum, each covered swap 

entity shall apply haircuts to any asset 

posted or received as initial margin 

under this section in accordance with 

the following table: 

STANDARDIZED HAIRCUT SCHEDULE

Cash in same currency as swap obligation ........................................... 0.0 

Eligible government and related debt 

(e.g., central bank, multilateral development bank, GSE securities 

identified in paragraph (a)(1)(iv) of 

this section): Residual maturity 

less than one-year ........................ 0.5 

Eligible government and related debt 

(e.g., central bank, multilateral development bank, GSE securities 

identified in paragraph (a)(1)(iv) of 

this section): Residual maturity 

between one and five years ......... 2.0 

Eligible government and related debt 

(e.g., central bank, multilateral development bank, GSE securities 

identified in paragraph (a)(1)(iv) of 

this section): Residual maturity 

greater than five years .................. 4.0 

Eligible corporate debt (including eligible GSE debt securities not 

identified in paragraph (a)(1)(iv) of 

this section): Residual maturity 

less than one-year ........................ 1.0 

Eligible corporate debt (including eligible GSE debt securities not 

identified in paragraph (a)(1)(iv) of 

this section): Residual maturity 

between one and five years ......... 4.0 

Eligible corporate debt (including eligible GSE debt securities not 

identified in paragraph (a)(1)(iv) of 

this section): Residual maturity 

greater than five years .................. 8.0 

Equities included in S&P 500 or related index ..................................... 15.0 

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STANDARDIZED HAIRCUT SCHEDULE— 

Continued 

Equities included in S&P 1500 Composite or related index but not 

S&P 500 or related index ............. 25.0 

Gold .................................................. 15.0 

Additional (additive) haircut on asset 

in which the currency of the swap 

obligation differs from that of the 

collateral asset .............................. 8.0 

(iii) The value of initial margin 

collateral that is calculated according to 

the schedule in paragraph (a)(3)(ii) of 

this section will be computed as 

follows: The value of initial margin 

collateral for any collateral asset class 

will be computed as the product of the 

total value of collateral in any asset 

class and one minus the applicable 

haircut expressed in percentage terms. 

The total value of all initial margin 

collateral is calculated as the sum of the 

value of each type of collateral asset. 

(4) Monitoring Obligation. A covered 

swap entity shall monitor the market 

value and eligibility of all collateral 

collected and held to satisfy initial 

margin required by this part. To the 

extent that the market value of such 

collateral has declined, the covered 

swap entity shall promptly collect such 

additional eligible collateral as is 

necessary to bring itself into compliance 

with the margin requirements of this 

part. To the extent that the collateral is 

no longer eligible, the covered swap 

entity shall promptly obtain sufficient 

eligible replacement collateral to 

comply with this part. 

(5) Excess initial margin. A covered 

swap entity may collect initial margin 

that is not required pursuant to this part 

in any form of collateral. 

(b) Variation margin—(1) Eligible 

assets. A covered swap entity shall pay 

and collect as variation margin to or 

from a covered counterparty only cash 

in the form of: 

(i) U.S. dollars; or 

(ii) A currency in which payment 

obligations under the swap are required 

to be settled. 

(2) Collection obligation. A covered 

swap entity shall not be deemed to have 

violated its obligation under this 

paragraph to collect variation margin if: 

(i) The counterparty has refused or 

otherwise failed to provide the variation 

margin to the covered swap entity; and 

(ii) The covered swap entity: 

(A) Has made the necessary efforts to 

collect the variation margin, including 

the timely initiation and continued 

pursuit of formal dispute resolution 

mechanisms, including § 23.504(b), if 

applicable, or has otherwise 

demonstrated upon request to the 

satisfaction of the Commission that it 

has made appropriate efforts to collect 

the variation margin; or 

(B) Has commenced termination of 

the swap or security-based swap with 

the counterparty. 

§ 23.157 Custodial arrangements. 

(a) Initial margin posted by covered 

swap entities. Each covered swap entity 

that posts initial margin with respect to 

an uncleared swap shall require that all 

funds or other property that the covered 

swap entity provides as initial margin 

be held by one or more custodians that 

are not affiliates of the covered swap 

entity or the counterparty. 

(b) Initial margin collected by covered 

swap entities. Each covered swap entity 

that collects initial margin required by 

§ 23.152 with respect to an uncleared 

swap shall require that such initial 

margin be held at one or more 

custodians that are not affiliates of the 

covered swap entity or the counterparty. 

