Covered Swap Entities Regulation - Comment Letters

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Dodd-Frank Timeline, Margin and Capital Requirements for Covered Swap Entities
Proposal Date Comment Period Reopened Comment Deadline
April 12, 2011 September 26, 2012 November 26, 2012

On April 12, 2011, five U.S. regulatory agencies ("Prudential Regulators") issued a joint rule proposal regarding the establishment of minimum margin and capital requirements for covered swap entities - registered swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants for which one of the Agencies is the prudential regulator. The agencies consist of:

  • Office of the Comptroller of the Currency, Treasury (OCC);
  • Board of Governors of the Federal Reserve System (Fed);
  • Federal Deposit Insurance Corporation (FDIC);
  • Farm Credit Administration (FCA); and
  • Federal Housing Finance Agency (FHFA).[1]

Some commenters chose to only submit letters to the CFTC in reference to its proposed rulemakings on capital and margin requirements.

Coalition for Derivatives End-Users - July 11, 2011

Margin and Capital Requirements for Covered Swap Entities
July 11, 2011

This 58-page letter detail's the coalition's views on how to regulate effectively the derivatives markets, does not pose undue burdens on the business community," including:

  • economic reasons why financial end-users should not be treated differently under the new regulatory structure and should not be subjected to margin requirements;
  • why parts of the proposed rule would unnecessarily burden end users and offers alternative formulations;
  • how portions of the proposed rule conflict with the stated goals underlying the derivatives title of the Dodd-Frank Act;
  • why the extraterritorial reach of the proposed margin rules extends too broadly and exceeds the authority of Dodd-Frank;
  • why end-user subsidiary entities that are affiliated with a parent entity should qualify as end-users regardless of their affiliation with the parent; and
  • why margin requirements should not be imposed on interaffiliate swaps between entities within a single corporate group because of the economic reality of these swaps.
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ISDA/SIFMA - July 11, 2011

Margin and Capital Requirements for Covered Swap Entities
July 11, 2011 This 42-page comment letter outlines critical issues regarding the implementation of margin requirements for uncleared swaps, including macroeconomic impact, extraterritoriality, requirements for entity types, proprietary margin models, netting, collateral, and implementation guidelines. Topics are as follows:

  1. Macro-economic Impact – discussion of the implications of the proposed margin rules on economic factors such as liquidity and capital formation;
  2. Extraterritoriality – discussion of transactions with non-U.S. counterparties;
  3. Requirements for Entity Types – discussion of counterparty types;
  4. Margin Requirements – discussion of initial and variation margin requirements, and rules regarding the posting of collateral;
  5. Eligible Collateral – discussion of assets that may be posted for margin and haircuts;
  6. Delivery Timing – discussion of posting timeframes;
  7. Inter-affiliate – discussion of inter-affiliate swaps;
  8. Implementation – discussion of rules related to effective date and implementation; and
  9. Documentation – discussion of required documentation.
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Managed Funds Association - July 11, 2011

Margin and Capital Requirements for Covered Swap Entities
July 11, 2011

From the comment letter:
"...we believe that sound regulation of margin delivered in connection with uncleared swaps includes at a minimum, the following attributes:

  • consistency of margin requirements among regulators;
  • parity among market participants in their obligations to deliver variation margin;
  • extensive use of netting to both abate counterparty credit risk and lower costs associated with the delivery of margin;
  • transparent methods for determining margin amounts that both CSEs and their counterparties can use independently; and
  • determination of variation margin in a negotiated manner that need not be formula-based."
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SIFMA - July 11, 2011

Margin and Capital Requirements for Covered Swap Entities
July 11, 2011

This letter was submitted by the Asset Management Group (AMG) of SIFMA. Summary of key points from the comment letter:

