CFTC Final Rule: Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
|FINAL RULE: Approved December 16, 2015. Effective April 1, 2016. Compliance is phased in beginning September 1, 2016.|
|Original Proposal||Re-proposal Approved||Final Rule Approved|
|May 12, 2011||September 17, 2014||December 16, 2015|
On December 16, 2015, the CFTC approved a final rulemaking requiring swap dealers, major swap participants and "financial end users" to exchange two way (posting and collecting) initial ("IM") and daily variation margin ("VM"). Commercial ("non-financial") end users would be exempt.
The rules apply to entities not covered by Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Farm Credit Administration’ or the Federal Housing Finance Agency (collectively the Prudential Regulators). The CFTC rules are mirrored after those adopted by the Prudential Regulators in October 2015.
The rulemaking passed 2-1. Chairman Tim Massad and Commissioner J. Christopher Giancarlo voted in favor of the rule. Commissioner Sharon Bowen voted against the rule.
The rules became effective April 1, 2016. The rules will be phased-in starting September 1, 2016 and ending September 1, 2020 from the largest participants to smaller ones. VM requirements would be effective September 1, 2016 for the largest participants and March 1, 2017 for the rest.
The Dodd-Frank Act includes a mandate for the CFTC to create specific rules for swap dealers and major swap participants, including the setting of policies for margin requirements for uncleared swaps. These rules would only apply to swap dealers (SDs) and major swap participants (MSPs) not subject to oversight by prudential regulators, such as the U.S. Department of the Treasury, the FDIC and the Federal Reserve.
On April 12, 2011, the Commodity Futures Trading Commission approved a proposed rule regarding margin requirements for uncleared swaps. Margin and capital rules for SDs and MSPs subject to such oversight by prudential regulators can be found in a separate proposal from April 12, 2011.
These rules were subsequently re-proposed in 2014 to reflect other new initiatives, such as the final CFTC/SEC rules on entity and product definitions and the Basel Committee on Banking Supervision/IOSCO/BIS September 2013 framework, Margin requirements for non-centrally cleared derivatives. (View the rules proposed by the five prudential regulators in September 2014).
Note: The Prudential Regulators issued their own final rule in October 2015.
The Final Rule
The CFTC rules cover SD/MSPs that are not "covered swap entities," meaning those participants who fall under the jurisdiction of the Prudential Regulators and their margin rules for uncleared swaps. Financial end users have a de minimis exemption set at $8 billion in gross notional exposure.
Margin calculation may be based on models or a standardized table, but must use a 99% confidence level over a holding period equal to the shorter of ten business days or the maturity of the swap or netting portfolio.
|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|
|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|
For multiple uncleared swaps subject to an eligible master netting agreement, the initial margin amount under the standardized table shall be computed using the formula:
Initial Margin = 0.4 x Gross Initial Margin + 0.6 x Net-to-Gross Ratio x Gross Initial Margin
IM may be in the form of cash, sovereign debt, government-sponsored debt, investment grade debt including corporate and municipal bonds, equities, and gold, and must be held at an independent custodian. Since rehypothecation is not permitted under the final rules, initial margin posted as collateral may not be transferred through securities lending, securities borrowing, reverse repurchase agreements or similar arrangements.
VM shall be calculated each business day and must rely, as much as practicable, on "recently-executed transactions, valuations provided by independent third parties, or other objective criteria." Alternative calculation measures must be in place in the event of a failure of any input required for valuation. For risk management purposes, "hypothetical" VM requirement must be calculated each day for which the counterparty is an exempt entity such as a non-financial end user.
For swaps traded with a swap entity, VM is required to be paid in cash. For swaps traded with a financial end user, VM may be posted and collected with any form of collateral as initial margin as described above.
Under the final rule, swaps traded between affiliated entities will not be required to post initial margin. This marks a change from the proposed rules as well as rules approved by the Prudential Regulators, and prompted Commissioner Sharon Bowen to vote against the rulemaking. In her dissent, Bowen states:
"The large financial institutions that benefit from this exemption have tremendously complicated organizational structures, webs of hundreds, sometimes thousands, of affiliates spread across the globe. These complicated structures allow these banks to shift risk across the globe through different legal entities in their quest to earn higher returns on capital."
Related Documents: Fact Sheet, Federal Register Entry
- Open Meeting on Thirteenth Series of Proposed Rules under the Dodd-Frank Act. CFTC. Retrieved on April 15, 2011.