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Federal Register, Volume 83 Issue 146 (Monday, July 30, 2018)
[Federal Register Volume 83, Number 146 (Monday, July 30, 2018)]
[Proposed Rules]
[Pages 36484-36494]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-16176]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 23
RIN 3038-AE78
Segregation of Assets Held as Collateral in Uncleared Swap
Transactions
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rule.
———————————————————————–
SUMMARY: The Commodity Futures Trading Commission (“Commission” or
“CFTC”) is proposing to amend selected provisions of its regulations
in order to simplify certain requirements for swap dealers (“SDs”)
and major swap participants (“MSPs”) concerning notification of
counterparties of their right to segregate initial margin for uncleared
swaps, and to modify requirements for the handling of segregated
initial margin (the “Proposal”).
DATES: Comments must be received on or before September 28, 2018.
ADDRESSES: You may submit comments, identified by RIN 3038-AE78, by any
of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the “Submit Comments” link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods. To
avoid possible delays with mail or in-person deliveries, submissions
through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
https://comments.cftc.gov. You should submit only information that you
wish to make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act (“FOIA”),1 a petition for confidential
treatment of the exempt information may be submitted according to the
procedures set forth in Sec. 145.9 of the Commission’s regulations.2
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1 5 U.S.C. 552.
2 17 CFR 145.9 (2017). Commission regulations referred to
herein are found at 17 CFR chapter I, and can be accessed through
the Commission’s website, www.cftc.gov.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from https://comments.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
the FOIA.
FOR FURTHER INFORMATION CONTACT: Matthew Kulkin, Director, (202) 418-
5213, [email protected]; Erik Remmler, Deputy Director, (202) 418-7630,
[email protected]; or Christopher Cummings, Special Counsel, (202) 418-
5445, [email protected], Division of Swap Dealer and Intermediary
Oversight, Commodity Futures Trading Commission, 1155 21st Street NW,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Introduction
A. Existing Requirements
Subpart L of the Commission’s regulations (“Segregation of Assets
Held as Collateral in Uncleared Swap Transactions” consisting of
Regulations 23.700 through 23.704) was published in the Federal
Register on November 6, 2013 and became effective January 6, 2014.3
Subpart L implements the requirements for segregation of initial margin
for uncleared swap transactions set forth in section 4s(l) of the
Commodity Exchange Act (“CEA” or the “Act”).4
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3 See 78 FR 66621 (Nov. 6, 2013).
4 7 U.S.C. 6s(l) (2012 & Supp. 2015). Like the Commission’s
regulations, the CEA can be accessed through the Commission’s
website.
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CEA section 4s(l) addresses segregation of initial margin held as
collateral in certain uncleared swap transactions. The section applies
only to swaps between a counterparty and an SD or MSP that are not
submitted for clearing to a derivatives clearing
[[Page 36485]]
organization (“DCO”). It requires that an SD or MSP notify a
counterparty that the counterparty has the right to require that any
funds or property the counterparty provides as initial margin be
segregated in a separate account from the SD’s or MSP’s assets. The
separate account must be held by an independent third-party custodian
and designated as a segregated account for the counterparty. CEA
section 4s(l) does not preclude the counterparty and the SD or MSP from
agreeing to their own terms regarding investment of initial margin
(subject to any regulations adopted by the Commission) or allocation of
gains or losses from such investment. If the counterparty elects not to
require segregation of margin, the SD or MSP is required to report
quarterly to the counterparty that the SD’s or MSP’s back office
procedures relating to margin and collateral are in compliance with the
agreement between the counterparty and the SD or MSP.
In January 2016, the Commission adopted margin requirements for
certain uncleared swaps applicable to SDs and MSPs for which there is
no prudential regulator (“CFTC Margin Rule”).5 The prudential
regulators (“Prudential Regulators”) include the Federal Reserve
Board, the Office of the Comptroller of the Currency, the Federal
Deposit Insurance Corporation, the Farm Credit Administration, and the
Federal Housing Finance Agency.6 The Prudential Regulators adopted
margin requirements similar to the CFTC Margin Rule for swaps entered
into by SDs and MSPs that they regulate (“Prudential Regulator Margin
Rules”) in November 2015.7 The CFTC Margin Rule and the Prudential
Regulator Margin Rules establish initial and variation margin
requirements for SDs and MSPs.8
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5 Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants, 81 FR 636 (Jan. 6, 2016). The CFTC Margin
Rule, which became effective April 1, 2016, is codified in part 23
of the Commission’s regulations. 17 CFR 23.150 through 23.159,
23.161.
6 7 U.S.C. 1a(39).
7 See Margin and Capital Requirements for Covered Swap
Entities, 80 FR 74840 (Nov. 30, 2015).
8 See 17 CFR 23.151.
—————————————————————————
Prior to the CFTC Margin Rule effective date of April 1, 2016, if
initial margin was to be exchanged by counterparties to uncleared swaps
involving an SD or MSP, the requirements of subpart L applied. The CFTC
Margin Rule amended Regulation 23.701 to clarify that from and after
the effective date of the CFTC Margin Rule, the requirements of
Regulations 23.702 and 23.703 did not apply in those circumstances
where segregation is mandatory under the CFTC Margin Rule.9 As a
result, Regulations 23.702 and 23.703 generally only apply when initial
margin is to be exchanged between an SD or MSP and (i) a nonfinancial
end-user, or (ii) a financial end-user without “material swaps
exposure,” as defined in the CFTC Margin Rule.
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9 81 FR 704 (Jan. 6, 2016). The amendment did not address the
application of subpart L to swaps subject to mandatory segregation
under the Prudential Regulator Margin Rules. As described below,
this Proposal would clarify that the swaps subject to the Prudential
Regulator Margin Rules are to be addressed in the same manner as
swaps subject to the CFTC Margin Rule.
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Regulation 23.700 defines certain terms used in subpart L.
Regulation 23.701 requires an SD or MSP: (1) To notify each
counterparty to a swap that is not submitted for clearing, that the
counterparty has the right to require that any initial margin it
provides be segregated; (2) to identify a creditworthy custodian that
is a non-affiliated legal entity, independent of the SD or MSP and the
counterparty, to act as depository for segregated margin assets; and
(3) to provide information regarding the costs of such segregation. The
regulation specifies that the notification is to be made (with receipt
confirmed in writing) to an officer (of the counterparty) responsible
for management of collateral (or to specified alternative person(s)),
and that it need only be made once in any calendar year. Finally, the
regulation provides that a counterparty can change its election to
require (or not to require) segregation of initial margin by written
notice to the SD or MSP.
Regulation 23.702 reiterates the requirement that the custodian be
a legal entity independent of the SD or MSP and the counterparty. It
also requires that segregated initial margin be held in an account
segregated for, and on behalf of, the counterparty and designated as
such. Finally, the regulation specifies that the segregation agreement
is to provide that: (1) Withdrawals from the segregated account be made
pursuant to agreement of both the counterparty and the SD or MSP, with
notification to the non-withdrawing party; and (2) the custodian can
turn over segregated assets upon presentation of a sworn statement that
the presenting party is entitled to control of the assets pursuant to
agreement among the parties.
Regulation 23.703 restricts investment of segregated assets to
investments permitted under Regulation 1.25, and (subject to that
restriction) permits the SD or MSP and the counterparty to agree in
writing as to investment of margin and allocation of gains and losses.
Regulation 23.704 requires the SD’s or MSP’s chief compliance
officer (“CCO”) to report quarterly to any counterparty that does not
elect to segregate initial margin whether or not the SD’s or MSP’s back
office procedures regarding margin and collateral requirements were, at
any point in the previous calendar quarter, not in compliance with the
agreement of the counterparties.