(c) Custodial agreement. Each covered 

swap entity shall enter into an 

agreement with each custodian that 

holds funds pursuant to paragraphs (a) 

or (b) of this section that: 

(1) Prohibits the custodian from 

rehypothecating, repledging, reusing, or 

otherwise transferring (through 

securities lending, repurchase 

agreement, reverse repurchase 

agreement or other means) the funds or 

other property held by the custodian; 

(2) Notwithstanding paragraph (c)(1) 

of this section, with respect to collateral 

posted or collected pursuant to § 23.152, 

requires the posting party, when it 

substitutes or directs the reinvestment 

of posted collateral held by the 

custodian: 

(i) To substitute only funds or other 

property that are in a form that meets 

the requirements of § 23.156 and in an 

amount that meets the requirements of 

§ 23.152, subject to applicable haircuts; 

and 

(ii) To reinvest funds only in assets 

that are in a form that meets the 

requirements of § 23.156 and in an 

amount that meets the requirements of 

§ 23.152, subject to applicable haircuts; 

(3) Is legal, valid, binding, and 

enforceable under the laws of all 

relevant jurisdictions including in the 

event of bankruptcy, insolvency, or a 

similar proceeding. 

§ 23.158 Margin documentation. 

(a) General requirement. Each covered 

swap entity shall execute 

documentation with each counterparty 

that complies with the requirements of 

§ 23.504 and that complies with this 

section. For uncleared swaps between a 

covered swap entity and a covered 

counterparty, the documentation shall 

provide the covered swap entity with 

the contractual right and obligation to 

exchange initial margin and variation 

margin in such amounts, in such form, 

and under such circumstances as are 

required by §§ 23.150 through 23.159. 

For uncleared swaps between a covered 

swap entity and a non-financial entity, 

the documentation shall specify 

whether initial and/or variation margin 

will be exchanged and, if so, the 

documentation shall comply with 

paragraph (b) of this section. 

(b) Contents of the documentation. 

The margin documentation shall specify 

the following: 

(1) The methodology and data sources 

to be used to value uncleared swaps and 

collateral and to calculate initial margin 

for uncleared swaps entered into 

between the covered swap entity and 

the counterparty; 

(2) The methodology and data sources 

to be used to value positions and to 

calculate variation margin for uncleared 

swaps entered into between the covered 

swap entity participant and the 

counterparty; 

(3) The procedures by which any 

disputes concerning the valuation of 

uncleared swaps, or the valuation of 

assets posted as initial margin or paid as 

variation margin may be resolved; 

(4) Any thresholds below which 

initial margin need not be posted by the 

covered swap entity and/or the 

counterparty; and 

(5) Any thresholds below which 

variation margin need not be paid by the 

covered swap entity and/or the 

counterparty. 

§ 23.159 Compliance dates. 

(a) Covered swap entities must 

comply with the minimum margin 

requirements for uncleared swaps on or 

before the following dates for uncleared 

swaps entered into on or after the 

following dates: 

(1) December 1, 2015 for the 

requirements in § 23.153 for variation 

margin. 

(2) December 1, 2015 for the 

requirements in § 23.152 for initial 

margin for any uncleared swaps where 

both the covered swap entity combined 

with all its affiliates and its 

counterparty combined with all its 

affiliates, have an average daily 

aggregate notional amount of uncleared 

swaps, uncleared security-based swaps, 

foreign exchange forwards, and foreign 

exchange swaps in June, July, and 

August 2015 that exceeds $4 trillion, 

where such amounts are calculated only 

for business days. 

(3) December 1, 2016 for the 

requirements in § 23.152 for initial 

margin for any uncleared swaps where 

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Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 59933 

both the covered swap entity combined 

with all its affiliates and its 

counterparty combined with all its 

affiliates, have an average daily 

aggregate notional amount of uncleared 

swaps, uncleared security-based swaps, 

foreign exchange forwards, and foreign 

exchange swaps in June, July and 

August 2016 that exceeds $3 trillion, 

where such amounts are calculated only 

for business days. 

