US Prudential Regulators Finalize Margin Exemption for Certain Uncleared Swaps | Practical Law

US Prudential Regulators Finalize Margin Exemption for Certain Uncleared Swaps | Practical Law

US prudential banking regulators adopted final regulations governing exemptions from requirements to exchange initial margin (IM) and variation margin (VM) between banks and their counterparties for uncleared swaps (including both non-security-based swaps (swaps) and security-based swaps (SBS)).

US Prudential Regulators Finalize Margin Exemption for Certain Uncleared Swaps

Practical Law Legal Update w-002-7329 (Approx. 4 pages)

US Prudential Regulators Finalize Margin Exemption for Certain Uncleared Swaps

by Practical Law Finance
Published on 01 Aug 2016 • USA (National/Federal)
US prudential banking regulators adopted final regulations governing exemptions from requirements to exchange initial margin (IM) and variation margin (VM) between banks and their counterparties for uncleared swaps (including both non-security-based swaps (swaps) and security-based swaps (SBS)).
On August 1, 2016, federal banking regulators adopted final regulations governing exemptions from requirements to exchange initial margin (IM) and variation margin (VM) between banks and their counterparties for uncleared swaps (including both non-security-based swaps (swaps) and security-based swaps (SBS)).
The federal banking regulators previously adopted final rules on the collection of IM and VM for uncleared swaps in October 2015 (prudential rules), which was published in the Federal Register on November 30, 2015 (see Practice note, The Dodd-Frank Act: Margin Posting and Collection Rules for Uncleared Swaps: Final Prudential Margin Rules).
The rules apply to swaps and SBS entered into by (and with) covered swap entities (CSEs), which are banks and bank holding companies (BHCs) subject to regulation by the prudential bank regulators that are also:
Concurrently with those final rules, US prudential regulators adopted an interim final rule (IFR) that exempted certain swap transactions from the margin collection requirements under the final rules. The new rule adopts the IFR without alteration (prudential margin exemption).
Under the prudential margin exemption, certain transactions between CSEs and certain other counterparties are exempt from the margin requirements under the prudential rules. Specifically, the margin requirements under the prudential rules do not apply to, and CSEs therefore do not have to post or collect margin for, uncleared swaps and SBS with a counterparty that:
  • Is a non-financial entity that falls under the clearing exception for swaps in section 2(h)(7)(A) of the Commodity Exchange Act (CEA) or the clearing exception for SBS in section 3C(g)(1) of the Securities Exchange Act (Exchange Act). This includes small banks with $10 billion or less in total assets, non-financial end-users, and captive finance companies, so long as the entity:
    • is a non-financial entity that qualifies for the clearing exemption under the CEA or the Exchange Act, as applicable;
    • is using the swap to hedge or mitigate commercial risk; and
    • notifies the CFTC or SEC how it generally meets its financial obligations associated with entering into non-cleared swaps.
  • Is a treasury affiliate that meets the clearing exemption under section 2(h)(7)(D) of the CEA or section 3C(g)(4) of the Securities Exchange Act, which includes affiliates of an entity that qualifies for the clearing exemption to hedge the entity's commercial risk.
  • Is a cooperative entity that fall under section 4(c)(1) of the CEA (note that these entities are not exempted from posting margin for SBS), which requires that the entity enter into a swap:
    • in connection with originating loans for its members; or
    • to hedge or mitigate commercial risk related to loans or swaps with their members or that arise from certain swaps with members.
For ease of use, the prudential regulators believe that:
  • For swaps that are required to be cleared under CFTC rules (see Practice Note, The Dodd-Frank Act: Swap Clearing and Exchange Trading Under Title VII), if the CSE's counterparty qualifies for the end-user exception (see Practice Note, The Dodd-Frank Act: The Commercial End-user Exception to the Mandatory Swap Clearing Requirement), the CSE needs no additional information from the eligible entity to proceed with the swap pursuant to the prudential margin exemption. For other swaps that do not meet the end-user exception, information gathered under CFTC requirements on the counterparty should be sufficient to determine whether the counterparty is eligible for the prudential margin exemption.
  • While currently no SBS are required to be cleared under SEC rules, once clearing and the associated clearing exceptions are required for certain SBS, the information gathered from SEC regulatory requirements will provide sufficient information for the CSE to determine whether the counterparty qualifies for the prudential margin exemption.
  • For swaps that are not required to be cleared, the CSE must take appropriate steps to establish a reasonable belief that the counterparty is eligible for the prudential margin exemption. There is no set procedure for determining eligibility, and the CSE may reasonably believe the statements of the counterparty to determine eligibility.
The prudential margin exemption becomes effective on October 1, 2016.
The rules encourage CSEs to continue with the current practice of collecting IM or VM at such times and in such forms and amounts (if any) as the CSE determines appropriate in its overall credit risk management of the swap entity's exposure to the customer.
The prudential regulators note in the rule that it establishes only minimum requirements with respect to IM and VM. Nothing in the final rule is intended to prevent or discourage a CSE from collecting or posting margin in amounts greater than is required under the final rule.