B. Factors Considered by the Commission
After more than four years of administering subpart L of part 23,
the Commission has observed that the detailed requirements of those
regulations have proven difficult for SDs and MSPs to implement and to
satisfy in a reasonably efficient manner. These observations have been
buttressed by suggestions submitted in response to the Commission’s
Project KISS initiative as described below. In addition, the Commission
understands that very few swap counterparties have exercised their
rights to elect to segregate initial margin collateral pursuant to
subpart L during the four years the regulations have been effective.
Early in the implementation period, in response to multiple
inquiries, Commission staff issued Staff Letter 14-132 (October 31,
2014) 10 providing interpretative guidance to SDs and MSPs regarding
application of certain of the segregated margin requirements. In
particular, the letter noted concerns expressed by SDs and MSPs that
despite their earnest efforts to obtain confirmation of receipt of
notification and election regarding segregation, failure by a
counterparty to respond to the SD or MSP could bar any further swap
transactions with the counterparty until a response was received.11
However, notwithstanding the issuance of Staff Letter 14-132, issues
regarding compliance with subpart L continue to be raised.12
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10 See CFTC Staff Letter No. 14-132 (October 31, 2014),
available at https://www.cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/14-132.pdf.
11 The Proposal would address generally some of the confusion
that prompted the issuance of Staff Letter 14-132 in the context of
other changes to subpart L that are proposed.
12 For example, issues regarding compliance with these
regulations have been raised with the National Futures Association
as recently as January 2018, indicating ongoing uncertainty. See pp.
6-7 of the transcript of the NFA Swap Dealer Examination Webinar,
January 18, 2018, available at https://www.nfa.futures.org/members/member-resources/files/transcripts/sdexamswebinartranscriptjan2018.pdf.
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[[Page 36486]]
On May 9, 2017, the Commission published in the Federal Register a
request for information 13 pursuant to the Commission’s Project KISS
initiative seeking suggestions from the public for simplifying the
Commission’s regulations and practices, removing unnecessary burdens,
and reducing costs. A number of suggestions received addressed various
provisions of subpart L. In general, the suggestions echoed Commission
staff concerns that the requirements in subpart L may be more
burdensome than is necessary to achieve the purposes of the statute and
that the requirements may be counterproductive by discouraging the use
of individual segregation accounts.14 Persons responding to Project
KISS also noted that some requirements cause confusion because they
overlap with segregation requirements in the margin regulations more
recently adopted by the CFTC and Prudential Regulators.15
Furthermore, responders noted that the requirements in subpart L are
overly prescriptive eliminating the possibility for reasonable
bilateral negotiation of certain terms that takes place in the normal
course to determine appropriate collateral arrangements based on the
circumstances of the broader counterparty relationship.16
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13 See 82 FR 21494 (May 6, 2017) and 82 FR 23765 (May 24,
2017).
14 See, e.g. letter from the Financial Services Roundtable
(“FSR Letter”), dated September 30, 2017 at 55 (noting that
“compliance with these regulations has proven to be unduly
burdensome for swap dealers when weighed against the protections
afforded to swap counterparties thereunder”), https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61427&SearchText=.
15 Id. See also letter from the Securities Industry and
Financial Markets Association (“SIFMA Letter”) dated September 29,
2017 at 2 (“These requirements create unnecessarily burdensome
obligations, which in many instances are duplicative or create
confusion due to parallel mandatory collateral segregation
requirements found within the CFTC and [prudential regulator] rules
on margin requirements for non-centrally cleared swaps, and similar
requirements in foreign jurisdictions.”).
16 See SIFMA Letter at 2. See also letter from the Global
Foreign Exchange Division of the Global Financial Markets
Association, dated September 29, 2017.
—————————————————————————
Responders also asserted that counterparties to uncleared swaps
rarely elect to require segregation of margin pursuant to the existing
provisions of subpart L.17 Commission staff has observed evidence of
minimal uptake of the election to segregate. In addition, Commission
staff has discussed this issue with the National Futures Association
(“NFA”) to ascertain NFA’s observations from examining a substantial
number of SDs in connection with the implementation of subpart L. Based
on this experience, it appears that for nearly every SD examined, fewer
than five counterparties elected segregation pursuant to subpart L
since registration. For some SDs, not a single counterparty has elected
to segregate pursuant to subpart L.
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17 See FSR Letter at 55 (“Our members have advised that
counterparties (i) rarely, if ever, elect to segregate [initial
margin] and (ii) have found little use for receiving the
notices.”).
—————————————————————————
In light of these considerations, the Commission is proposing to
amend the regulations governing segregation of margin for uncleared
swaps. The Commission believes that the amendments proposed today will
reduce unnecessary burdens on registrants and market participants by
simplifying some overly detailed provisions, thereby reducing the
intricate and prescriptive requirements that have been found during
implementation to provide little or no benefit. These changes will also
facilitate more efficient swap execution by eliminating complexity and
confusion that slows down documentation and negotiation of hedging and
other swap transactions. Finally, the amendments, by reducing the
prescriptive elements of the rule, potentially could encourage more
segregation (as was intended by the statute) by providing flexibility
for the parties to establish segregation arrangements that better suit
their specific needs.
At the same time that the Commission is proposing specific changes,
it is seeking comment from the public on the appropriateness of these
changes, as well as suggestions for other amendments that can
streamline, simplify, and reduce the costs of these regulations without
sacrificing the protections called for by CEA section 4s(l).
II. The Proposal
A. Regulation 23.700–Definitions
Section 23.700 defines “Margin” as “both Initial Margin and
Variation Margin.” 18 As proposed to be amended, subpart L would no
longer refer collectively to initial margin and variation margin, since
the right to require segregation applies only to initial margin, and
not to variation margin. Thus, there is no need for the separate
defined term “Margin.” The Commission therefore proposes to eliminate
the definition of Margin from Regulation 23.700, and to make conforming
changes to subpart L by replacing the term “Margin” with “Initial
Margin” in Regulations 23.701, 23.702, and 23.703.19
—————————————————————————
18 See 17 CFR 23.700.
19 A grammatical change is also proposed for the definition of
the term “segregate.”
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B. Regulation 23.701–Notification of the Right To Require Segregation
Paragraphs (a) and (b) of Regulation 23.701 direct an SD or MSP to
notify each counterparty of the right to require segregation of initial
margin. The language used is consistent with CEA section 4s(l).
Paragraphs (c), (d) and (e) add specific requirements not expressly
established in the statute. Paragraph (c) requires the SD or MSP to
furnish the required notification to an officer of the counterparty
responsible for management of collateral, or if no such person is
identified by the counterparty, then to the chief risk officer, or if
there is no such officer, to the chief executive officer, or if none,
the highest-level decision-maker for the counterparty. Paragraph (d)
requires the SD or MSP, “prior to confirming the terms of any such
swap,” to obtain confirmation of receipt of the notification, and the
counterparty’s election to require or not require segregation of
initial margin (such confirmation to be retained in accordance with
Regulation 1.31). Paragraph (e) provides that the notification need be
made only once in any calendar year.20 Finally, paragraph (f)
provides that the counterparty may change the segregation election at
its discretion by providing a written notice to the SD or MSP.
Paragraph (f) is not being amended in this Proposal except to
redesignate it as paragraph (d).
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20 Some confusion has been caused by the requirement in
paragraph (d) to provide the notice “prior to confirming the terms
of any such swap,” and the requirement in paragraph (e) to provide
the notice once in any calendar year.
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Based on staff’s implementation experience and on suggestions
received in connection with Project KISS, the Commission believes that
these requirements are unnecessarily prescriptive and that they do not
reflect the practical realities of how over-the-counter swap
transactions are negotiated and managed by the parties. Accordingly,
the Commission is proposing to modify the notification requirement in
paragraph (a) and to remove the requirements in existing paragraphs
(c), (d) and (e).