(4) December 1, 2017 for the 

requirements in § 23.152 for initial 

margin for any uncleared swaps where 

both the covered swap entity combined 

with all its affiliates and its 

counterparty combined with all its 

affiliates have an average daily aggregate 

notional amount of uncleared swaps, 

uncleared security-based swaps, foreign 

exchange forwards, and foreign 

exchange swaps in June, July and 

August 2017 that exceeds $2 trillion, 

where such amounts are calculated only 

for business days. 

(5) December 1, 2018 for the 

requirements in § 23.152 for initial 

margin for any uncleared swaps where 

both the covered swap entity combined 

with all its affiliates and its 

counterparty combined with all its 

affiliates have an average daily aggregate 

notional amount of uncleared swaps, 

uncleared security-based swaps, foreign 

exchange forwards, and foreign 

exchange swaps in June, July and 

August 2018 that exceeds $1 trillion, 

where such amounts are calculated only 

for business days. 

(6) December 1, 2019 for the 

requirements in § 23.152 for initial 

margin for any other covered swap 

entity with respect to uncleared swaps 

entered into with any other 

counterparty. 

(b) Once a covered swap entity and its 

counterparty must comply with the 

margin requirements for uncleared 

swaps based on the compliance dates in 

paragraph (a) of this section, the covered 

swap entity and its counterparty shall 

remain subject to the requirements of 

this subpart. 

§§ 23.160–23.199 [Reserved] 

■ 3. In § 23.701 revise paragraphs (a)(1), 

(d), and (f) to read as follows: 

§ 23.701 Notification of right to 

segregation. 

(a) * * * 

(1) Notify each counterparty to such 

transaction that the counterparty has the 

right to require that any Initial Margin 

the counterparty provides in connection 

with such transaction be segregated in 

accordance with §§ 23.702 and 23.703 

except in those circumstances where 

segregation is mandatory pursuant to 

§ 23.157; 

* * * * * 

(d) Prior to confirming the terms of 

any such swap, the swap dealer or major 

swap participant shall obtain from the 

counterparty confirmation of receipt by 

the person specified in paragraph (c) of 

this section of the notification specified 

in paragraph (a) of this section, and an 

election, if applicable, to require such 

segregation or not. The swap dealer or 

major swap participant shall maintain 

such confirmation and such election as 

business records pursuant to § 1.31 of 

this chapter. 

* * * * * 

(f) A counterparty’s election, if 

applicable, to require segregation of 

Initial Margin or not to require such 

segregation, may be changed at the 

discretion of the counterparty upon 

written notice delivered to the swap 

dealer or major swap participant, which 

changed election shall be applicable to 

all swaps entered into between the 

parties after such delivery. 

PART 140—ORGANIZATION, 

FUNCTIONS, AND PROCEDURES OF 

THE COMMISSION 

■ 4. The authority citation for part 140 

continues to read as follows: 

Authority: 7 U.S.C. 2(a)(12), 12a, 13(c), 

13(d), 13(e), and 16(b). 

■ 5. In § 140.93, add paragraph (a)(6) to 

read as follows: 

§ 140.93 Delegation of authority to the 

Director of the Division of Swap Dealer and 

Intermediary Oversight. 

(a) * * * 

(6) All functions reserved to the 

Commission in §§ 23.150 through 

23.159 of this chapter. 

* * * * * 

Issued in Washington, DC, on September 

23, 2014, by the Commission. 

Christopher J. Kirkpatrick, 

Secretary of the Commission. 

Note: The following appendices will not 

appear in the Code of Federal Regulations. 

Appendices to Margin Requirements for 

Uncleared Swaps for Swap Dealers and 

Major Swap Participants—Commission 

Voting Summary, Chairman’s 

Statement, and Commissioner’s 

Statement 

Appendix 1—Commission Voting 

Summary 

On this matter, Chairman Massad and 

Commissioners Wetjen, Bowen, and 

Giancarlo voted in the affirmative. No 

Commissioner voted in the negative. 

Appendix 2—Statement of Chairman 

Timothy G. Massad 

I support this proposed rule on 

margin requirements for uncleared 

swaps. 

A key mandate of the Dodd-Frank Act 

was central clearing of swaps. This is a 

significant tool to monitor and mitigate 

risk, and we have already succeeded in 

increasing the overall percentage of the 

market that is cleared from an estimated 

17% in 2007 to 60% last month, when 

measured by notional amount. 

But cleared swaps are only part of the 

market. Uncleared, bilateral swap 

transactions will continue to be an 

important part of the derivatives market. 

