Federal Register, Volume 80 Issue 134 (Tuesday, July 14, 2015)

[Federal Register Volume 80, Number 134 (Tuesday, July 14, 2015)]

[Proposed Rules]

[Pages 41375-41408]

From the Federal Register Online via the Government Publishing Office [www.gpo.gov]

[FR Doc No: 2015-16718]

[[Page 41375]]

Vol. 80

Tuesday,

No. 134

July 14, 2015

Part VI

Commodity Futures Trading Commission

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17 CFR Part 23

Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap

Participants–Cross-Border Application of the Margin Requirements;

Proposed Rule

Federal Register / Vol. 80 , No. 134 / Tuesday, July 14, 2015 /

Proposed Rules

[[Page 41376]]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 23

RIN 3038-AC97

Margin Requirements for Uncleared Swaps for Swap Dealers and

Major Swap Participants–Cross-Border Application of the Margin

Requirements

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rule.

———————————————————————–

SUMMARY: On October 3, 2014, the Commission published proposed

regulations to implement section 4s(e) of the Commodity Exchange Act,

as added by section 731 of the Dodd-Frank Wall Street Reform and

Consumer Protection Act (“Dodd-Frank Act”). This provision requires

the Commission to adopt initial and variation margin requirements for

swap dealers (“SDs”) and major swap participants (“MSPs”) that do

not have a Prudential Regulator (collectively, “CSEs” or “Covered

Swap Entities”). In the October 3, 2014 proposing release, the

Commission also issued an Advance Notice of Proposed Rulemaking

(“ANPR”) requesting public comment on the cross-border application of

such margin requirements. In this release, the Commission is proposing

a rule for the application of the Commission’s margin requirements to

cross-border transactions.

DATES: Comments must be received on or before September 14, 2015.

ADDRESSES: You may submit comments, identified by RIN 3038-AC97 and

“Margin Requirements for Uncleared Swaps for Swap Dealers and Major

Swap Participants–Cross-Border Application of the Margin

Requirements” by any of the following methods:

CFTC Web site: http://comments.cftc.gov. Follow the

instructions for submitting comments through the Comments Online

process on the Web site.

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: Same as Mail, above.

Federal eRulemaking Portal: http://www.regulations.gov.

Follow the instructions for submitting comments.

Please submit your comments using only one of these methods.

All comments must be submitted in English, or if not, accompanied

by an English translation. Comments will be posted as received to

http://www.cftc.gov. You should submit only information that you wish

to make available publicly. If you wish the Commission to consider

information that may be exempt from disclosure under the Freedom of

Information Act, a petition for confidential treatment of the exempt

information may be submitted according to the established procedures in

Sec. 145.9 of the Commission’s regulations, 17 CFR 145.9.

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 www.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 Freedom of Information

Act.

FOR FURTHER INFORMATION CONTACT: Laura B. Badian, Assistant General

Counsel, 202-418-5969, [email protected], or Paul Schlichting, Assistant

General Counsel, 202-418-5884, [email protected], Office of the

General Counsel, Commodity Futures Trading Commission, Three Lafayette

Centre, 1155 21st Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. Dodd-Frank Act and the Scope of This Rulemaking

