CFTC Adopts Final Rules on Uncleared Swaps Margin | Practical Law

CFTC Adopts Final Rules on Uncleared Swaps Margin | Practical Law

The CFTC adopted final margin rules under Title VII of the Dodd-Frank Act requiring margin collection by swap dealers (SDs) and major swap participants (MSPs) that are not covered by the final bank margin rules recently adopted by US bank regulators in connection with uncleared swaps that these SDs and MSPs enter into with financial counterparties.

CFTC Adopts Final Rules on Uncleared Swaps Margin

Practical Law Legal Update w-001-0934 (Approx. 7 pages)

CFTC Adopts Final Rules on Uncleared Swaps Margin

by Practical Law Finance
Published on 17 Dec 2015 • USA (National/Federal)
The CFTC adopted final margin rules under Title VII of the Dodd-Frank Act requiring margin collection by swap dealers (SDs) and major swap participants (MSPs) that are not covered by the final bank margin rules recently adopted by US bank regulators in connection with uncleared swaps that these SDs and MSPs enter into with financial counterparties.
On December 16, 2015, the CFTC adopted final margin rules and an interim final rule (IFR) under Title VII of the Dodd-Frank Act requiring margin collection by swap dealers (SDs) and major swap participants (MSPs) that are not covered by the final bank margin rules recently adopted by US bank regulators (bank margin rules) in connection with uncleared swaps that these SDs and MSPs (Covered Swap Entities or CSEs) enter into with financial counterparties.
Under the IFR, swaps for which a counterparty qualifies for an exception or exemption from clearing under Dodd Frank are exempt from the uncleared swaps margin rules. Comments on the IFR must be received by February 5, 2016.
According to the CFTC, the final rules are very similar to the final bank margin rules (see Legal Update, Final Uncleared Swaps Margin Rules for Banks Adopted by US Bank Regulators) and align with international rules promulgated by the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) (see Legal Update, Final Global Margin Rules for Uncleared Derivatives Released by International Regulators).
The final CFTC rules require parties to collect margin to cover counterparty risk in connection with uncleared swaps between a CSE and either:
  • Counterparties that are swap entities (such as another SD or MSP); or
  • Counterparties that are financial end users.
The final CFTC margin rules do not impose margin requirements on commercial end-users.

Initial Margin (IM)

The final CFTC margin rules require daily two-way posting and collection of initial margin (IM) for:
  • All trades between CSEs and SDs or MSPs; and
  • Trades between CSEs and material financial end users that have over $8 billion in gross notional exposure in uncleared swaps.
Trades between a CSE and a non-material financial end user are not subject to initial margin requirements under the final rules.
IM may be based on either:
  • An internal model with a 99% confidence level over a 10-day liquidation time; or
  • The following standardized table:
Asset Class
Gross Initial Margin (% 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
The rule incorporates a $50 million threshold level, below which IM need not be collected. IM that is collected must be held at an independent custodian and is not eligible for rehypothecation.
  • Assets eligible for posting as IM collateral under the final rules include:
  • Cash.
  • Sovereign and government-sponsored debt.
  • Investment-grade debt (including corporate bonds).
  • Equities.
  • Gold.
  • Certain fund shares.

Variation Margin (VM)

Variation margin (VM) is to be calculated using methods and inputs that rely on recent trades or third-party valuations. VM must be posted in cash and require daily:
  • Cash payment for trades between CSEs and SDs or MSPs; and
  • Posting for all trades between CSEs and financial end users.

“Financial End User” Definition

A financial end user is defined as a counterparty that is not a swap entity and which is also:
  • A bank holding company or an affiliate thereof, a savings and loan holding company, a US intermediate holding company established or designated for purposes of compliance with 12 CFT 252.153, 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).
  • A depository institution, a foreign bank, a federal credit union or a state credit union as defined in section 2 of the Federal Credit Union Act (12 U.S.C. 1752(1) & (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)).
  • An entity that is state licensed or registered as 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. However, excluded are entities registered or licensed solely on account of financing of the entity’s direct sales of goods or services to customers.
  • An entity that is state licensed or registered as a money-services businesses including check cashers, money transmitters, currency dealers and exchanges, and money order or traveler’s check issuers.
  • 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.
  • 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.
  • 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 SEC under the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) or a company that has elected to be regulated as a business development company (BDC) pursuant to section 54(a) of the Investment Company Act of 1940 (15 U.S.C. 80a-53).
  • A private fund, as defined in section 202(a) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-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).
  • A commodity pool, a commodity pool operator, a commodity trading advisor, a floor broker, a floor trader, an introducing broker or a futures commission merchant.
  • An employee benefit plan as defined in paragraphs (3) and (32) of section 3 of the Employee Retirement Income and Security Act of 1974 (ERISA) (29 U.S.C. 1002).
  • An entity that is organized as an insurance company that is primarily engaged in writing insurance or reinsuring risks underwritten by insurance companies, or which is subject to supervision as such by a state insurance regulator or foreign insurance regulator.
  • An entity, person, or arrangement that is, or holds itself out as being, an entity, person, or arrangement that raises money from investors, accepts money from clients, or uses its own money primarily for investing or trading or facilitating the investing or trading in loans, securities, swaps, funds, or other assets.
  • An entity that would be a financial end user or a swap entity if it were organized under the laws of the United States or any state thereof.
The term “financial end user” does not include any counterparty that is:
Financial end users are split between financial end users with and without material swaps exposure. A financial end user is considered to have material swaps exposure if the entity and its affiliates have an average daily aggregate notional amount of covered swaps and foreign exchange forwards and swaps with all counterparties for June, July, and August of the prior calendar year that exceeds $8 billion.

Inter-Affiliate Swaps

For inter-affiliate swaps, VM must be exchanged by the parties.
Uncleared swaps between a CSE's own divisions and affiliates are generally exempted from collecting IM, provided that:
  • The swaps are subject to centralized risk management that is designed to monitor and manage risks associated with inter-affiliate swaps; and
  • The CSE exchanges VM with its affiliate.
However, CSEs must collect (one-way) IM from their non-US financial end-user affiliates.
The bank margin rules require SDs and MSPs governed by those rules to collect IM from affiliates that are swaps entities or financial end users. Therefore, if a CSE governed by the final CFTC margin rules enters into a swap with a swap entity governed by the bank margin rules, the CSE must post IM but will not be required to collect it for that transaction. (This was structured to avoid requiring two-way margin exchange as a result of each entity having to collect margin under the rules applicable to it.)

Compliance Timetable

IM requirements under the final CFTC margin rules will be phased in beginning with the largest market participants on September 1, 2016 and will conclude September 1, 2020. VM will be required beginning on September 1, 2016 for the largest participants, and on March 1, 2017 for the remainder of the market.