Under the Proposal, paragraph (a) would be revised to require that
the notification to a counterparty be made prior to execution of the
first uncleared swap transaction that provides for the
[[Page 36487]]
exchange of initial margin,21 not prior to each transaction or
annually as currently prescribed by paragraphs (d) and (e).22 CEA
section 4s(l) requires notification of the right to segregate “at the
beginning of a swap transaction.” The Commission is interpreting that
phrase to mean at the beginning of an SD’s or MSP’s swap transaction
relationship with each counterparty.
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21 This revision is consistent with guidance provided in Staff
Letter 14-132, cited above.
22 Thus, under the Proposal paragraph (e) of Regulation 23.701
(providing that the notification need only be made once in any
calendar year) would become unnecessary, and is proposed to be
deleted.
—————————————————————————
This interpretation is consistent with the Commission’s stated view
when it originally proposed and adopted Regulation 23.701(e), which
only requires notice once a year. With respect to the phrase in the
statute “at the beginning of a swap transaction,” the Commission
noted that “[w]hile this language could be read to require
transaction-by-transaction notification, where the parties have a pre-
existing or on-going relationship, such repetitive notification could
be redundant, costly and needlessly burdensome.” 23
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23 78 FR 66625.
—————————————————————————
When adopting final Regulation 23.701(e), the Commission considered
comments requesting a loosening of the once-per-year notice requirement
and rejected the requests in the belief that requiring notification
once each year would balance the burden of providing notices and
getting responses with the importance of the right to segregate initial
margin.24 At this time, based on implementation experience, the
Commission is proposing to require notification at the beginning of a
swap trading relationship that provides for exchange of initial margin.
The importance of the notification informing the counterparty of the
right to segregate is paramount at the beginning of the SD/MSP–
counterparty relationship. It is at the time the parties initiate the
first transaction that the decision to segregate initial margin will
typically be made.25 Subsequent notifications are repetitive to the
initial notification and risk adding confusion over the duration of the
contractual relationship of the parties. In this regard, the Commission
understands that counterparties rarely change their election, once
made. Accordingly, in addition to modifying the notification
requirement in paragraph (a), the Commission proposes to eliminate
paragraph (e)’s annual notification requirement in lieu of the proposed
notification at the beginning of the first uncleared swap transaction
that provides for exchange of initial margin.
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24 Id.
25 For existing master netting agreements for which the SD has
already sent a segregation notice, the Commission is of the view
that such notice would be sufficient for purposes of complying with
the amended regulations, if adopted, and therefore the SD would not
be required to send a new notice.
—————————————————————————
Paragraph (a) would also be revised to eliminate the notification
requirement where segregation is mandatory under Regulation 23.157 and
where it is mandated under applicable rules adopted by a Prudential
Regulator under CEA section 4s(e)(3). Paragraph (a)(2) (the requirement
that the notification identify one or more creditworthy, independent
custodians) would be deleted because selection of a custodian can be
made when and if the counterparty elects to require segregation.
Because very few counterparties elect to require segregation, it is
unnecessarily burdensome to require an SD or MSP to confirm which
custodians are available and continually update its notification form
with the name of the custodian(s) available. Moreover, the Commission
understands that a counterparty’s initial decision to consider
requiring (or not requiring) segregation is driven principally by
whether the counterparty is concerned about protecting its initial
margin and the terms of the segregation agreement, and not by the
identity of the custodian. Similarly, paragraph (a)(3) (information
regarding the price for segregation for each custodian) would be
deleted because such pricing may vary for each segregation arrangement
and would normally be subject to negotiation. To the extent pricing
would be a factor in the decision to segregate, counterparties can and
do discuss pricing as a term of the custodial arrangement when the
counterparty indicates an interest in segregation. Moreover, the
requirements in paragraphs (a)(2) and (a)(3) are not found in CEA
section 4s(l).
Similarly, the Proposal would eliminate the requirement in current
paragraph (c) that the SD or MSP provide the notification to a person
at the counterparty with a specific job title. Based on implementation
experience, the Commission is of the view that the regulation as
initially adopted is unnecessarily prescriptive in dictating who must
receive the notification. For example, in many cases, the person at the
counterparty best situated to evaluate the notification and the
decision to segregate will be a person directly involved in negotiating
the swap regardless of that person’s title. The Commission notes that
in removing the specific designation of officers to receive the
notification it is not eliminating the expectation that each registrant
will use reasonable judgment in identifying an appropriate person at
the counterparty who can evaluate the right to elect segregation (and
either act on it or bring it to the attention of someone in a position
to act on it). The Commission continues to believe that, to be
effective, the notification must be made to a person at the
counterparty who understands its meaning and, to the extent necessary,
can direct it to the appropriate personnel at the counterparty. The
proposed change seeks to advance the same underlying policy objective
as the current requirement (namely that the notification be given to
appropriate personnel at the counterparty), but would recognize that
dictating how counterparties communicate the information in question
creates unnecessary burdens and potentially hinders the ability of the
parties to direct the information to the person(s) best situated to
evaluate it.
As proposed, new paragraph (c) would simplify requirements in
existing Regulation 23.701 by providing that “[i]f the counterparty
elects to segregate initial margin, the terms of segregation shall be
established by written agreement.”
As noted above, the Commission is proposing to eliminate the
additional requirements in existing paragraph (d), which are more
extensive than the notification requirements set forth in CEA section
4s(l). Subsequent to adoption of subpart L, experience with
implementation of the requirements of Regulation 23.701 has made the
Commission aware of problems experienced by registrants in complying
with these additional requirements. For example, persons seeking
guidance have noted that paragraph (d)’s current requirement that the
SD not execute a swap with the counterparty until it receives
confirmation of the counterparty’s receipt of the notification has the
potential to block swap trading in some circumstances.26 Instances of
forestalled trading caused by this requirement could be particularly
harmful for nonfinancial end-users that have ongoing, dynamic hedging
programs (to hedge, for example, commodity price risk or foreign
exchange risk).
—————————————————————————
26 See Staff Letter 14-132, cited above.
—————————————————————————
Based on implementation experience, compliance with the existing
segregation notification requirements in the regulation necessitates
lengthy explanations and instructions from SDs and MSPs to their
counterparties and imposes additional administrative
[[Page 36488]]
processes requiring counterparties to take steps that are outside of
the normal course of transacting in swaps. Some of these steps cause
transaction delays and deviations from established business procedures
for collateral custodial arrangements and disclosure of counterparty
rights generally, and do not advance the counterparty’s right to
segregate initial margin. For nonfinancial end-user counterparties who
tend to use swaps primarily for hedging purposes, these added
compliance steps often cause confusion and uncertainty that can inhibit
opportune, timely hedging. For counterparties that execute swaps
frequently and have determined that they wish to segregate, the
additional requirements merely add unnecessary hurdles to the
transaction process. Accordingly, the Commission does not believe that
the burdens imposed by these prescriptive requirements provide
meaningful regulatory benefits beyond those provided by the provisions
in proposed amended Regulation 23.701.
C. Regulation 23.702–Requirements for Segregated Margin
Existing Regulation 23.702 sets forth requirements for the custody
of initial margin segregated pursuant to a counterparty’s election
under Regulation 23.701. Paragraph (c)(2) of Regulation 23.702 provides
specific requirements for the withdrawal and turnover of control of
initial margin. In particular, paragraph (c)(2) requires the custodian
to turn over control of initial margin upon presentation of a written
statement made by an authorized representative under oath or under
penalty of perjury as specified in 28 U.S.C. 1746. The Statement must
state that the counterparty, SD or MSP, as the case may be, is entitled
to assume control of the initial margin pursuant to the parties’
agreement. The other party must be immediately notified of the turnover
of control.
The Commission believes that, while paragraph (c)(2) may generally
be consistent with the manner in which custodial arrangements work, the
prescriptive requirements of the regulation, including requiring a
specific form, the language used, and the certification needed, do not
account for change in control arrangements in custodial agreements that
are sometimes customized to reflect the unique business facts and
circumstances that may exist between any two parties and the custodian.