B. Key Considerations in the Cross-Border Application of the

Margin Regulations

C. Advance Notice of Proposed Rulemaking

1. Guidance Approach

2. Prudential Regulators’ Approach

3. Entity-Level Approach

4. Comments on the Alternative Approaches Discussed in the ANPR

II. The Proposed Rule

A. Overview

1. Use of Hybrid, Firm-Wide Approach

B. Key Definitions

1. U.S. Person

2. Guarantees

3. Foreign Consolidated Subsidiaries

C. Applicability of Margin Requirements to Cross-Border

Uncleared Swaps

1. Uncleared Swaps of U.S. CSEs or Non-U.S. CSEs Whose

Obligations Under the Relevant Swap Are Guaranteed by a U.S. Person

2. Uncleared Swaps of Non-U.S. CSEs (Including Foreign

Consolidated Subsidiaries) Whose Obligations Under the Relevant Swap

Are Not Guaranteed by a U.S. Person

3. Exclusion for Uncleared Swaps of Non-U.S. CSEs Where Neither

Counterparty’s Obligations Under the Relevant Swap Are Guaranteed by

a U.S. Person and Neither Counterparty Is a Foreign Consolidated

Subsidiary Nor a U.S. Branch of a Non-U.S. CSE

4. U.S. Branches of Non-U.S. CSEs

D. Substituted Compliance

E. General Request for Comments

III. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

C. Cost-Benefit Considerations

1. Introduction

2. Proposed Rule

a. U.S. Person

b. Availability of Substituted Compliance and Exclusion

i. Uncleared Swaps of U.S. CSEs or of Non-U.S. CSEs Whose

Obligations Under the Relevant Swap Are Guaranteed by a U.S. Person

ii. Uncleared Swaps of Non-U.S. CSEs Whose Obligations Under the

Relevant Swap Are Not Guaranteed by a U.S. Person

iii. Exclusion for Uncleared Swaps of Non-U.S. CSEs Where

Neither Counterparty’s Obligations Under the Relevant Swap Are

Guaranteed by a U.S. Person and Neither Counterparty Is a Foreign

Consolidated Subsidiary Nor a U.S. Branch of a Non-U.S. CSE

iv. Foreign Consolidated Subsidiaries

v. U.S. Branch of a Non-U.S. CSE

c. Alternatives

d. Comparability Determinations

3. Section 15(a) Factors

a. Protection of Market Participants and the Public

b. Efficiency, Competitiveness, and Financial Integrity

i. Efficiency

ii. Competitiveness

iii. Financial Integrity of Markets

c. Price Discovery

d. Sound Risk Management Practices

e. Other Public Interest Considerations

4. General Request for Comment

I. Background

A. Dodd-Frank Act and the Scope of This Rulemaking

In the fall of 2008, as massive losses spread throughout the

financial system and many major financial institutions failed or

narrowly escaped failure with government intervention, confidence in

the financial system was replaced by panic, credit markets seized up,

and trading in many markets grounded to a halt. The financial crisis

revealed the vulnerability of the U.S. financial system to widespread

systemic risk resulting from, among other things, excessive leverage,

poor risk management practices at financial firms, and the lack of

integrated supervisory oversight of financial institutions and

[[Page 41377]]

financial markets.1 The financial crisis also highlighted the

contagion risks of under-collateralized counterparty exposures in a

highly interconnected financial system.2

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1 See Financial Crisis Inquiry Commission, “The Financial

Crisis Inquiry Report: Final Report of the National Commission on

the Causes of the Financial and Economic Crisis in the United

States,” Jan. 2011, at xviii-xxv, 307-8, 363-5, 386, available at

http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.

2 Id. at xxiv-xxv, 49-51.

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In the wake of the financial crisis, Congress enacted the

provisions of the Commodity Exchange Act (“CEA”) relating to swaps in

Title VII of the Dodd-Frank Act,3 which establishes a comprehensive

new regulatory framework for swaps. One of the cornerstones of this

regulatory framework is the reduction of systemic risk to the U.S.

financial system through the establishment of margin requirements for

uncleared swaps.4

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3 Pub. L. 111-203, 124 Stat. 1376 (2010).

4 The Financial Crisis Inquiry Commission stated in its report

that the failure of American International Group, Inc. (“AIG”) was

possible because the sweeping deregulation of over-the-counter

derivatives (including credit default swaps) effectively eliminated

federal and state regulation of these products, including capital

and margin requirements that would have reduced the likelihood of

AIG’s failure. Id. at 352.

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Section 731 of the Dodd-Frank Act added a new section 4s, which

directs the Commission to adopt rules establishing minimum initial and

variation margin requirements for SDs and MSPs on all swaps that are

not cleared by a registered derivatives clearing organization. Section

4s(e) further provides that the margin requirements must: (i) Help

ensure the safety and soundness of the SD or MSP; and (ii) be

appropriate for the risk associated with the uncleared swaps held as a

SD or MSP.5

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5 Section 4s(e)(3)(A)(i) of the CEA, 7 U.S.C. 6s(e)(3)(A)(i).

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The Dodd-Frank Act also requires that the Prudential Regulators,6

in consultation with the Commission and the Securities and Exchange

Commission (“SEC”), adopt a joint margin rule. Accordingly, each SD

and MSP for which there is a Prudential Regulator must meet margin

requirements established by the applicable Prudential Regulator, and

each SD and MSP for which there is no Prudential Regulator must comply

with the Commission’s margin requirements. Further, the Dodd-Frank Act

requires that the Commission, the Prudential Regulators and the SEC, to

the maximum extent practicable, establish and maintain comparable

minimum capital and minimum initial and variation margin requirements,

including the use of noncash collateral, for SDs and MSPs.7

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6 The term “Prudential Regulator” is defined in section

1a(39) of the CEA, as amended by section 721 of the Dodd-Frank Act.

This definition includes the Board of Governors of the Federal

Reserve System (“FRB”); the Office of the Comptroller of the

Currency (“OCC”); the Federal Deposit Insurance Corporation

(“FDIC”); the Farm Credit Administration; and the Federal Housing

Finance Agency.

7 See section 4s(e)(3)(D)(ii) of the CEA, 7 U.S.C.

6s(e)(3)(D)(ii), which was added by section 731 of the Dodd-Frank

Act. The Prudential Regulators, the Commission, and the SEC are also

required to consult periodically (but not less frequently than

annually) on minimum capital requirements and minimum initial and

variation margin requirements. See section 4s(e)(3)(D)(i) of the

CEA, 7 U.S.C. 6s(e)(3)(D)(i).

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In determining whether, and the extent to which, section 4s(e)

should apply to a CSE’s swap activities outside the United States, the

Commission focused on the text and objectives of that provision

together with the language of section 2(i) of the CEA.8 As discussed

further below, the primary reason for the margin requirement is to

protect CSEs in the event of a counterparty default. That is, in the

event of a default by a counterparty, margin protects the CSE by

allowing it to absorb the losses using collateral provided by the

defaulting entity and to continue to meet all of its obligations. In

addition, margin functions as a risk management tool by limiting the

amount of leverage that a CSE can incur. Specifically, by requiring a

CSE to post margin to its counterparties, the margin requirements

ensure that a CSE has adequate eligible collateral to enter into an

uncleared swap.