  • Variation margin requirements for uncleared swaps should be bilateral. To the extent the Prudential Regulators or the CFTC require CSEs to collect initial margin, they should also require those CSEs to post margin to the counterparty upon the election of such counterparty.
  • The initial margin calculation methodology in the Proposals should be substantially revised.
  • CSEs should not be required to collect initial margin from RICs, ERISA funds, government benefit plans or foreign pension plans.
  • The definition of “low-risk financial end user” should be substantially revised.
  • The maximum allowable uncollateralized threshold of initial margin for “low-risk” financial end users should be increased to $100 million and there should be no uncollateralized threshold for variation margin.
  • Variation margin should be collected and posted by both parties on a daily basis, though minimum transfer amounts up to $500,000 should be allowed.
  • The classes of eligible collateral should be broadened to include assets beyond those explicitly allowed by the Proposals.
  • Each party to a swap should be provided a sufficient period of time after execution of the swap to collect margin from its counterparty.
  • Uncleared margin collection rules should only become effective once submitted margin models have been reviewed and operational requirements for uncleared margin requirements can be met. If the CFTC and SEC phase in swap clearing requirements by category of swap, the uncleared margin collection rules for a given swap should not become effective until clearing is required for that category of swap.
  • Parties to swaps entered into prior to the effectiveness of the margin rules should be permitted to include those swaps in post-effective margin calculations only if both parties agree to do so.
  • The AMG is concerned that the extraterritorial application of initial margin requirements on foreign CSEs could result in duplicative and potentially inconsistent margin requirements being imposed on U.S. buy-side counterparties.
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Deutsche Bank - July 11, 2011

Margin and Capital Requirements for Covered Swap Entities
July 11, 2011

From the comment letter:

"We do not believe, however, that the broad-brush distinctions made in the Proposed Rules between types of derivatives counterparties are in fact useful in distinguishing among the risks posed by each type. We are concerned that the Prudential Regulators’ overly prescriptive approach will lead to unnecessary costs, inefficiencies and illiquidity without a corresponding benefit in reduced risks. Overly burdensome requirements on margin and margin segregation will generate a substantial cost to the economy due to a reduction in available liquidity and the supply of capital."

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Farm Credit Council - July 11, 2011

Margin and Capital Requirements for Covered Swap Entities
July 11, 2011

Summary of key points from the comment letter:

  • "Small financial institutions, including Farm Credit System institutions, should be treated as nonfinancial end users for purposes of margin requirements consistent with congressional intent and the end-user exception to mandatory clearing.
  • The prudential regulators should not set maximum initial and variation margin thresholds for low-risk financial end users, or if they do, those thresholds for net exposure should be set no lower than $40 million.
  • To permit more meaningful comment, the prudential regulators should provide further guidance on the circumstances that might result in entities that are not swap dealers or major swap participants being designated “covered swap entities.”
  • With respect to the definition of “qualifying master netting agreement,” the prudential regulators should clarify that an agreement will qualify for the definition regardless of whether the insolvency scheme applicable to either counterparty effectively stays the exercise of rights under the agreement.
  • Low-risk financial end users should not be required to collect margin from swap entity counterparties, and the decision to collect margin should be determined by the individual entity’s risk management.
  • Consistent with market practice, variation margin should not be subject to segregation and rehypothecation restrictions.
  • Low-risk financial end users should be able to rely on initial margin models used by their swap entity counterparties.
  • With respect to the effective date, Farm Credit System institutions will need more than 180 days from publication of final rules to comply with new margin requirements."
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PIMCO - July 11, 2011

Margin and Capital Requirements for Covered Swap Entities
July 11, 2011

The comment letter highlights six key points:

  1. The collateral requirements are "overly rigid and onerous;"
  2. In the interest of preventing systemic risk, the rules should allow for "bilateral posting of margin;
  3. End-users such as pension funds should be considered "low-risk entities;"
  4. Swap agreements entered into prior to the effective date should be allowed to be considered in margin calculations, if both parties to the swap consent;
  5. Proposed rules should ensure that initial margin held at third-party custodians available for all counterparties; and
  6. Implementation should be delayed until related infrastructure is in place.
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Financial Services Roundtable - July 11, 2011

Margin and Capital Requirements for Covered Swap Entities
July 11, 2011

Among the key points in the comment letter:

