Swap Dealers and Major Swap Participants Regulation - Margin Requirements for Uncleared Swaps - Comment Letters

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Dodd-Frank Timeline, Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, CFTC
Proposal Date Comment Period Reopened New Comment Deadline
May 12, 2011 July 12, 2012 September 14, 2012

Comment Letters addressing the Margin Requirements for Uncleared Swaps for swap dealers and major swap participants. The CFTC also issued a rule proposal regarding capital requirements for swap dealers and major swap participants. These comment letters can be found here.

Other regulatory agencies "Prudential Regulators" have proposed capital and margin requirements for entities under such jurisdiction. Many of the comment letters below address the rules proposed by these regulators. Additional comment letters submitted to Prudential Regulators can be found HERE.

In September 2011, the CFTC issued a proposed compliance and implementation schedule for documentation and margining. Comment letters on this rule can be found HERE.

NOTE: On July 12, 2012, the CFTC reopened the comment period for this rule and set the new deadline for September 14, 2012. Letters submitted during the reopened period can be found near the top of this page.

Contents

Markit - September 14, 2012

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
September 14, 2012

From the comment letter:

"...we believe that the Commission should design its margin regime in a manner that: (1) enables a larger number of counterparties to calculate IM on the basis of approved models; (2) allows counterparties to agree on the IM amounts for a swap transaction to be performed by the same third party provider or base their IM calculation on the same set of inputs and calculation methodologies as provided by a third party; (3) allows for choice between the use of model-based and grid-based approach to IM calculation on a sufficiently granular level; (4) clarifies the frequency with which IM/VM calculations and collection will be required; and (5) permits the use of effective procedures that facilitate agreement on VM amounts.

Furthermore, we believe that an appropriate balance must be struck between incentivizing the clearing of standardized swaps and recognizing the relevance of uncleared swaps as well as the end-user exception. Margin requirements for both cleared and uncleared swaps should be balanced fairly vis-à-vis each other and should leave sufficient room for appropriate contractual arrangements to take place between the parties."

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Global Pension Coalition - September 14, 2012

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
Margin and Capital Requirements for Covered Swap Entities September 14, 2012

The coalition includes The American Benefits Council, the Committee on Investment of Employee Benefit Assets, the European Federation for Retirement Provision, National Coordinating Committee for Multiemployer Plans, and the Pension Investment Association of Canada.

From the comment letter:

"...the Consultative Document lacks clarity in several important areas, such as what types of entities would be subject to uncleared margin requirements. We do not support subjecting all entities defined as financial entities” to the same margin requirements without regard for the entity structure and systemic risk profile. As discussed below, we respectfully submit that pension plans should be excluded from any uncleared swap margin requirements. Consistent with prior comments to the CFTC and Prudential Regulators,4 we are also recommending changes to the specifications for calculating initial margin."

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ISDA/SIFMA - September 14, 2012

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
September 14, 2012

Summary of key points from the comment letter:

  • "The Commission should re-propose its rules on margin after it has had the opportunity to review and consider the final findings of the Basel/IOSCO working group on margining requirements (the "Basel/IOSCO Working Group")."
  • "We propose that the Commission provide a phased-in implementation schedule for margin requirements to alleviate the pressures of collective compliance."
  • "Implementation and timing of the Commission's margin rules should be coordinated and consistent with the margin requirements of the Prudential Regulators, the Securities and Exchange Commission (the "SEC") and regulators in other jurisdictions."
  • "Proprietary models, subject to the Commission's review, and models approved by other regulators should be eligible initial margin models."
  • "We recommend that the Commission allow netting to the full extent it is legally enforceable and allow portfolio-based margining across cleared and uncleared swaps, other products and across legal entities."
  • "Segregation and third party custody should not be required by regulation, although we recognize that the Commodity Exchange Act ("CEA") requires CSEs to offer segregation to its counterparties for initial margin."
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Consortium of Captive Finance Companies - September 14, 2012

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
September 14, 2012

From the comment letter:

"Because of the role that captive finance companies play in the U.S. economy, we urge the CFTC and the other U.S. regulators to fully respect the intent of Congress and exempt such entities and their securitization trusts from margin requirements. In its NPR, the CFTC correctly concluded that entities exempt from the clearing requirements of Section 2(h)(7)(C) of the CEA should also be exempt from margin requirements. Accordingly, we submit that the CFTC should clarify that captive finance companies and their securitization trusts that meet the 90/90 test are not “financial entities” for the purpose of the margin rules. The CFTC should not deviate from the definition of “financial entity” provided in Title VII of the Dodd-Frank Act, which includes an explicit exemption for captive finance companies. We further submit that sound policy underlies the statutory exemption for captives and urge the international regulators to clarify that captive finance companies be treated as non-financial commercial end-users for the purpose of application of margin rules in all relevant jurisdictions."