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8 See 7 U.S.C. 2(i). Section 2(i) of the CEA states that the

provisions of the Act relating to swaps that were enacted by the

Wall Street Transparency and Accountability Act of 2010 (including

any rule prescribed or regulation promulgated under that Act), shall

not apply to activities outside the United States unless those

activities–(1) have a direct and significant connection with

activities in, or effect on, commerce of the United States; or (2)

contravene such rules or regulations as the Commission may prescribe

or promulgate as are necessary or appropriate to prevent the evasion

of any provision of the Act [CEA] that was enacted by the Wall

Street Transparency and Accountability Act of 2010.

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Risk arising from uncleared swaps can potentially have a

substantial adverse effect on any CSE–irrespective of its domicile or

the domicile of its counterparties–and therefore the stability of the

U.S. financial system because each CSE has a sufficient nexus to the

U.S. financial system to require registration as a CSE. In light of the

role of margin in ensuring the safety and soundness of CSEs and

preserving the stability of the U.S. financial system, and consistent

with section 2(i), section 4s(e)’s margin requirements extend to all

CSEs on a cross-border basis.

Pursuant to its new section 4s(e) authority, on October 3, 2014,

the Commission published reproposed regulations to implement initial

and variation margin requirements on uncleared swaps (“Proposed Margin

Rules”) for SDs and MSPs that do not have a Prudential Regulator

(collectively, “CSEs” or “Covered Swap Entities”).9 In the same

release, the Commission also published an ANPR requesting public

comment on the cross-border application of such margin requirements. In

this release, the Commission is proposing a rule for the application of

the Commission’s uncleared swap margin requirements to cross-border

transactions (referred to herein as the “Proposed Rule”).

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9 The Commission’s Proposed Margin Rules are set forth in

proposed rules Sec. Sec. 23.150 through 23.159 of part 23 of the

Commission’s regulations, proposed as 17 CFR 23.150 through 23.159.

See Margin Requirements for Uncleared Swaps for Swap Dealers and

Major Swap Participants, 79 FR 59898 (Oct. 3, 2014). In September

2014, the Prudential Regulators published proposed regulations to

implement initial and variation margin requirements for SDs and MSPs

that have a Prudential Regulator. See Margin and Capital

Requirements for Covered Swap Entities, 79 FR 53748 (Sept. 24,

2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-09-24/pdf/2014-22001.pdf. The Commission originally proposed margin rules for

public comment in 2011. See Margin Requirements for Uncleared Swaps

for Swap Dealers and Major Swap Participants, 76 FR 23732 (April 28,

2011).

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B. Key Considerations in the Cross-Border Application of the Margin

Regulations

The swaps market is global in nature. Swaps are routinely entered

into between counterparties located in different jurisdictions. Dealers

and other market participants conduct their swaps business through

subsidiaries, affiliates, and branches dispersed across geographical

boundaries. The global and highly interconnected nature of the swaps

market heightens the potential that risks assumed by a firm overseas

can be transmitted across national borders to cause or contribute to

substantial losses to U.S. persons and threaten the stability of the

entire U.S. financial system. Therefore, it is important that margin

requirements for uncleared swaps apply on a cross-border basis in a

manner that effectively addresses risks to U.S. persons and the U.S.

financial system.

The Commission recognizes that non-U.S. CSEs and non-U.S.

counterparties may be subject to comparable or different rules in their

home jurisdictions. Conflicting and duplicative requirements between

U.S. and foreign margin regimes could potentially lead to market

inefficiencies

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and regulatory arbitrage, as well as competitive disparities that

undermine the relative position of U.S. CSEs and their counterparties.

Therefore, it is essential that a cross-border margin framework takes

into account the global nature of the swaps market and the supervisory

interests of foreign regulators with respect to entities and

transactions covered by the Commission’s margin regime.10

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10 In developing the proposed cross-border framework, the

Commission is guided by principles of international comity, which

counsels due regard for the important interests of foreign

sovereigns. See Restatement (Third) of Foreign Relations Law of the

United States (the “Restatement”). The Restatement provides that

even where a country has a basis for jurisdiction, it should not

prescribe law with respect to a person or activity in another

country when the exercise of such jurisdiction is unreasonable. See

Restatement section 403(1). The reasonableness of such an exercise

of jurisdiction, in turn, is to be determined by evaluating all

relevant factors, including certain specifically enumerated factors

where appropriate: (a) The link of the activity to the territory of

the regulating state, i.e., the extent to which the activity takes

place within the territory, or has substantial, direct, and

foreseeable effect upon or in the territory; (b) the connections,

such as nationality, residence, or economic activity, between the

regulating state and the persons principally responsible for the

activity to be regulated, or between that state and those whom the

regulation is designed to protect; (c) the character of the activity

to be regulated, the importance of regulation to the regulating

state, the extent to which other states regulate such activities,

and the degree to which the desirability of such regulation is

generally accepted; (d) the existence of justified expectations that

might be protected or hurt by the regulation; (e) the importance of

the regulation to the international political, legal, or economic

system; (f) the extent to which the regulation is consistent with

the traditions of the international system; (g) the extent to which

another state may have an interest in regulating the activity; and

(h) the likelihood of conflict with regulation by another state. See

Restatement section 403(2).