For example, the unique nature of the collateral posted or the specific
terms of change in control triggers may warrant different notice
procedures than those specified by paragraph (c)(2). Alternative notice
procedures may allow for more timely and effective change in control
under real-world circumstances and better protect each party’s
interests. Accordingly, the Commission believes that more flexibility
is warranted, and that it is more appropriate to leave these matters up
to negotiation by the parties.
D. Regulation 23.703–Investment of Segregated Margin
Regulation 23.703 requires initial margin segregated pursuant to
subpart L to be invested consistent with Commission Regulation 1.25.
Regulation 1.25 sets forth standards for investment of customer funds
by a futures commission merchant or derivatives clearing organization
in the context of exchange-traded futures and cleared swaps. When
proposing Regulation 23.703, the Commission expressed its view that
Regulation 1.25 “has been designed to permit an appropriate degree of
flexibility in making investments with segregated property, while
safeguarding such property for the parties who have posted it, and
decreasing the credit, market, and liquidity risk exposures of the
parties who are relying on that margin.” 27
—————————————————————————
27 See 75 FR 75432, 75434 (Dec. 3, 2010).
—————————————————————————
A suggestion in response to the Project KISS initiative noted that
Regulation 1.25 is designed to protect exchange customers for which
margin investment decisions are outside of their control.28
Regulation 1.25 includes fairly extensive and specific requirements as
to the mechanisms for holding and investing margin and the qualitative
aspects of the investments held. With respect to initial margin for
uncleared swaps that is not held in accordance with Regulation 23.157
or with the Prudential Regulator Margin Rules, the margin investment
decisions are typically a matter of contract subject to negotiation
between the parties. As such, each counterparty has a voice in how the
initial margin may be invested.
—————————————————————————
28 See SIFMA Letter at 4.
—————————————————————————
In addition, the terms of most exchange-traded and cleared products
are standardized and the customer’s primary relationship with the FCM
or DCO centers upon the trading and clearing of those standardized
products. Conversely, over-the-counter swaps, by their nature, tend to
be more customized and are often part of a broader financial
relationship. For example: Interest rate swaps with end-users are often
designed to match maturities of loans or bonds, with the rate of the
swap tied to the rate on the loan or bond; commodity swaps often hedge
the counterparty’s physical commodity production or consumption risks
that arise from a particular commercial enterprise; and foreign
exchange swaps often hedge an entity’s exposure to cross-border
commercial transactions. In each case, the SD or MSP sometimes plays
additional financial roles, such as providing a loan or other credit or
liquidity support, brokering physical commodity purchases or sales, or
acting as a correspondent bank. Accordingly, each counterparty,
particularly nonfinancial end-user counterparties, may find better
transactional efficiencies and may be better served and protected in
related credit transactions if the types of collateral and the
investment procedures and mechanisms used are determined through
bilateral negotiation of the terms thereof by the parties.
Given the greater breadth and variability, both in the terms and
purposes of uncleared swaps and in the nature of the relationship
between the counterparty and the SD or MSP, the Commission believes a
regulation that provides greater flexibility for the parties to
negotiate appropriate initial margin investment terms will, in most
cases, better serve the interests of the parties. For the same reasons,
allowing greater flexibility may also encourage more counterparties to
elect to segregate pursuant to subpart L.
The Commission recognizes that in some circumstances, nonfinancial
end-user counterparties might have less negotiating leverage with a
sophisticated SD or MSP. However, the regulations as originally adopted
give little or no flexibility for counterparties and SDs or MSPs to
negotiate mutually beneficial terms and to consider other factors such
as the broader financial relationship between the parties. For
nonfinancial end-user counterparties the segregation of initial margin
is at their discretion. If these counterparties have a voice in how
segregated initial margin is invested, the returns of which they will
often receive, they may be more likely to elect to require segregation.
E. Regulation 23.704–Requirements for Non-Segregated Margin
Existing Regulation 23.704(a) requires the CCO of each SD or MSP to
report quarterly to each counterparty that does not elect segregation
of initial margin on whether or not the SD’s or MSP’s back office
procedures relating to margin and collateral requirements failed at any
time during the previous calendar quarter to comply with the agreement
of
[[Page 36489]]
the counterparties.29 The Commission believes it is unnecessary to
specify that the CCO be the individual that makes such reports, so long
as the information is provided to counterparties. For many firms,
middle or back office staff, not the CCO, implement collateral
management pursuant to the terms of each collateral management
agreement. Those staff people are therefore better situated to assess
compliance with agreements and to provide the quarterly report.
Accordingly, there are likely personnel at each SD other than the CCO
who are better situated to more accurately and efficiently provide the
report.30 The Commission therefore proposes to require that the SD or
MSP make the reports without specifying any particular person to
perform that requirement. The Commission further proposes to simplify
the language regarding timing of the required reports to eliminate
uncertainty as to the regulation’s meaning. With respect to paragraph
(b) of the regulation, the Commission is proposing to specify that the
reports required under paragraph (a) need be delivered only to
counterparties who choose not to require segregation (as opposed to the
current wording that simply says “with respect to each counterparty”)
to more closely follow the statutory language underlying this
requirement.
—————————————————————————
29 Consistent with Staff Letter 14-132, the Commission
confirms that the reporting requirement under Regulation 23.704 does
not apply if no initial margin will be required as part of the swap
transaction.
30 The Commission notes that the CCO continues to be
responsible, under Commission regulation 3.3, to report in the CCO
annual report any material non-compliance issues involving back
office procedure relating to margin and collateral requirements.
—————————————————————————
III. Request for Comment
The Commission requests comments, generally, regarding the proposed
changes to Regulations 23.700, 23.701, 23.702, 23.703, and 23.704. The
Commission also specifically requests comment on the following
questions:
Are the proposed amendments to subpart L appropriate in
light of the requirements of CEA section 4s(l) and in light of the
commercial realities encountered by SDs, MSPs, and counterparties
engaging in uncleared swap transactions?
Should the Commission revise or eliminate any other
provisions of subpart L? Are there additional ways in which the
Commission can simplify, streamline, and reduce the costs of these
regulations without impairing the rights and safeguards intended by CEA
section 4s(l)?
Do the proposed amendments appropriately preserve the
rights of counterparties articulated in CEA section 4s(l)? Is the
Commission’s proposed interpretation of CEA section 4s(l)(1)(A)
reasonable given the commercial realities of uncleared swaps
transactions and relationships between SDs and MSPs and their
counterparties?
As proposed, Regulation 23.701(a) provides that “[a]t the
beginning of the first swap transaction that provides for the exchange
of Initial Margin” an SD or MSP must notify the counterparty of its
right to require segregation of initial margin. Should the Commission
provide specific benchmark events that call for delivery of a
segregation notification? If so, would entering into a master netting
agreement or other contractual relationship be appropriate? What other
events may be relevant for marking “the beginning of the first swap
transaction”? Should the Commission provide that the counterparty may
request or opt to continue to receive an annual or some other periodic
notification? Should the Commission provide that the counterparty may
request or opt to receive notification at the beginning of each swap
transaction?
The Commission notes that the proposed deletion of
paragraph (a)(2) of Regulation 23.701 (requirement to identify one or
more custodians as an acceptable depository for segregated initial
margin) also removes language specifying that one of the identified
custodians “be a creditworthy non-affiliate.” Under the Proposal,
Regulation 23.702(a) would continue to require that the custodian
“must be a legal entity independent of both the swap dealer or major
swap participant and the counterparty.” Should the Commission adopt
more specific financial or affiliation qualifications for the custodian
that an SD or MSP uses as a depository for segregated initial margin,
and if so, what should those qualifications be?
Under Regulation 23.703(a), margin that is segregated
pursuant to an election under Regulation 23.701 may only be invested
consistent with Regulation 1.25. How has the limitation impacted
counterparties’ decisions to make an election under Regulation 23.701?