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Better Markets - September 18, 2011

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
September 18, 2011

Key considerations from the comment letter:

  • "Congress' ultimate objective in the Dodd-Frank Act was to prevent another crisis and the massive costs it would inflict;
  • Prudent margining of uncleared swaps is an integral component of the reforms that Congress decided were necessary to achieve this objective; and
  • The costs of compliance and reduced profit margins that industry may have to absorb by virtue of these margin requirements pale in comparison with the benefits of preventing another crisis - a benefit that can be valued at over $12.8 trillion."
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Alternative Investment Management Association - June 28, 2011

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
June 28, 2011

Summary of key points from the comment letter:

  • AIMA supports proposed rules which set minimum requirements as to the amount and types of acceptable collateral;
  • it should be permissible to apply initial margin requirements on a portfolio basis, including to pre-effective date swaps within the portfolio, provided sufficient time is given between proposed minimum margin requirements being specified and those requirements being applied;
  • financially sound swap counterparties should have the benefit of an initial margin threshold, below which they are not required to provide collateral, which is reasonable and proportionate to their creditworthiness;
  • rules proposed by the Commission and by the Prudential Authorities’ should be as closely aligned as possible, including the proposed methods of calculating minimum margin requirements;
  • eligible collateral should include US and non-US government securities and immediately-available cash funds denominated in US dollars or a foreign currency, even where such currency is not the currency in which payment obligations under the swaps are required to be settled;
  • the US Authorities should each consult on the extraterritorial scope of their rules. Where some degree of extraterritorial application of the rules is unavoidable, the relevant rules should be framed, as far as possible, so that they do not subject firms’ counterparties with overlapping and conflicting obligations. International coordination should be sought in order to minimize the possibility of market fragmentation. Further, requirements should only apply where the activities of Swap Entities “have a direct and significant connection with activities in, or effect on, commerce of the United States”.
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ISDA/SIFMA - July 11, 2011

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
July 11, 2011

This 46-page comment letter outlines critical issues regarding the implementation of margin requirements for uncleared swaps, including macro0economic impact, extraterritoriality, requirements for entity types, proprietary margin models, netting, collateral, and implementation guidelines. The comments are organized as follows:

  1. Macro-economic Impact – discussion of the implications of the proposed margin rules on economic factors such as liquidity and capital formation (page 4);
  2. Extraterritoriality – discussion of transactions with non-U.S. counterparties (page 5);
  3. Requirements for Entity Types – discussion of counterparty types (page 7);
  4. Margin Requirements – discussion of initial and variation margin requirements, and rules regarding the posting of collateral (page 13);
  5. Eligible Collateral – discussion of assets that may be posted for margin and haircuts (page 25);
  6. Delivery Timing – discussion of posting timeframes (page 27);
  7. Inter-affiliate – discussion of inter-affiliate swaps (page 28);
  8. Implementation – discussion of rules related to effective date and implementation (page 29); and
  9. Documentation – discussion of required documentation (page 31).
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Institute of International Bankers - July 1, 2011

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
Capital Requirements of Swap Dealers and Major Swap Participants
Margin and Capital Requirements for Covered Swap Entities
July 1, 2011

In the comment letter, the Institute of International Bankers (IIB) offers several recommendations regarding capital and margin requirements, including:

  • CFTC rules should be consistent with those of other prudential regulators.
  • Commission should permit Foreign-supervised SD/MSPs to comply with regulations, initial margin models, recordkeeping and reporting requirements of the home country in lieu of U.S. requirements.
  • The Commission and the Prudential Regulators should take a more flexible approach toward the risk of a custodian’s insolvency, consistent with the Commission’s earlier proposal for addressing legal risk more generally.
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Managed Funds Association - July 11, 2011

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
Capital Requirements for Swap Dealers and Major Swap Participants
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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Investment Company Institute - July 11, 2011

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
July 11, 2011

From the comment letter:

"Among our concerns, the rules would apply only to the collection of minimum margin amounts by a covered swap entity from its counterparties instead of also including specific requirements that a covered swap entity must post margin to its counterparties. ICI therefore recommends that the CFTC modify the proposal to eliminate any regulatory gaps by requiring covered swap entities to post margin at the same levels and in the same manner as would be required under the proposal for the particular type of counterparty...We also recommend that the CFTC modify the definition of end-user to clarify that registered investment companies are low-risk financial end users because of the stringent regulatory regime under which they operate..."