Notably, the Restatement does not preclude concurrent regulation

by multiple jurisdictions. However, where concurrent jurisdiction by

two or more jurisdictions creates conflict, the Restatement

recommends that each country evaluate its own interests in

exercising jurisdiction and those of the other jurisdiction, and

where possible, to consult with each other.

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In granting the Commission new authorities under the Dodd-Frank

Act, Congress also reaffirmed and called for coordination and

cooperation among domestic and foreign regulators. Section 752(a) of

the Dodd-Frank Act requires the Commission, the Prudential Regulators,

and the SEC to consult and coordinate with foreign regulatory

authorities on the “establishment of consistent international

standards” with respect to the regulation of swaps.11 In this

regard, the Commission recognizes that efforts are underway by other

domestic and foreign regulators to implement margin reform and that

regulatory harmonization and coordination are indispensable to

achieving a workable cross-border framework.

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11 15 U.S.C. 8325(a) (added by section 752 of the Dodd-Frank

Act). Also, before commencing any rulemaking or issuing an order

regarding swaps, the Commission must consult and coordinate to the

extent possible with the SEC and the Prudential Regulators for the

purposes of assuring regulatory consistency and comparability, to

the extent possible. See 15 U.S.C. 8302(a)(1) (added by section

712(a)(1) of the Dodd-Frank Act).

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In developing a cross-border framework for margin regulations, the

Commission aims to strike the proper balance among these sometimes

competing considerations. To that end, the Commission has consulted and

coordinated with the Prudential Regulators and foreign regulatory

authorities. Commission staff worked closely with the staff of the

Prudential Regulators, and the Proposed Rule is closely aligned with

the cross-border proposal that was published by the Prudential

Regulators in September 2014. In addition, Commission staff has

participated in numerous bilateral and multilateral discussions with

foreign regulatory authorities addressing national efforts to implement

margin reform and the possibility of conflicts and overlaps between

U.S. and foreign regulatory regimes. Recognizing that systemic risks

arising from global and interconnected swaps market must be addressed

through coordinated regulatory requirements for margin across

international jurisdictions, the Commission has played an active role

in encouraging international harmonization and coordination of margin

requirements for uncleared swaps.

The Commission notes that its collaboration with the Basel

Committee on Banking Supervision (“BCBS”) and the Board of the

International Organization of Securities Commissions (“IOSCO”) as a

member of the Working Group on Margining Requirements (“WGMR”)

resulted in the issuance of a final margin policy framework for non-

cleared, bilateral derivatives in September 2013 (referred to herein as

the “BCBS-IOSCO framework”).12 Individual regulatory authorities

across major jurisdictions (including the EU, Japan, and the United

States) have since started to develop their own margin rules.13 The

Proposed Rule is consistent with the standards in the final BCBS-IOSCO

framework, and we have been in continuous communication with regulators

in the EU and Japan as we developed our cross-border margin proposal.

Although at this time foreign jurisdictions do not yet have their

margin regimes in place, the Commission has participated in ongoing,

collaborative discussions with regulatory authorities in the EU and

Japan regarding their cross-border approaches to the margin rules,

including the anticipated scope of application of margin requirements

in their jurisdiction to cross-border swaps, their plans for

recognizing foreign margin regimes, and their anticipated timelines.

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12 See Margin Requirements for Non-centrally Cleared

Derivatives (Sept. 2013), available at http://www.bis.org/publ/bcbs261.pdf.

13 See European Banking Authority, European Securities and

Markets Authority, and European Insurance and Occupational Pensions

Authority, Consultation Paper on draft regulatory technical

standards on risk-mitigation techniques for OTC-derivative contracts

not cleared by a CCP under Article 11(15) of Regulation (EU) No 648/

2012 (for the European Market Infrastructure Regulation) (April 14,

2014), available at https://www.eba.europa.eu/documents/10180/655149/JC+CP+2014+03+%28CP+on+risk+mitigation+for+OTC+derivatives%29.pdf, and Second Consultation Paper on draft regulatory technical

standards on risk-mitigation techniques for OTC-derivative contracts

not cleared by a CCP under Article 11(15) of Regulation (EU) No 648/

2012 (for the European Market Infrastructure Regulation) (Jun. 10,

2015), available at https://www.eba.europa.eu/documents/10180/1106136/JC-CP-2015-002+JC+CP+on+Risk+Management+Techniques+for+OTC+derivatives+.pdf;

Financial Services Agency of Japan, draft amendments to the

“Cabinet Office Ordinance on Financial Instruments Business” and

“Comprehensive Guidelines for Supervision” with regard to margin

requirements for non-centrally cleared derivatives (July 3, 2014).