IV. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (“RFA”) requires Federal agencies
to consider whether the regulations they propose will have a
significant economic impact on a substantial number of small entities
and, if so, provide a regulatory flexibility analysis respecting the
impact.31 Whenever an agency publishes a general notice of proposed
rulemaking for any regulation, pursuant to the notice-and-comment
provisions of the Administrative Procedure Act,32 a regulatory
flexibility analysis or certification typically is required.33 The
Commission previously has established certain definitions of “small
entities” to be used in evaluating the impact of its regulations on
small entities in accordance with the RFA.34 The Commission has
previously established that SDs, and MSPs and ECPs 35 are not small
entities for purposes of the RFA.36
—————————————————————————
31 5 U.S.C. 601 et seq.
32 5 U.S.C. 553. The Administrative Procedure Act is found at
5 U.S.C. 500 et seq.
33 See 5 U.S.C. 601(2), 603, 604, and 605.
34 See Registration of Swap Dealers and Major Swap
Participants, 77 FR 2613 (Jan. 19, 2012).
35 Eligible contract participants, as defined in CEA section
1a(18), 7 U.S.C. 1a(18).
36 See Further Definition of “Swap Dealer,” “Security-Based
Swap Dealer,” “Major Swap Participant,” “Major Security-Based
Swap Participant” and “Eligible Contract Participant,” 77 FR
30596, 30701 (May 23, 2012).
—————————————————————————
Accordingly, the Chairman, on behalf of the Commission, hereby
certifies pursuant to 5 U.S.C. 605(b) that the Proposal will not have a
significant economic impact on a substantial number of small entities.
B. Paperwork Reduction Act
1. Background
The Paperwork Reduction Act of 1995 (“PRA”) 37 imposes certain
requirements on Federal agencies (including the Commission) in
connection with their conducting or sponsoring a collection of
information as defined by the PRA. The Proposal would result in such a
collection, as discussed below. A person is not required to respond to
a collection of information unless it displays a currently valid
control number issued by the Office of Management and Budget (“OMB”).
The Proposal contains a collection of information for which the
Commission has previously received a control number from OMB. The title
for this collection of information is “Disclosure and Retention of
Certain Information Relating to Swaps Customer Collateral, OMB control
number 3038-0075.” 38 Collection 3038-0075 is currently in force
with its control number having been provided by OMB.
—————————————————————————
37 44 U.S.C. 3501 et seq.
38 See OMB Control No. 3038-0075, https://www.reginfo.gov/public/do/PRAOMBHistory?ombControlNumber=3038-0075# (last visited
June 29, 2017).
—————————————————————————
The Commission is proposing to revise collection 3038-0075 to
[[Page 36490]]
incorporate proposed changes to reduce the number of notices a SD or
MSP must provide to its counterparties with respect to the rights of
such counterparties to segregate initial margin for uncleared swaps.
The Commission does not believe the Proposal would impose any other new
collections of information that require approval of OMB under the PRA.
2. Modification of Collection 3038-0075
The Proposal would modify collection 3038-0075 by eliminating the
requirement that the notification of the right to segregate be provided
on an annual basis to a specified officer of the counterparty such that
the notice would only need to be provided once to each counterparty at
the beginning of the first non-cleared swap transaction that provides
for the exchange of initial margin. The Commission originally estimated
that each SD and MSP would, on average, provide the segregation notice
to approximately 1,300 counterparties each year and that the burden for
preparing and furnishing the notice would be 2 hours, for an annual
burden of 2,600 hours.39 The Commission is estimating that each SD
and MSP would, on average, have approximately 300 new counterparties
each year for a total burden of 600 hours per registrant. Accordingly,
the Commission is proposing to revise its overall burden estimate
associated with Regulation 23.701 for this collection by reducing the
per registrant annual burden by 2,000 hours.
—————————————————————————
39 See 78 FR at 66631.
—————————————————————————
C. Cost-Benefit Considerations
1. Background
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders.40 Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
five broad areas of market and public concern: (1) Protection of market
participants and the public; (2) efficiency, competitiveness, and
financial integrity of futures markets; (3) price discovery; (4) sound
risk management practices; and (5) other public interest
considerations. With respect to the proposed regulation changes
discussed above, the Commission considers the costs and benefits
resulting from its discretionary determinations with respect to the
section 15(a) factors, and seeks comments from interested persons
regarding the nature and extent of such costs and benefits.
—————————————————————————
40 7 U.S.C. 19(a).
—————————————————————————
2. Regulations 23.700, 23.701, 23.702 and 23.703–Notification of Right
to Initial Margin Segregation
The baseline for these cost and benefit considerations is the
status quo, which is existing market conditions and practice in
response to the requirements of current Sec. Sec. 23.700, 23.701,
23.702, and 23.703.41 Subpart L: (1) Requires SDs or MSPs to notify
counterparties of the right to segregate initial margin; (2)
establishes certain procedures regarding the notification; and (3)
establishes certain requirements for the initial margin segregation
arrangements.
—————————————————————————
41 See 78 FR at 66632-36 (discussing the cost-benefit
considerations with regard to the segregation regulation).
—————————————————————————
The Commission is proposing a more flexible approach that reduces
some regulatory burdens that provide little or no corresponding
benefit. The Proposal would eliminate the definition of “Margin”
because it would no longer be needed. The Proposal would also revise
when the segregation notice is required. Additionally, the Proposal
would eliminate the requirements that (1) the SD or MSP provide the
segregation notice to an officer of the counterparty with specific
qualifications, and (2) the SD or MSP obtain the counterparty’s
confirmation of receipt of the segregation notice. Finally, the
Proposal would allow the parties to establish the notice of change of
control provisions and the commercial arrangements for investment of
segregated collateral by contract instead of imposing specific
requirements.
(i) Cost and Benefit Considerations
The general purpose of the changes proposed is to reduce burdens
and improve the benefits intended by subpart L. The Commission
preliminarily believes the proposed changes to subpart L would not
impose any new requirements on registrants and instead would reduce or
make the regulations more flexible allowing market participants to use
standard market practices regarding the implementation of the initial
margin segregation requirements. The simplification of the notification
requirements would likely reduce the time needed to complete the
notification process and may facilitate more efficient and timely
trading for new customer relationships. The proposed changes would also
reduce costs by eliminating the requirements for those swaps that must
comply with the Prudential Regulator Margin Rules mandatory margin
requirements. In addition, the changes will provide benefits to the
parties to swaps by allowing the parties to establish by contract the
terms for collateral management and for change in control and
investment of segregated initial margin in a manner that better suits
their business needs. To the extent the parties would be able to
negotiate more efficient segregation agreements and agree to investment
arrangements that generate higher returns that are passed on to the
counterparty, as is most often the case for uncleared swaps, the
parties would benefit. The Commission believes that the simplification
of the requirements and greater flexibility will therefore encourage
more counterparties to elect to segregate initial margin.
As noted above, in some circumstances, nonfinancial end-user
counterparties might have less negotiating leverage when negotiating
the terms of segregation agreements with experienced SDs or MSPs.
Reducing the prescriptive requirements in the current rule could
therefore reduce protections for the counterparties. However, it is not
clear how incentives or disincentives may impact the negotiating
choices of SDs and MSPs as well as the counterparties and therefore the
extent to which the requirements provide protections. For example,
regarding the choice of investments, the SD or MSP may seek to restrict
investments to the most liquid investments that would be easily
liquidated if the counterparty defaults. Those liquid investments,
which would likely be similar to the investments permitted under
Regulation 1.25, may in turn generate lower returns passed on to the
SD/MSP’s counterparties. Conversely, the current regulations give
little or no flexibility for counterparties and SDs or MSPs to
negotiate mutually beneficial terms and consider other factors such as
the broader financial relationship between the parties. Furthermore,
for nonfinancial end-user counterparties, the segregation of initial
margin is discretionary. If the counterparties have no voice in how
segregated initial margin is invested, there may be less incentive for
the counterparty to elect to require segregation.