This is so for a variety of reasons. 

Sometimes, commercial risks cannot be 

hedged sufficiently through clearable 

swap contracts. Therefore market 

participants must craft more tailored 

contracts that cannot be cleared. In 

addition, certain products may lack 

sufficient liquidity to be centrally riskmanaged and cleared. This may be true 

even for products that have been in 

existence for some time. And there 

will—and always should be— 

innovation in the market, which will 

lead to new products. 

That is why margin for uncleared 

swaps is important. It is a means to 

mitigate the risk of default and therefore 

the potential risk to the financial system 

as a whole. To appreciate the 

importance of the rule being proposed, 

we need only recall how Treasury and 

the Federal Reserve had to commit $182 

billion to AIG, because its uncleared 

swap activities threatened to bring 

down our financial system. 

The proposed rule requires swap 

dealers and major swap participants to 

post and collect margin in their swaps 

with one another. They must also do so 

in their swaps with financial entities, if 

the level of activity is above certain 

thresholds. The proposal does not 

require commercial end-users to post or 

collect margin, nor does it require any 

swap dealer or major swap participant 

to collect margin from or post margin to 

commercial end-users. This is an 

important point. 

Today’s proposal on margin also 

reflects the benefit of substantial 

collaboration between our staff and our 

colleagues at the Federal Reserve, the 

Office of the Comptroller of the 

Currency, and the Federal Deposit 

Insurance Corporation, as well as 

significant public comment. The DoddFrank Act directs each of the prudential 

regulators to propose rules on margin 

for the entities for which it is the 

primary regulator, whereas the CFTC is 

directed to propose a rule for other 

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59934 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

1SIFMA v. CFTC, No. 13–cv–1916 slip op. at 72 

(D.D.C. Sept. 16, 2014). 

2Phillip Stafford, Sense of Urgency Underpins 

Fresh Scrutiny of Markets, Financial Times, Sept. 

16, 2014, available at http://www.ft.com/intl/cms/s/ 

0/a373646a-344b-11e4-b81c-00144

feabdc0.html?siteedition=intl#axzz3DPM3AEzi. 

3Mike Kentz, Derivatives: Fed backs off corporate 

margin requirements, IFRAsia, Sept. 11, 2014, 

available at http://www.ifrasia.com/derivatives-fedbacks-off-corporate-margin-requirements/

21162697.fullarticle. 

entities engaging in uncleared swap 

transactions. The Dodd-Frank Act also 

directed us to harmonize our rules as 

much as possible. Today’s proposed 

rule is very similar to the proposal of 

the prudential regulators that was 

published recently. I want to again 

thank our staff, as well as the staffs of 

the prudential regulators, for working 

together so well to accomplish that task. 

We have also sought to harmonize our 

proposal with rules being developed in 

Europe and Asia. Our proposed rule is 

largely consistent with the standards 

proposed by Basel Committee on 

Banking Supervision and the 

International Organization of Securities 

Commissions, and we have been in 

touch with overseas regulators as we 

developed our proposal. 

The importance of international 

harmonization cannot be understated. It 

is particularly important to reach 

harmonization in the area of margin for 

uncleared swaps, because this is a new 

requirement and we do not want to 

create the potential for regulatory 

arbitrage in the market by creating 

unnecessary differences. Margin for 

uncleared swaps goes hand in hand 

with the global mandates to clear swaps. 

Imposing margin on uncleared swaps 

will level the playing field between 

cleared and uncleared swaps and 

remove any incentive not to clear swaps 

that can be cleared. 

Proposing this rule is an important 

step in our effort to finish the job of 

implementing the Dodd-Frank Act and 

will help us achieve the full benefit of 

the new regulatory framework, while at 

the same time protecting the interests 

of—and minimizing the burdens on— 

commercial end-users who depend on 

the derivatives markets to hedge normal 

business risks. 

We recognize that more stringent 

margin requirements impose costs on 

market participants, and therefore the 

proposal includes a detailed cost-benefit 

analysis. I believe the proposed rule 

balances the inherent trade-off between 

mitigating systemic risk and minimizing 

costs on individual participants. I look 

forward to having public feedback on 

that analysis, as well as on the proposal 

as a whole. 

Appendix 3—Statement of 

Commissioner J. Christopher Giancarlo 

I support the issuance of the proposed 

rules for uncleared margin. I look forward to 

reviewing well-considered, responsive and 

informative comments from the public. 