Available in Japanese at http://www.fsa.go.jp/news/26/syouken/20140703-3.html.

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The Commission believes that its ongoing bilateral and multilateral

discussions with foreign regulatory authorities in major jurisdictions

(including the EU and Japan) are critical to fostering international

cooperation and harmonization and in reducing conflicting and

duplicative regulatory requirements. The Commission expects that these

discussions will continue as it finalizes and then implements its

framework for the application of margin requirements to cross-border

transactions, and as other jurisdictions develop their own respective

approaches.

C. Advance Notice of Proposed Rulemaking

The ANPR sought public comment on three potential alternative

approaches to the cross-border application of its margin requirements:

(1) A transaction-level approach that is consistent with the

Commission’s cross-border guidance (“Guidance Approach”); 14 (2) an

[[Page 41379]]

approach that is consistent with the approach proposed by the

Prudential Regulators (the “Prudential Regulators’ Approach”); 15

and (3) an entity-level approach described in the ANPR (“Entity-Level

Approach”). To provide context for the discussion of the Proposed

Rule, the three alternative approaches discussed in the ANPR are

summarized below.

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14 Interpretative Guidance and Policy Statement Regarding

Compliance with Certain Swap Regulations, 78 FR 45292 (July 26,

2013) (“Guidance”). The Commission addressed, among other things,

how the swap provisions in the Dodd-Frank Act (including the margin

requirement for uncleared swaps) generally would apply on a cross-

border basis. In this regard, the Commission stated that as a

general policy matter it expected to apply the margin requirement as

a transaction-level requirement.

15 See Margin and Capital Requirements for Covered Swap

Entities, 79 FR 53748 (Sept. 24, 2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-09-24/pdf/2014-22001.pdf.

—————————————————————————

1. Guidance Approach

Under the first alternative discussed in the ANPR, the Commission’s

margin requirements would be applied on a transaction-level basis,

consistent with its cross-border Guidance.16 The Commission stated in

the Guidance that it would generally treat its margin requirements for

uncleared swaps as a transaction-level requirement. Consistent with the

rationale stated in the Guidance, under this transaction-level

approach, the Commission’s Proposed Margin Rules would apply to a U.S.

SD/MSP (other than a foreign branch of a U.S. bank that is a SD/MSP)

for all of its uncleared swaps, regardless of whether its counterparty

is a U.S. person,17 without substituted compliance.

—————————————————————————

16 See Interpretative Guidance and Policy Statement Regarding

Compliance with Certain Swap Regulations, 78 FR 45292 (July 26,

2013).

17 The scope of the term “U.S. person” as used in the Cross-

Border Guidance Approach and the Entity-Level Approach would be the

same as under the Guidance. See Guidance at 45316-45317 for a

summary of the Commission’s interpretation of the term “U.S.

person.”

—————————————————————————

However, under this approach the margin requirements would apply to

a non-U.S. SD/MSP (whether or not it is a “guaranteed affiliate” 18

or an “affiliate conduit” 19) only with respect to its uncleared

swaps with a U.S. person counterparty and a non-U.S. counterparty that

is a guaranteed affiliate or an affiliate conduit; the margin

requirements would not apply to uncleared swaps with a non-U.S. person

counterparty that is not a guaranteed affiliate or an affiliate

conduit. Where the non-U.S. counterparty is a guaranteed affiliate or

an affiliate conduit, the Commission would allow substituted compliance

(i.e., the non-U.S. SD/MSP would be permitted to comply with the margin

requirements of its home country’s regulator if the Commission

determines that such requirements are comparable to the Commission’s

margin requirements).20

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18 Under the Guidance, id. at 45318, the term “guaranteed

affiliate” refers to a non-U.S. person that is an affiliate of a

U.S. person and that is guaranteed by a U.S. person. The scope of

the term “guarantee” under the Guidance Approach and the Entity-

Level Approach would be the same as under note 267 of the Guidance

and accompanying text.

19 Under the approach discussed in the Guidance, id. at 45359,

the factors that are relevant to the consideration of whether a

person is an “affiliate conduit” include whether: (i) The non-U.S.

person is majority-owned, directly or indirectly, by a U.S. person;

(ii) the non-U.S. person controls, is controlled by, or is under

common control with the U.S. person; (iii) the non-U.S. person, in

the regular course of business, engages in swaps with non-U.S. third

party(ies) for the purpose of hedging or mitigating risks faced by,

or to take positions on behalf of, its U.S. affiliate(s), and enters

into offsetting swaps or other arrangements with such U.S.

affiliate(s) in order to transfer the risks and benefits of such

swaps with third-party(ies) to its U.S. affiliates; and (iv) the

financial results of the non-U.S. person are included in the

consolidated financial statements of the U.S. person. Other facts

and circumstances also may be relevant.

20 Where the uncleared swap is between a non-U.S. SD/MSP

(whether or not it is a guaranteed affiliate or an affiliate

conduit) and a foreign branch of a U.S. bank that is a SD/MSP,

substituted compliance would be available if certain conditions are

met.