The Commission believes that the proposed changes to subpart L
might lead to reduced costs for registrants, because they would no
longer have to comply with some of the more prescriptive requirements
imposed by the regulations. The Commission is, however, unable to
quantify the potential cost savings because the cost savings depend on
numerous factors that are particular to each SD or MSP
[[Page 36491]]
and each counterparty relationship. For example, the factors affecting
the costs involved could include: The size and complexity of an SD’s
dealing activities, the complexity of the swap transactions, the level
of sophistication of each counterparty, the degree to which automated
notice technologies may be used to satisfy these requirements, and the
nature of the custodial and investment documents in particular
segregation arrangements.
(ii) Section 15(a) Considerations
a. Protection of Market Participants and the Public
Subpart L is intended to provide counterparties to SDs and MSPs
with notice of the right to elect to segregate initial margin. The
Commission recognizes that the proposed changes to make the regulations
less prescriptive might potentially negatively impact the goal of
protecting market participants by removing specific requirements for
the segregation agreements. However, the Commission is of the view that
the intended purpose and benefits of subpart L remain in place because
the Proposal continues to implement the statutory requirements. In
addition, the parties and the selected custodian would now have the
flexibility to establish requirements for margin segregation through
negotiated contracts that meet their respective needs, thereby
providing market participants with the flexibility and opportunity to
protect themselves better by contract. Finally, the greater flexibility
provided by the amended regulations may increase the voluntary use of
initial margin segregation by counterparties, a process that was
intended to provide better protection for the counterparty in the event
of default by the SD or MSP.
b. Efficiency, Competitiveness, and Financial Integrity of Markets
Subpart L promotes the financial integrity of markets by providing
for the protection of counterparty collateral and by mitigating
systemic risk that may result from the loss of access to the collateral
in the event of a counterparty default. As discussed above, given that
registrants would still be expected to enter into segregation
arrangements with counterparties that elect to segregate, and, with the
amendments, registrants would now be able to develop segregation
arrangements tailored to their businesses and swap transactions, the
Commission is of the view that the proposed changes likely would have a
positive impact on market integrity.
The Commission preliminarily believes that the proposed amendments
will not have a significant impact on the competiveness or efficiency
of markets because this rulemaking only affects how collateral is
protected and segregated but not how market participants elect to
trade.
c. Price Discovery
The Commission believes the proposed amendments to subpart L will
not have a significant effect on price discovery.
d. Sound Risk Management
Subpart L provides for the management and protection of
counterparty collateral and therefore mitigates the risk of loss of
access to the collateral, which loss can have an adverse impact on
registrants, counterparties and the U.S. financial markets. As
discussed, the proposed changes remove certain prescriptive
requirements, but do not alter the overall principles of the existing
requirements of subpart L. Therefore, the Commission is of the view
that sound risk management practices will not be adversely impacted by
the proposed changes.
e. Other Public Interest Considerations
The Commission has not identified any other public purpose
considerations for the proposed changes to subpart L.
(iii) Request for Comment
The Commission invites comment on its preliminary consideration of
the costs and benefits associated with the proposed changes to subpart
L, especially with respect to the five factors the Commission is
required to consider under CEA section 15(a). In addressing these areas
and any other aspect of the Commission’s preliminary cost-benefit
considerations, the Commission encourages commenters to submit any data
or other information they may have quantifying and/or qualifying the
costs and benefits of the proposal. The Commission also specifically
requests comment on the following questions:
To what extent do the proposed amendments reduce or
increase burdens and costs for SDs or MSPs or their counterparties?
To what extent do the proposed amendments impact
collateral management risk considerations?
Will there be any effects on the financial system if
initial margin is not invested pursuant to Regulation 1.25? If yes,
please explain.
Are counterparties to SDs or MSPs at a substantial
disadvantage when negotiating the terms for segregation arrangements
that would no longer be required if the proposed amendments are
adopted? Would that disadvantage cause them to receive unfair terms on
those segregation arrangements? Are there mitigating factors?
Would the elimination of the requirement to list at least
one non-affiliated custodian and the cost of the custodial services
have an effect on the selection of an independent custodian and the
cost of the services to the non-SD/MSP counterparty? If yes, please
explain.
D. Antitrust Considerations
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by antitrust laws and
endeavor to take the least anticompetitive means of achieving the
purposes of the CEA, in issuing any order or adopting any Commission
rule or regulation (including any exemption under section 4(c) or
4c(b)), or in requiring or approving any bylaw, rule, or regulation of
a contract market or registered futures association established
pursuant to section 17 of the CEA.42
—————————————————————————
42 See 7 U.S.C. 19(b).
—————————————————————————
The Commission believes that the public interest to be protected by
the antitrust laws is generally to protect competition. The Commission
requests comment on whether the proposed rule implicates any other
specific public interest to be protected by the antitrust laws.
The Commission has considered the proposed rule to determine
whether it is anticompetitive and has preliminarily identified no
anticompetitive effects. The Commission requests comment on whether the
proposed rule is anticompetitive and, if it is, what the
anticompetitive effects are.
Because the Commission has preliminarily determined that the
proposed rule is not anticompetitive and has no anticompetitive
effects, the Commission has not identified any less anticompetitive
means of achieving the purposes of the Act. The Commission requests
comment on whether there are less anticompetitive means of achieving
the relevant purposes of the Act that would otherwise be served by
adopting the proposed rule.
List of Subjects in 17 CFR Part 23
Custodians, Major swap participants, Margin, Segregation, Swap
dealers, Swaps, Uncleared swaps.
For the reasons stated in the preamble, the Commodity Futures
[[Page 36492]]
Trading Commission proposes to amend 17 CFR part 23 as follows:
PART 23–SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
0
1. The authority citation for part 23 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.
Section 23.160 also issued under 7 U.S.C. 2(i); Sec. 721(b),
Pub. L. 111-203, 124 Stat. 1641 (2010).
0
2. Revise subpart L to read as follows:
Subpart L–Segregation of Assets Held as Collateral in Uncleared Swap
Transactions
Sec.
23.700 Definitions.
23.701 Notification of right to segregation.
23.702 Requirements for segregated initial margin.
23.703 Investment of segregated initial margin.
23.704 Requirements for non-segregated margin.
Subpart L–Segregation of Assets Held as Collateral in Uncleared
Swap Transactions
Sec. 23.700 Definitions.
As used in this subpart:
Initial Margin means money, securities, or property posted by a
party to a swap as performance bond to cover potential future exposures
arising from changes in the market value of the position.
Segregate means to keep two or more items in separate accounts, and
to avoid combining them in the same transfer between two accounts.
Variation Margin means a payment made by or collateral posted by a
party to a swap to cover the current exposure arising from changes in
the market value of the position since the trade was executed or the
previous time the position was marked to market.
Sec. 23.701 Notification of right to segregation.
(a) At the beginning of the first swap transaction that provides
for the exchange of Initial Margin, a swap dealer or major swap
participant must notify the counterparty that the counterparty has the
right to require that any Initial Margin the counterparty provides in
connection with such transaction be segregated in accordance with
Sec. Sec. 23.702 and 23.703, except in those circumstances where
segregation is mandatory pursuant to Sec. 23.157 or rules adopted by
the prudential regulators pursuant to section 4s(e)(2)(A) of the Act.
(b) The right referred to in paragraph (a) of this section does not
extend to Variation Margin.
(c) If the counterparty elects to segregate Initial Margin, the
terms of segregation shall be established by written agreement.
(d) A counterparty’s election, if applicable, to require
segregation of Initial Margin or not to require such segregation, may
be changed at the discretion of the counterparty upon written notice
delivered to the swap dealer or major swap participant, which changed
election shall be applicable to all swaps entered into between the
parties after such delivery.