Seeking further public comment on this 

proposal is necessary given the passage of 

time and the further deliberations with our 

fellow regulators since the publishing of our 

2011 proposal. For the same reasons, I urge 

the Commission to re-propose capital 

requirements for swap dealers and major 

swap participants, which are closely linked 

to the uncleared margin rules. 

Uncleared over-the-counter swaps (OTC) 

and derivatives are vital to the U.S. economy. 

Used properly, they enable American 

companies and the banks they borrow from 

to manage changing commodity and energy 

prices, fluctuating currency and interest 

rates, and credit default exposure. They 

allow our state and local governments to 

manage their obligations and our pension 

funds to support healthy retirements. 

Uncleared swaps serve a key role in 

American business planning and risk 

management that cannot be filled by cleared 

derivatives. They do so by allowing 

businesses to avoid basis risk and obtain 

hedge accounting treatment for more 

complex, non-standardized exposures. While 

much of the swaps and OTC derivatives 

markets will eventually be cleared—a 

transition I have long supported—uncleared 

swaps will remain an important tool for 

customized risk management by businesses, 

governments, asset managers and other 

institutions whose operations are essential to 

American economic growth. 

Advance Notice of Proposed Rulemaking: 

Cross-Border 

I support the Commission’s decision to 

issue an advance notice of proposed 

rulemaking to determine how the uncleared 

margin rule should apply extraterritorially. I 

have long advocated that the Commission 

take a holistic, global approach to the crossborder application of its rules. This approach 

should prioritize the critical need for 

international harmony and certainty for 

American businesses and other market 

participants. It is undeniable that the lack of 

such certainty in the Commission’s crossborder framework is causing fragmentation of 

what were once global markets, increasing 

systemic risk rather than diminishing it. I 

therefore applaud the Commission’s decision 

to seek public comment on the most optimal 

cross-border framework with respect to 

uncleared margin. 

In light of the recent decision from the U.S. 

District Court for the District of Columbia 

holding that the Commission’s cross-border 

guidance is non-binding and that the 

Commission will have to justify the crossborder application of its rules each time it 

brings an enforcement action,1 it is important 

that the Commission provide swaps market 

participants with certainty on how the 

uncleared margin rule will apply 

extraterritorially. 

I believe that the advance notice of 

proposed rulemaking for the cross-border 

application of the uncleared margin rules 

demonstrates a pragmatism and flexibility 

that belies the oft repeated notion that CFTC 

rulemaking widely and woodenly 

overreaches in its assertion of extraterritorial 

jurisdiction. I commend it to our fellow 

regulators abroad as a portent of greater 

accord in global regulatory reform. 

I look forward to reading and addressing 

well-considered comments on the crossborder issues. In particular, I join 

Commissioner Wetjen in welcoming 

thoughtful comment and analysis on the 

potential competitive impacts associated 

with each of the different approaches 

identified in the advance notice of proposed 

rulemaking. I encourage commentators to 

quantify, if practical, and be specific about 

particular provisions or concerns. 

Furthermore, I think this rulemaking 

should be a template for things to come. I 

urge the Commission to follow the Securities 

and Exchange Commission’s (SEC) lead and 

replace its non-binding guidance with a 

comprehensive set of rules, supported by a 

rigorous cost-benefit analysis, delineating 

when activities outside the United States will 

have a direct and significant connection with 

activities in, or effect on, commerce in the 

United States. Good regulation requires 

nothing less. 

Notwithstanding my support for the 

issuance of these proposed rules and the 

advance notice of proposed rulemaking on 

cross-border issues in order to solicit 

comment, I have a number of substantive 

concerns which I will now address. 

Ten-Day Margin Requirement 

Today’s proposal requires collateral 

coverage on uncleared swaps equal to a tenday liquidation period. This ten-day 

calculation comports with rules adopted 

recently by the U.S. prudential bank 

regulators. Yet, it still must be asked: Is ten 

days the right calculation? Why not nine 

days; why not eleven? Should it be the same 

ten days for uncleared credit default swaps 

as it is for uncleared interest rate swaps and 

for all other swaps products? Surely, all noncleared swap products do not have the same 

liquidity characteristics or risk profiles. I 

encourage commenters to provide their input 

on these questions. 