—————————————————————————

2. Prudential Regulators’ Approach

The second alternative discussed in the ANPR was the Prudential

Regulators’ Approach to cross-border application of the margin

requirements.21 Under the Prudential Regulators’ proposal issued in

September 2014 (the “September proposal”), the Prudential Regulators

would apply the margin requirements to all uncleared swaps of CSEs

under their supervision with a limited exception.22 Specifically, the

Prudential Regulators would not apply their margin requirements to any

foreign non-cleared swap of a foreign covered swap entity.23 This

exclusion would only be available where neither the non-U.S. SD/MSP’s

nor the non-U.S. counterparty’s obligations under the relevant swap are

guaranteed by a U.S. person and neither party is “controlled” by a

U.S. person. Under the “control” test used in the September proposal,

the term “control” of another company means: (1) Ownership, control,

or power to vote 25 percent or more of a class of voting securities of

the company, directly or indirectly or acting through one or more other

persons; (2) ownership or control of 25 percent or more of the total

equity of the company, directly or indirectly or acting through one or

more other persons; or (3) control in any manner of the election of a

majority of the directors or trustees of the company.

—————————————————————————

21 See section 9 of the proposed rule on Margin and Capital

Requirements for Covered Swap Entities, 12 CFR part 237 (Sept. 24,

2014) for a complete description of the proposed cross-border

application of margin requirements to swaps by the Prudential

Regulators, available at http://www.gpo.gov/fdsys/pkg/FR-2014-09-24/pdf/2014-22001.pdf.

22 A summary of the Prudential Regulators’ Approach to the

cross-border application of their proposed margin requirements is

included in the ANPR. See Margin Requirements for Uncleared Swaps

for Swap Dealers and Major Swap Participants, 79 FR 59917(Oct. 3,

2014). For further information on the Prudential Regulators’

Approach generally, see Margin and Capital Requirements for Covered

Swap Entities, 79 FR 53748 (Sept. 24, 2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-09-24/pdf/2014-22001.pdf.

23 The Prudential Regulators define a “foreign covered swap

entity” as any covered swap entity that is not (i) an entity

organized under U.S. or State law, including a U.S. branch, agency,

or subsidiary of a foreign bank; (ii) a branch or office of an

entity organized under U.S. or State law; or (iii) an entity

controlled by an entity organized under U.S. or State law. Under the

Prudential Regulators’ proposal, a “foreign non-cleared swap”

would include any non-cleared swap of a foreign covered swap entity

to which neither the counterparty nor any guarantor (on either side)

is (i) an entity organized under U.S. or State law, including a U.S.

branch, agency, or subsidiary of a foreign bank; (ii) a branch or

office of an entity organized under U.S. or State law; or (iii) a

covered swap entity controlled by an entity organized under U.S. or

State law.

—————————————————————————

3. Entity-Level Approach

Under the third alternative discussed in the ANPR, margin

requirements would be treated as an entity-level requirement. Under

this Entity-Level Approach, the Commission would apply its proposed

cross-border rules on margin on a firm-wide level–that is, to all

uncleared swaps activities of a SD/MSP registered with the Commission,

irrespective of whether the counterparty is a U.S. person, and with no

possibility of exclusion. This approach takes into account that a non-

U.S. SD/MSP entering into uncleared swaps faces counterparty credit

risk regardless of where the swap is executed or whether the

counterparty is a U.S. person.24 That risk, if it leads to a default

by the non-U.S. SD/MSP, could cause adverse consequences to its U.S.

counterparties and the U.S. financial system. At the same time, in

recognition of international comity, under this approach the Commission

would consider, where appropriate, allowing CSEs to avail themselves of

substituted compliance.

—————————————————————————

24 A summary of the Entity-Level Approach to the cross-border

application of the Proposed Margin Rules is included in the ANPR.

See Margin Requirements for Uncleared Swaps for Swap Dealers and

Major Swap Participants, 79 FR 59917 (Oct. 3, 2014).

—————————————————————————

4. Comments on the Alternative Approaches Discussed in the ANPR

After publishing the ANPR, the Commission received comments that

responded to the three alternative approaches.25 There was no

consensus

[[Page 41380]]

among commenters on a preferable approach.

—————————————————————————

25 Comment letters received in response to the ANPR may be

found on the Commission’s Web site at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1528.