Sec. 23.702 Requirements for segregated initial margin.
(a) The custodian of Initial Margin, segregated pursuant to an
election under Sec. 23.701, must be a legal entity independent of both
the swap dealer or major swap participant and the counterparty.
(b) Initial Margin that is segregated pursuant to an election under
Sec. 23.701 must be held in an account segregated for, and on behalf
of, the counterparty, and designated as such. Such an account may, if
the swap dealer or major swap participant and the counterparty agree,
also hold Variation Margin.
(c) Any agreement for the segregation of Initial Margin pursuant to
this section shall be in writing, shall include the custodian as a
party, and shall provide that any instruction to withdraw Initial
Margin shall be in writing and that notification of the withdrawal
shall be given immediately to the non-withdrawing party.
Sec. 23.703 Investment of segregated initial margin.
The swap dealer or major swap participant and the counterparty may
enter into any commercial arrangement, in writing, regarding the
investment of Initial Margin segregated pursuant to Sec. 23.701 and
the related allocation of gains and losses resulting from such
investment.
Sec. 23.704 Requirements for non-segregated margin.
(a) Each swap dealer or major swap participant shall report to each
counterparty that does not choose to require segregation of Initial
Margin pursuant to Sec. 23.701(a), on a quarterly basis, no later than
the fifteenth business day after the end of the quarter, that the back
office procedures of the swap dealer or major swap participant relating
to margin and collateral requirements are in compliance with the
agreement of the counterparties.
(b) The obligation specified in paragraph (a) of this section shall
apply no earlier than the 90th calendar day after the date on which the
first swap is transacted between the counterparty and the swap dealer
or major swap participant.
Issued in Washington, DC, on July 24, 2018, by the Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Segregation of Assets Held as Collateral in Uncleared
Swap Transactions–Commission Voting Summary, Chairman’s Statement, and
Commissioner’s Statement
Appendix 1–Commission Voting Summary
On this matter, Chairman Giancarlo and Commissioners Quintenz
and Behnam voted in the affirmative. No Commissioner voted in the
negative.
Appendix 2–Statement of Chairman J. Christopher Giancarlo
After more than four years of administering the final rules in
subpart L of part 23 (Commission Regulations 23.700-23.704), CFTC
staff have observed that the detailed requirements of these
regulations have been difficult and burdensome for swap dealers to
satisfy. The requirements have also caused some confusion by end
user counterparties who rely on our markets to hedge commercial
risk. These observations were supported by comments made in response
to the Commission’s Project KISS initiative.
Congress mandated that counterparties of swap dealers be given a
choice regarding whether or not they elect the protections that come
from segregation of initial margin collateral, which I support. Part
of this important decision is protected by making sure the
counterparty clearly, and easily, understands its rights. It appears
that very few swap counterparties have exercised their right to make
that choice. Part of the reluctance may be because that choice is
accompanied by a range of overly complicated regulatory requirements
and obligations.
The swaps market is a marketplace of professional market
participants. It is closed to retail participation. Public policy is
not well served by imposing prescriptive consumer and investor
protections in markets that exclusively serve professional market
participants.
This proposal looks to reduce the burdens, costs and confusion
that have proved counterproductive and discouraged the election of
segregation. This proposal will also make it more efficient for
counterparties, such as pension funds, insurance companies, and
community banks, to be able to elect segregation and receive those
protections while hedging their risk in the swaps markets.
[[Page 36493]]
As part of the proposal, the Commission would permit more
flexibility in custodial arrangements and margin investment. Rather
than the current prescriptive requirements of the regulation, it
would leave it up to commercial negotiation by professional trading
counterparties. Another change is removing the overly prescriptive
requirement that initial margin segregation be invested pursuant to
Commission Regulation 1.25, in the anticipation that doing so could
encourage more segregation elections.
Enabling the election of segregation is a bipartisan goal,
starting with a unanimous Commission rulemaking by a previous
commission. Now with time and experience, we see that this goal
could be more easily met, and changes to the rules are appropriate
to better further these important public policy objectives.
I support this proposed rule from the Division of Swap Dealer &
Intermediary Oversight. I look forward to hearing comments on the
proposal.
Appendix 3–Concurring Statement of Commissioner Rostin Behnam
I respectfully concur with the Commodity Futures Trading
Commission’s (the “Commission” or “CFTC”) approval of its
proposed rule (the “Proposal”) regarding amendments to subpart L
of the Commission’s Regulations (“Segregation of Assets Held as
Collateral in Uncleared Swap Transactions” consisting of
Regulations 23.700 through 23.704), which implement Section 4s(l) of
the Commodity Exchange Act (“CEA” or the “Act”). While I have
strong reservations about the Commission’s proposed interpretation
of CEA section 4s(l) and its slash and burn approach to “simplify”
requirements for swap dealers (“SDs”) and major swap participants
(“MSPs”) absent meaningful consideration of the impact on swap
counterparties, I am hopeful that the Proposal’s solicitation of
comments on these key points will produce a balanced record from
which to adopt a final rule that more precisely simplifies the
current requirements and provides tailored regulatory relief.
Since joining the Commission, I have emphasized both my strong
opposition to any rollbacks of Dodd-Frank initiatives and my belief
that, while a more principles-based approach may be suitable in
certain situations, any changes must be narrowly targeted to ensure
that core reforms remain whole and intact. I am concerned that this
Proposal forgoes a surgical approach in favor of a blunt,
insensitive strike at the purpose of the statute and implementing
regulations.
While the preamble purports that the Proposal is supported by
Commission experience, in reality the Commission heavily relies on a
few comment letters from a limited segment of the market submitted
in response to its “Project KISS” initiative. In the absence of
corroborative evidence from those most impacted by the Proposal–
non-financial end-users and financial end-users without “material
swaps exposure,” as defined in the CFTC Margin Rule 1–I am
concerned that the Commission’s proposed amendments take too much of
a shoot first, ask questions later tactic. While I am supportive of
the Project KISS initiative, I believe that the exercise requires a
more diligent approach to evaluating the potential impact of
proposing amendments to existing rules.
—————————————————————————
1 17 CFR 23.150-23.159, 23.161.
—————————————————————————
My greatest concerns with the Proposal relate to the
Commission’s proposed interpretation of the notice requirement in
CEA section 4s(l)(1) and the proposed removal of all limitations on
the investment of margin that is segregated pursuant to an election
under Regulation 23.701. As I explain below, I am concerned that the
Proposal’s focus on reducing burdens to SDs and MSPs through
amending the rules in subpart L may obscure valid issues regarding
implementation–matters which may be resolved through more precise
amendments with less chance of negatively impacting market
participants.
The Commission previously interpreted the language in CEA
section 4s(l)(1)(A) “as a segregation right that can be elected or
renounced by the SD’s or MSP’s counterparty.” 2 Citing the plain
language of the statute, the Commission noted Congress’s emphasis on
the importance of the ability of a counterparty to elect to have its
collateral segregated by describing segregation as a “right.” 3
Regarding this “right,” the Commission understood that, “the
statute does not merely grant counterparties the legal right to
segregation; it specifically requires that the existence of this
right be communicated to them.” 4 At a minimum, the Commission
determined that this requirement is met when an SD or MSP provides
notification to a counterparty at least once in each calendar year
in which the SD or MSP enters a swap with the counterparty.5 At
the time, the Commission recognized that requiring notification on a
transaction-by-transaction basis–e.g., “at the beginning of a swap
transaction,” 6 may be overly costly and burdensome, and that
annual notification “ensures that the right to segregation is
called to the attention of the counterparties reasonably close in
time to the point at which they make decisions regarding the
handling of collateral for particular swaps transactions.” 7
While the Commission considered requiring only an initial
notification, it rejected that approach, noting the importance of
the counterparty’s right to elect to have its collateral segregated,
and the minimal administrative burden on SDs and MSPs.8
—————————————————————————
2 Protection of Collateral of Counterparties to Uncleared
Swaps; Treatment of Securities in a Portfolio Margining Account in a
Commodity Broker Bankruptcy, 78 FR 66621, 66623 (Nov. 6, 2013).