SEC Chair Mary Jo White recently stated: 

‘‘Our regulatory changes must be informed by 

clear-eyed, unbiased, and fact-based 

assessments of the likely impacts—positive 

and negative—on market quality for investors 

and issuers.’’ 2 Chair White’s standard of 

assessment must surely apply to the 

proposed margin rule on uncleared swaps. 

Where is the clear-eyed assessment of the 

ten-day margin requirement? Where is the 

cost benefit analysis? What are the intended 

consequences? What will be the unintended 

ones? Will American swaps end users wind 

up paying for the added margin costs even 

though they are meant to be exempt? I would 

be interested to hear from commentators on 

this issue. 

I am troubled by recent press reports of 

remarks by unnamed Fed officials that the 

coverage period may be intentionally 

‘‘punitive’’ in order to move the majority of 

trades into a cleared environment.3 I would 

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Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 59935 

4CEA section 4s(e)(3)(D)(ii). 

5Margin Requirements for Uncleared Swaps for 

Swap Dealers and Major Swap Participants, 76 FR 

23732, 23736–37 (Apr. 28, 2011). 

6The prudential regulator’s proposal contains the 

following provision: ‘‘A covered swap entity is not 

required to collect initial margin with respect to any 

non-cleared swap or non-cleared security-based 

swap with a counterparty that is neither a financial 

end user with material swaps exposure nor a swap 

entity but shall collect initial margin at such times 

and in such forms (if any) that the covered swap 

entity determines appropriately address the credit 

risk posed by the counterparty and the risks of such 

non-cleared swaps and non-cleared security-based 

swaps.’’ Margin and Capital Requirements for 

Covered Swap Entities, slip copy at 167, available 

at http://www.federalreserve.gov/newsevents/press/

bcreg/bcreg20140903c1.pdf. This is somewhat 

different, but not inconsistent with the 

Commission’s proposal, which will allow the 

parties to exchange margin by agreement, or to 

arrange other types of collateral agreements 

consistent with their needs. 

7Basel Committee on Banking Supervision/

International Organization of Securities 

Commissions. 

8Sam Fleming and Phillip Stafford, JPMorgan 

Tells Clearers to Build Bigger Buffers, Financial 

Times, Sept. 11, 2014 available at http://

www.ft.com/intl/cms/s/0/48aa6b02-38f9-11e4-9526-

00144feabdc0.html#axzz3DPM3AEzi. 

9End-User Exception to the Clearing Requirement 

for Swaps, 77 FR 42560, 42578 (Jul. 19, 2012); 17 

CFR 50.50(d). 

10Clearing Exemption for Certain Swaps Entered 

into by Cooperatives, 78 FR 52286 (Aug. 22, 2013); 

17 CFR 50.51. 

be interested to review any considered 

analysis of the likely impact of the ten-day 

liquidation period and whether or not it may 

have a punitive effect on markets for 

uncleared swaps products. 

Any punitive or arbitrary squeeze on noncleared swaps will surely have 

consequences—likely unintended—for 

American businesses and their ability to 

manage risk. With tens of millions of 

Americans falling back on part-time work, it 

is not in our national interest to deter U.S. 

employers from safely hedging commercial 

risk to free capital for new ventures that 

create full-time jobs. It is time we move away 

from punishing U.S. capital markets toward 

rules designed to revive American prosperity. 

I look forward to reviewing well-considered 

comments as to the appropriateness of a tenday liquidation period, as well as its 

estimated costs and benefits, particularly the 

impact on American economic growth. 

End Users 

As noted in the preamble, the Dodd-Frank 

Act requires the CFTC, the SEC, and the 

prudential regulators to establish comparable 

initial and variation margin requirements for 

uncleared swaps.4 In 2011, however, the 

Commission and the prudential regulators 

issued proposals that varied significantly in 

several respects. In particular, the rules 

proposed by the prudential regulators in 

2011 would have required non-financial end 

users to pay initial and variation margin to 

banks, while the Commission’s rules 

exempted these entities in accordance with 

Congressional intent.5

I am pleased that the prudential regulators 

have moved in the CFTC’s direction and will 

not require that non-financial end users pay 

margin unless necessary to address the credit 

risk posed by the counterparty and the risks 

of the swap.6 It is widely recognized that 

non-financial end users, that generally use 

swaps to hedge their commercial risk, pose 

less risk as counterparties than financial 

entities. It is my hope that upon finalization 

of these rules, swap dealers and major swap 

participants will treat non-financial end 

users consistently when it comes to margin, 

no matter which set of rules apply. 