—————————————————————————

Several commenters supported the Guidance Approach, with

modifications, on the basis that margin rules should not apply to swaps

between a foreign swap dealer and a foreign, non-guaranteed

counterparty.26 Some of these commenters suggested modifications to

the availability of substituted compliance in the approach described in

the Guidance.27 For example, one commenter suggested that the

Commission should treat non-U.S. margin requirements that conform to

the BCBS-IOSCO framework as “essentially identical” to the

Commission’s regime and therefore accessible to all SDs as a means of

complying with the Commission’s margin requirements.28 Another

commenter suggested that the Commission modify its approach to

substituted compliance outlined in the Guidance to allow substituted

compliance for trades between U.S. persons and non-U.S. persons at such

parties’ mutual agreement.29 In addition, some commenters that

supported the Guidance Approach expressed the view that it should

include an emerging markets exception.30 Still another commenter

argued that the Commission’s Guidance correctly classified margin as a

transaction-level rather than an entity-level requirement because, as

with the clearing requirement, it is practicable to separate out

transactions which are subject to the margin requirements and

transactions which are not. This commenter stated that it would be an

odd result if the Commission were to determine that the reach of the

clearing requirement was not as great as that of the margin

requirement, given that both requirements are intended to address

counterparty credit risk.31

—————————————————————————

26 See International Swaps and Derivatives Association, Inc.

(“ISDA”) (Nov. 24, 2014), Managed Funds Association (“MFA”)

(Dec. 2, 2014), and INTL FCStone Inc. (Dec. 3, 2014).

27 See ISDA (Nov. 24, 2014) and MFA (Dec. 2, 2014).

28 See ISDA (Nov. 24, 2014).

29 See MFA (Dec. 2, 2014).

30 See ISDA (Nov. 24, 2014) and American Bankers Association

(Nov. 25, 2014).

31 See INTL FCStone Inc. (Dec. 3, 2014).

—————————————————————————

In contrast, some commenters argued against adopting the Guidance

Approach. One commenter argued that the Guidance Approach has become a

significant driver of conflict between U.S. and European regulatory

requirements, and is undermining the goal of a globally coordinated

regulatory framework.32 Another commenter argued that this approach

provides an excessively broad exemption for “non-guaranteed” foreign

affiliates of U.S. banks, and that it is completely inappropriate to

apply such an exemption to a crucial prudential requirement such as

derivatives margin, which could pose major risks to the financial

system by encouraging a race to the bottom among jurisdictions

concerning margin requirements.33

—————————————————————————

32 See Alternative Investment Management Association

(“AIMA”) (Dec. 2, 2014).

33 See Americans for Financial Reform (“AFR”) (Dec. 2,

2014).

—————————————————————————

Other commenters generally supported the Entity-Level Approach,

with modifications, on the basis that it captures all registrants’

uncleared trades, regardless of the domicile of the registrant or the

counterparty. These commenters generally favored this approach because,

rather than exempting foreign to foreign transactions, it makes

substituted compliance available for these transactions. One commenter

stated that the Entity-Level Approach is the most appropriate choice

because it provides market participants with more certainty in

determining which jurisdiction’s margin requirements apply. Further,

this commenter stated that the Entity-Level Approach is consistent with

how collateral is currently handled under a single master agreement and

would mitigate legal uncertainty and operational errors that can arise

if trades are subject to different margin requirements under the same

master agreement.34 Another commenter favored the Entity-Level

Approach because it imposes prudential rules on all swaps activities of

U.S.-headquartered firms, regardless of where the swap transaction is

booked. This commenter stated that both the Prudential Regulators’

Approach and the Guidance Approach provide a means for U.S. firms to

escape U.S. oversight.35

—————————————————————————

34 See Securities Industry and Financial Markets Association,

Asset Management Group (Nov. 24, 2014).

35 See Public Citizen (Dec. 2, 2014).

—————————————————————————

Another commenter supported a cross-border approach that combines

the Guidance Approach with certain enhancements found in the Entity-

Level Approach. This commenter suggested that the Entity-Level Approach

correctly subjects certain non-U.S. SDs and MSPs to U.S. regulations–

at least with respect to variation margin and the collection of initial

margin–where the Guidance Approach would permit substituted compliance

to both parties in all respects. However, this commenter stated that

the Entity-Level Approach also contains provisions that are

significantly weaker than the Guidance Approach, such as making

substituted compliance available to certain non-U.S. counterparties of

U.S. SDs or MSPs. This commenter also expressed the view that the

Guidance Approach correctly requires both counterparties to fully

comply with U.S. rules in all transactions involving a U.S. SD or

MSP.36

—————————————————————————

36 See Better Markets, Inc. (Dec. 2, 2014).

—————————————————————————

Commenters generally did not support the Prudential Regulators’

Approach as their first choice, but two commenters thought it might be

workable with modifications. The first commenter stated that if the

Commission elects not to adopt the “Entity-Level” Approach, the

Prudential Regulators’ Approach might be workable, although this

commenter had reservations about situations where different

jurisdictions’ regimes apply to the same transaction.37 The other

commenter argued that if its first choice, the Entity-Level Approach,

is not adopted, the Prudential Regulators’ Approach is greatly superior

to the Guidance Approach, as it would apply margin requirements to

foreign affiliates of U.S. banks that are classified as SDs or MSPs,

regardless of whether such affiliates are nominally guaranteed.