  • "We support less stringent requirements for transactions with low-risk financial entities as opposed to high-risk financial entities, and believe that the criteria for low-risk financial entities should be modified."
  • Sovereign governments should be treated as commercial end-users rather than as financial entities, with no set limits.
  • Covered swap entities should have the ability to establish agreements pursuant to which commercial end-users are not at risk of margin calls.
  • The Agencies should allow much greater flexibility in the forms of margin permitted for commercial end-users.
  • Intercompany transactions should be exempt from all margin requirements.
  • "The Agencies have proposed that the new margin regulations would become effective 6 months after the date of adoption of the final regulations. We believe this will not allow sufficient time for most covered swap entities to bring their swaps businesses in line with the new requirements."
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Freddie Mac - July 11, 2011

Margin and Capital Requirements for Covered Swap Entities
July 11, 2011

Among the recommendations from the comment letter: The Prudential Regulators should:

  • permit netting of variation margin;
  • clarify that mortgage-backed securities backed by Freddie Mac and Fannie Mae are eligible collateral for initial margin;
  • provide greater flexibility for covered swap entities to establish minimum transfer amounts based on approved standards; and
  • adopt a standards-based approach to custodial risk.
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Markit - July 11, 2011

Margin and Capital Requirements for Covered Swap Entities
July 11, 2011

From the comment letter:
"We believe that:

  1. counterparties may not be able to agree upon a valuation method as part of their trading documentation that is as detailed as required by the Proposed Rule, so counterparties should be able to reference inputs, methodologies, or valuations provided by appropriately qualified ITPPs; #the inputs and assumptions used in internal IM models should be independent or should be independently verified, and all of the Agencies should explicitly permit CSEs to delegate IM calculation to ITPPs;
  2. DCO models are generally not appropriate to calculate IM for uncleared swaps; and
  3. the rules should reflect that expected liquidation horizons vary between swaps based on a number of factors.
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Association of Institutional Investors - July 11, 2011

Margin and Capital Requirements for Covered Swap Entities
July 11, 2011

Among the recommendations from the comment letter:

  • Initial margin calculation should be based on a 5-day horizon, as opposed to a 10-day horizon.
  • High quality fixed income instruments should be included in acceptable collateral.
  • RICs, ERISA accounts, and government benefit plans should be treated as low-risk end-users.
  • Regulations should harmonize with both other U.S. regulators and foreign regulators.
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Coalition for Derivatives End-Users - July 11, 2011

Margin and Capital Requirements for Covered Swap Entities
July 11, 2011

From the comment letter:
"We believe that:

  • high margin requirements for uncleared swaps create unnecessary incentives to use cleared swaps;
  • requiring the use of credit support arrangements does not simply codify the status quo;
  • margin lending facilities are not an effective solution to issues raised by the proposed rule;
  • the proposed rule overly-restricts the use of non-cash collateral;
  • the proposed rule may not adequately account for the benefits of credit hedging;
  • end-users will face unnecessary micromanagement of their counterparty relationships; and
  • the proposed rule would reduce the competitiveness of American firms.
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Investment Company Institute - July 11, 2011

Margin and Capital Requirements for Covered Swap Entities
July 11, 2011

From the comment letter:

"To truly minimize risk to the financial system and market participants, margin requirements, when imposed, should be bilateral between a swap entity and its counterparty."

"ICI recommends various amendments to the proposed definition of financial end-user, the margin calculations and the categories of eligible capital."

"We also encourage the regulators to coordinate and harmonize, to the extent possible, the proposed rules with their fellow regulators in the United States and abroad..."

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BNY Mellon/Northern Trust/State Street - July 11, 2011

Margin and Capital Requirements for Covered Swap Entities
July 11, 2011

From the comment letter:

"While the Custodian Banks believe the use of independent custody for swaps margin provides high levels of protection for each counterparty to a swap, for the reasons set forth herein, we are concerned that including the insolvency regime-related requirement in a final rule would not mitigate risks faced by Swap Entities that enter into Uncleared Swaps and would have undesirable consequences. Accordingly, we respectfully request that the insolvency regime requirement be excluded from the final rulemaking."

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References

  1. Margin and Capital Requirements for Covered Swap Entities. FDIC. Retrieved on May 10, 2011.

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