Threshold for Swaps Exposure 

I am also pleased that our collaboration 

with the BCBS/IOSCO 7 international 

working group has resulted in proposed rules 

that are largely harmonious with the 2013 

international framework. There is a particular 

and significant difference that troubles me, 

however. The CFTC and the prudential 

regulators have set the threshold for material 

swaps exposure by financial end users at $3 

billion, while the 2013 international 

framework sets the threshold at Ö8 billion 

(approximately $11 billion). This means that 

a whole middle-tier of American financial 

end users could be subject to margin 

requirements that will not be borne by 

similar firms overseas. It may well limit the 

number of counterparties willing to enter 

into swaps with these important lenders to 

American business. I am concerned that this 

could potentially reduce the utility of risk 

reducing strategies for a class of middle-tier, 

U.S. financial institutions that have already 

been hit hard by new capital constraints, 

among other rules. 

In this time of dismal economic growth, it 

is hard to justify placing higher burdens on 

America’s medium-sized financial firms than 

those their overseas competitors face. We 

have not, in my opinion, sufficiently 

addressed in our cost benefit analysis the 

impact of this threshold difference on 

American firms and their customers. Where 

is the clear-eyed analysis of the impact of this 

rule on the American economy? I hope that 

the Commission will not perpetuate this 

divergence in the final rules without 

carefully weighing the costs and benefits. I 

encourage commenters to address this point 

and to supply any data and analysis that may 

be illuminating. It is time our rules were 

designed less to punish and more to promote 

U.S. capital markets. Punishment as a 

singular regulatory policy is getting old and 

counterproductive. It is time our rules 

focused on returning America to work and 

prosperity. 

Increase Reliance on International 

Collaboration 

Similarly, I want to echo Commissioner 

Wetjen’s call for comments on two areas 

where the Commission can harness 

international collaboration. First, I welcome 

comments on whether the Commission 

should exclude from the scope of this 

rulemaking any derivative cleared by a 

central counterparty (CCP) that is subject to 

regulation and supervision consistent with 

the CPSS–IOSCO Principles for Financial 

Market Infrastructures (PFMIs), an alternative 

on which the Commission seeks comment in 

the preamble. It is reported that at least one 

U.S. financial firm is a member at 70 

different CCPs around the globe. The present 

proposal, if finalized, could result in trades 

cleared on many of these CCPs being treated 

as if they are uncleared.8 This would seem 

to be a needlessly costly and burdensome 

imposition on American commerce. Global 

regulators have already agreed on 

international standards in the PFMIs to 

determine how CCPs should be regulated and 

supervised. It makes sense to leverage these 

standards where we can. I encourage 

comment on this issue. 

I would also be interested in commenters’ 

views on how the Commission should 

conduct its comparability analysis under this 

rulemaking. In the advance notice of 

proposed rulemaking, the Commission 

proposes to permit market participants to 

comply with foreign rules, if such rules are 

comparable to the Commission’s margin 

requirements. Yet, a better approach may be 

to compare a foreign regime to the 

international standards put forward by the 

BCBS/IOSCO international working group 

that included participation from over 20 

regulatory authorities. Doing so would give 

the Commission some comfort that foreign 

rules meet a necessary baseline, but could 

avoid unnecessary and potentially 

destabilizing disputes over comparability in 

the future. I hope the insights of interested 

parties will guide not only the Commission, 

but also the prudential regulators. I further 

hope all concerned parties can use this 

rulemaking as an opportunity to promote 

international comity at a time when it is 

sorely needed. 

Treatment of Small Financial Entities 

Another aspect of the proposed rules that 

concerns me is the treatment of financial 

entities that qualify for the small bank 

exemption from clearing and financial 

cooperatives. Section 2(h)(7)(C)(ii) of the CEA 

directed the Commission to consider whether 

to exempt from the definition of ‘‘financial 

entity’’ small banks, savings associations, 

farm credit system institutions and credit 

unions with total assets of $10 billion or less. 