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Fannie Mae - July 8, 2011

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
July 8, 2011

Summary of key points from the comment letter:

  • "Segregating variation margin (VM) will increase costs and decrease transparency; counterparty risk mitigation can be achieved in other manners without the need for VM segregation."
  • "Requiring custodians to be independent and located in a jurisdiction that applies the same insolvency regime as the posting party may not be practical in all instances."
  • "Margin rules should be consistent across regulatory bodies to the greatest extent practicable."
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Council of Institutional Investors - June 30, 2011

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
June 30, 2011

From the comment letter:

"The Council believes that swaps and security-based swaps involving a non-financial entity should not be exempt from margin requirements, as requiring margin reduces risk to taxpayers and to the financial system. This position is consistent with the recommendations of the Investors’ Working Group (IWG),2 a blue ribbon panel of industry and market experts. According to the IWG’s 2009 report, 'All OTC trades should be subject to federally imposed margin requirements.'"

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Coalition for Derivatives End-Users - July 11, 2011

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
July 11, 2011

This 49-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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Independent Community Bankers of America - July 11, 2011

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
July 11, 2011

From the comment letter:

"We urge regulators not to prohibit rehypothecation of initial margin utilized to facilitate the interest rate swaps of community banks. Instead, we urge the agencies to make distinctions between the truly risky and highly complex swaps that some large financial institutions utilized in the OTC market that actually contributed to the financial crisis versus the low risk interest rate swaps used by community banks which do not pose systemic risks.

"It was not congressional intent to count community banks as swap dealers if they utilize swaps for hedging their own risks or serving their customers’ needs. If community banks are unable to access the swaps market due to the unintended consequences of over-reaching regulations, both community banks and their customers will be needlessly harmed. It is important that community banks not be erroneously classified as swap dealers.

"We also urge the agencies not to impose a burdensome and costly segregation regime that unnecessarily imposes new costs upon the swaps market. In general, there is no need to abolish the ability of community banks to access the swaps market as these regulations would do."

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MetLife - July 11, 2011

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
July 11, 2011

Recommended modifications from the comment letter:

  • Expanding the range of eligible collateral to include High-quality Corporate Bonds and Agency RMBS;
  • Reducing initial margin requirements to be more consistent with comparable cleared trades and consistent with the actual risk of the particular transaction;
  • Preserving mutual two-way netting and collateral arrangements consistent with current market practice;
  • Providing a measure of flexibility to financial end users and CSEs in the calculation of initial margin, the choice of margin model; and
  • Phasing-in new margin requirements in coordination with clearinghouse capabilities and in coordination with U.S. and foreign derivatives regulations.
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Cargill - July 6, 2011

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
July 6, 2011

Key points from the comment letter:

  • Transactions with affiliates should not result in capital charges.
  • NFA should be permitted to approve internal risk models.
  • Swap dealer financial information available to the public should be limited to the same type of information that is published for FCMs.
  • Provisions regarding reporting of valuation disputes should be revised.
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BlackRock - July 11, 2011

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
Margin and Capital Requirements for Covered Swap Entities
July 11, 2011 From the comment letter:

  • "The proposed rules would make the cost of using the uncleared swap markets uneconomical

while potentially over-collateralizing these trades."

  • "We believe the margin levels set in the Proposed Rules are extremely conservative and respectfully

recommend that the CFTC and the Prudential Regulators adopt final rules that set margin requirements at appropriate levels to allow for an orderly close out or other risk mitigation of swap positions."

  • The comment letter also includes two hypothetical examples demonstrating the impact of margin rules on swap portfolios.
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Markit - July 11, 2011

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants
July 11, 2011

From the comment letter:

"The requirement for Covered Swap Entities (“CSEs”) to compute and collect both initial margin (“IM”) and variation margin (“VM”) for uncleared swaps across asset classes, products and counterparties will pose significant operational challenges to the marketplace. Further, for IM and VM collection to result in the desired reduction of systemic risk, their calculation needs to be performed in a reliable, unbiased, timely and consistent fashion.

"We believe that the proposed rules can be improved in several aspects, and that independent third party providers (“ITPPs”) can provide services related to IM and VM calculations that will help achieve the above objectives while delivering benefits to all stakeholders. Specifically, we believe that: (1) the risk-based IM models in the Proposed Rule are exposed to a number of challenges because: (a) margin models used by derivatives clearing organizations (“DCOs”) cannot appropriately reflect the risks associated with uncleared swaps, (b) the process for approval of internal, proprietary margin models could take a significant amount of time and Commission staff resources, and (c) the Proposed Rule does not require IM models supplied by third-party vendors to be validated or tested for accuracy; (2) the “Alternative Method” for IM calculation should be more granular because utilizing only two multipliers for all types of swaps is not suitable for the whole variety of swap products. Additionally, the determination of which swaps are “comparable” should be performed by the Commission or appropriately qualified ITPPs; and (3) IM calculations would be more accurate and comparable if CSEs maximized the independence of the inputs and assumptions utilized or if those and several other determinations were independently validated. Further, CSEs should be expressly authorized to outsource IM and VM calculations to ITPPs because this will help reduce potential for disputes between counterparties and increase objectivity and verifiability in the margin calculation processes."

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References

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