3 Id. at 66623 and 66625.
4 Id. at 66625.
5 Id.; 17 CFR 23.701(e).
6 7 U.S.C. 6s(l)(1)(A) (emphasis added).
7 78 FR at 66635 (emphasis added); see also 78 FR at 66633
(adding that annual notice offers this benefit “without requiring
excessive or repetitive notification in cases where a counterparty
engages in multiple swaps with a particular SD or MSP over the
course of a year.”).
8 78 FR at 66633 (“The Commission believes that the cost of
requiring SDs and MSPs to deliver one notification per year to each
counterparty is not overly burdensome, particularly when one
considers the importance of the counterparty’s decision to require
segregation and the large dollar volume of business that is
typically done by SDs and MSPs.”).
—————————————————————————
The Commission and subpart L are largely silent with regard to
content and delivery manner and method of the notice required by CEA
section 4s(l)(1)(A) other than provisions in Regulation 23.701(a)(1)
and (2) requiring the notification to identify one or more
creditworthy, independent custodians and to include information
regarding the price of segregation for each custodian, to the extent
the SD or MSP has such information.9 Though not specifically
required by CEA section 4s(l)(1)(A), the Commission determined that
this limited set of disclosures represents information material to a
counterparty’s informed decision making process regarding exercise
of the right to segregation and when considering a segregation
package offered by an SD or MSP.10
—————————————————————————
9 17 CFR 23.701(a)(2) and (3). While Commission Regulation
23.701(d) requires the SD or MSP to obtain confirmation of receipt
of the segregation notification, since 2014, the Commission has
permitted SDs and MSPs to rely on negative consent for purposes of
Regulation 23.701(d), provided that the notice under Regulation
23.701(a) includes a prominent and unambiguous statement to that
effect. See CFTC Staff Letter No. 14-132 (Oct. 31, 2014) at 7,
available at https://www.cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/14-132.pdf; See also
Transcript of the NFA Swap Dealer Examinations Webinar at 6 (Jan.
18, 2018), available at https://www.nfa.futures.org/members/member-resources/files/transcripts/sdexamswebinartranscriptjan2018.pdf.
10 See 78 FR at 66624.
—————————————————————————
The Proposal would amend subpart L, in part, to require a
single, one-time notification to a counterparty of their right to
require segregation of any initial margin the counterparty provides
in connection with all transactions following the first transaction
that provides for the exchange of initial margin. The Proposal would
also entirely remove Regulations 23.701(a)(2) and (3), generally
finding that, since very few counterparties elect to require
segregation, the underlying activity of “confirming which
custodians are available” is “unnecessarily burdensome” and that
pricing for segregation may vary, is normally subject to
negotiation, and can be discussed when the counterparty indicates an
interest in segregation. Consistent with CEA section 4s(l)(1)(B),
the Proposal preserves the ability of a counterparty to change its
election upon written notice.
In proposing these amendments, the Commission appears to be
taking the view that a counterparty’s decision with regard to
segregation is made with respect to a trading relationship with a
particular SD or MSP at the relationship’s inception, and that while
these types of counterparties are sophisticated enough to elect
segregation and negotiate the terms of segregation arrangements, the
annual receipt of a notice reminding them that they may change their
election at any time is confusing. It also assumes that evidence of
minimal uptake of
[[Page 36494]]
the election to segregate indicates that subpart L is largely
superfluous.
While it may be true that swap counterparties have not elected
segregation in droves, CEA section 4s(l) and subpart L are not
intended to advance any particular outcome. Rather they concern the
rights of counterparties to SDs and MSPs and aim to increase the
safety in the market for uncleared swaps by creating a self-
effectuating requirement for the segregation of counterparty initial
margin in an entity legally separate from the SD or MSP.11 As
previously noted by the Commission in proposing subpart L, a goal of
the regulation was to “increase the likelihood that any lack of use
of segregated collateral accounts by uncleared swaps counterparties
is the result of genuine choices by counterparties and reduce the
likelihood that it is the result of inertia, market power, or other
market imperfections.” 12 Indeed, based on some of the preamble
discussion, it may be that we should consider the possibility that
swap counterparties are not electing segregation specifically
because the current system of annual notification does not provide
them adequate notice of their ongoing right to segregation. If that
is the case, the appropriate Commission response may be more (or
clearer) notification, rather than the reduction in notification
proposed today.
—————————————————————————
11 Id. at 66621 and 66632.
12 Protection of Collateral of Counterparties to Uncleared
Swaps; Treatment of Securities in a Portfolio Margining Account in a
Commodity Broker Bankruptcy, 75 FR 75432, 75437 (proposed Dec. 3,
2010).
—————————————————————————
I am concerned that the Commission’s proposal could undermine
the right to segregation as well as Congressional intent by removing
the periodic notification and minimal disclosures currently required
by subpart L. I believe there are prescriptive elements of subpart L
that can be removed with little impact to counterparties.13
However, I am concerned by the Proposal’s reliance on
representations by SDs and unverified assumptions regarding
counterparty behavior to justify regulatory rollbacks in the absence
of further examination of whether and how the manner in which the
annual notice requirement is currently implemented has contributed
to claims of confusion and burden. I am also concerned that the
Proposal may discourage commenters from suggesting alternative means
of complying with the current language in Regulation 23.701(a) which
may better preserve Congressional intent.14
—————————————————————————
13 I also believe that the Commission can respond to specific
burdens identified by SDs and MSPs by, for example, codifying staff
interpretive guidance. See, e.g. Letter from the Financial Services
Roundtable at 56 (Sept. 30, 2017) (urging the Commission to codify
its interpretation in CFTC Staff Letter No. 14-132 with respect to
SDs’ ability to rely on negative consent), https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61427&SearchText=.
14 For example, through the use of additional clauses in
customer onboarding or relationship documentation as a means to
append the required notification and disclosures to each new swap
confirmation thereby ensuring and simultaneously documenting that
the counterparty is notified of their right to require segregation
at least at the beginning of each swap transaction.
—————————————————————————
I am similarly concerned that the Proposal’s removal of the
requirement in Regulation 23.703 that limits the investment of
initial margin segregated pursuant to subpart L to be invested
consistent with Commission Regulation 1.25 is a knee-jerk response
to a single Project KISS comment letter that ignores current
practice and presupposes that the rollback will encourage more
counterparties to elect to segregate pursuant to subpart L, which,
as stated above, is not the goal of the statute or implementing
regulation. While I am not opposed to permitting greater flexibility
with regard to the investment of initial margin, I would have
preferred that the Commission seek additional information regarding
whether and how the current limitations in Regulation 23.703 have
impacted counterparties and their decision making under subpart L
before proposing alternative regulatory language.
I commend the Commission and its staff for engaging through
Project KISS in efforts to identify and reduce unnecessary burdens
in the Commission regulations. I appreciate staff’s consideration
and inclusion of several of my suggested edits to this Proposal. To
be clear, I believe the Proposal provides for many sound
improvements to subpart L that respond to ongoing concerns and
confusion created by the finalization of the CFTC and Prudential
Regulator Margin Rules and CFTC interpretive guidance.15 However,
where the Proposal aims to strip out regulatory provisions that the
Commission previously determined were essential to effectuating the
language and purpose of CEA section 4s(l), I believe the Commission
may be engaging in shortsighted and unnecessary rollbacks to the
detriment of the swap counterparties subpart L is intended to
protect.
—————————————————————————
15 See CFTC Staff Letter No. 14-132, supra note 9.
[FR Doc. 2018-16176 Filed 7-27-18; 8:45 am]
BILLING CODE 6351-01-P
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