In response, the Commission exempted these 

small financial institutions from the 

definition of financial entity for purposes of 

clearing. It recognized that these institutions 

serve a crucial function in the markets for 

hedging the commercial risk of non-financial 

end users. Moreover, the Commission 

acknowledged that the costs associated with 

clearing, including margin and other fees and 

expenses, may be prohibitive relative to the 

small number of swaps these firms execute 

over a given period of time.9 In addition, 

using its Section 4(c) exemptive authority, 

the Commission permits cooperative 

financial entities, including those with total 

assets exceeding $10 billion, to elect an 

exemption from mandatory clearing for 

swaps executed in connection with 

originating loans for their members, or that 

hedge or mitigate commercial risk related to 

loans or swaps with their members.10

Despite the CFTC’s otherwise appropriate 

treatment of these small banks and financial 

cooperatives, the proposed margin rules treat 

them as financial institutions required to post 

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59936 Federal Register / Vol. 79, No. 192 / Friday, October 3, 2014 / Proposed Rules 

11Clearing Exemption for Swaps Between Certain 

Affiliated Entities, 78 FR 21750 (Apr. 11, 2013); 17 

CFR 50.52. 

12 Id. at 21751–54. 

13Separately, I also welcome comments on the 

sufficiency of the no-action relief issued by the 

Division of Clearing and Risk for swaps entered into 

by treasury affiliates, and whether it may serve as 

a model for future rulemaking to provide greater 

certainty in this area. See CFTC Letter No. 13–22 

(Jun. 4, 2013). 

margin when their swaps exposure exceeds 

the $3 billion threshold. This means that 

small banks and cooperative financial 

institutions entitled to a clearing exemption 

will have to pay margin for their uncleared 

activity with swap dealers or major swap 

participants when they have material swaps 

exposure. It makes no sense to provide these 

entities with an exemption from clearing on 

the one hand, only to turn around and 

require them to bear the potentially even 

greater costs associated with uncleared 

swaps. They deserve the full benefit of their 

clearing exemption, which they may not get 

if they have to post margin. I encourage 

comment on this issue, which I will weigh 

carefully in the process of considering a final 

rule. 

Inter-Affiliate Exemption 

The proposed rules may also diminish the 

utility of the critically important, interaffiliate clearing exemption the Commission 

adopted last year for certain eligible affiliate 

counterparties.11 The exemption was 

premised on recognition that transactions 

between affiliates do not present the same 

risks as market-facing swaps, and generally 

provide risk-mitigating, hedging, and netting 

benefits within a corporate group.12 I 

welcome comments addressing the impact 

the proposed rules may have on the ability 

of affiliated entities to efficiently manage 

their risk.13

Use of Approved Models to Calculate Capital 

Finally, I believe it is important to allow 

the use of models when calculating initial 

margin. The proposed rules require the 

Commission’s prior written approval before a 

model can be used, even though the 

Commission lacks adequate staff and 

expertise for evaluating models. We 

recognize in the preamble that many covered 

swap entities are affiliates of entities whose 

margin models are reviewed by one of the 

prudential regulators, the SEC, or a foreign 

regulator, and to avoid duplicative efforts we 

plan to coordinate with other regulators in an 

effort to expedite our review. Rather than go 

through a special approval process, however, 

I believe we should accept models approved 

by our fellow regulators, so long as they 

contain the required elements. Alternatively, 

as mentioned in the preamble and discussed 

at the open meeting, this may be an area in 

which the National Futures Association can 

provide assistance, and I am interested in 

hearing its views on the issue. I also join 

Commissioner Wetjen’s call for discussion on 

the circumstances in which the Commission 

may permit market participants to continue 

using models while Commission staff is 

reviewing them. Given the CFTC’s limited 

resources, I believe we should make every 

effort to leverage the expertise of other 

qualified regulators before asking for more 

tax dollars from Americans working two jobs 

just to stay afloat. 

Conclusion 

In spite of my stated concerns, I support 

the issuance of these proposed rules in order 

to solicit comment. They raise a number of 

important issues, particularly in their impact 

on the U.S. economy and job creation and the 

extent of their application across the globe. 

It is vital that we hear from interested parties 

on how to get them right. I commend the 

Chairman and my fellow Commissioners for 

their thoughtfulness and open-mindedness in 

arriving at the final proposals. I look forward 

to receiving and reviewing comments on the 

issues discussed above and all aspects of the 

rules. 

[FR Doc. 2014–22962 Filed 10–2–14; 8:45 am] 

BILLING CODE 6351–01–P 

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