However, this commenter argued that the Prudential Regulators’ Approach

is flawed in that, like the Guidance Approach, it would exempt

controlled foreign subsidiaries of U.S. banks that are not registered

with the Commission as swaps entities.38

—————————————————————————

37 See AIMA (Dec. 2, 2014).

38 See AFR (Dec. 2, 2014).

—————————————————————————

Two commenters specifically argued against the Prudential

Regulators’ Approach. One commenter contended that the Prudential

Regulators’ Approach provides limited clarity on how the “control”

test should be applied, which means that foreign bank subsidiaries of

U.S. banks cannot be certain whether they are subject to U.S. rules or

foreign rules, and provides limited guidance as to how foreign covered

swaps entities can determine whether a financial end-user counterparty

is a U.S. entity or a foreign entity, in comparison to the clear “U.S.

person” standard in the Guidance.39 The other commenter is concerned

with the Prudential Regulators’ Approach as it relates to funds. This

commenter stated that the Prudential Regulators’ definition of

“foreign non-cleared swap” effectively classifies funds organized

outside of the United States, but with a U.S. principal place of

business (e.g., funds with a U.S.-based manager), as foreign entities.

This

[[Page 41381]]

commenter stated that if funds with a U.S.-based manager are not

considered “U.S. persons” subject to U.S. derivatives regulation,

even though they have a substantial U.S. nexus, they would likely be

required to margin their covered swaps in accordance with the foreign

margin rules to which their non-U.S. CSE counterparty is subject, which

would give too much deference to the foreign regulatory regime.40

—————————————————————————

39 See Committee on Capital Markets Regulation (Nov. 24,

2014).

40 See MFA (Dec. 2, 2014).

—————————————————————————

One commenter asserted that both the Prudential Regulators’

Approach and the Guidance Approach would appropriately exclude swaps

between foreign-headquartered swap entities that are not controlled or

guaranteed by a U.S. person and a non-U.S. person that is not

guaranteed by a U.S. person from the scope of the margin rules, noting

that if U.S. rules require the foreign-headquartered swap entity to

post margin, this would create the potential for conflicts or

inconsistencies with its home country margin requirements.41

—————————————————————————

41 See Institute of International Bankers (Nov. 24, 2014).

This commenter also stated that these foreign swaps would have

little effect on the U.S. financial system in the event of a

default; further, under the Dodd-Frank Act, the risk to the United

States of a default by the foreign-headquartered swap entity on its

swaps with U.S. counterparties would already be mitigated by capital

and margin collection requirements.

—————————————————————————

One commenter did not explicitly support any of the three

approaches, noting that all of the proposals diverge in potentially

significant ways from the final framework developed by BCBS and IOSCO

and the OTC margin framework proposed in April 2014 by European

supervisory agencies, and that none of the proposals embrace

substituted compliance in a comprehensive manner that would address

cross-border conflicts or inconsistencies that could arise. This

commenter suggested that the Commission should use an outcomes-based

approach that looks to whether giving full recognition to an equivalent

foreign OTC margin framework as a whole would ensure an acceptable

reduction of aggregate unmargined risk.42

—————————————————————————

42 See Securities Industry and Financial Markets Association

(“SIFMA”) (Nov. 24, 2014).

—————————————————————————

II. The Proposed Rule

A. Overview

Based on, among other things, consideration of the comments to the

ANPR and after close consultation with the Prudential Regulators, the

Commission is proposing a rule for the application of the Commission’s

Proposed Margin Rules to cross-border transactions (as noted above, the

proposed cross-border margin rule is referred to herein as the

“Proposed Rule”). As discussed above, a cross-border framework for

margin necessarily involves consideration of significant, and sometimes

competing, legal and policy considerations, including the impact on

market efficiency and competition.43 The Commission, in developing

the Proposed Rule, aims to balance these considerations to effectively

address the risk posed to the safety and soundness of CSEs, while

creating a workable framework that reduces the potential for undue

market disruptions and promotes global harmonization. The Commission

also recognizes that there are other possible approaches to applying

the margin rules in the cross-border context. Accordingly, the

Commission invites public comment regarding all aspects of the Proposed

Rule.

—————————————————————————

43 The Commission’s consideration of the costs and benefits

associated with the Proposed Rule is discussed in section III.C.

below.

—————————————————————————

1. Use of Hybrid, Firm-Wide Approach

The Proposed Rule is a combination of the entity- and transaction-

level approaches and is closely aligned with the Prudential Regulators’

Approach. In general, under the Proposed Rule, margin requirements are

designed to address the risks to a CSE, as an entity, associated with

its uncleared swaps (entity-level); nevertheless, certain uncleared

swaps would be eligible for substituted compliance or excluded from the

Commission’s margin rules based on the counterparties’ nexus to the

United States relative to other jurisdictions (transaction-level).

Although margin is calculated for individual transactions or

positions, and therefore, could be applied on a transaction-level

basis, the Commission believes that as a general matter margin

requirements should apply on a firm-wide basis, irrespective of the

domicile of the counterparties or where the trade is executed. The

primary reason for collecting margin from counterparties is to protect

an entity in the event of a counterparty default. That is, in the event

of a default by a counterparty, margin protects the non-defaulting

counterparty by allowing it to absorb the losses using collateral

provided by the defaulting entity and to continue to meet all of its

obligations. In addition, margin functions as a risk management tool by

limiting the amount of leverage that a CSE can incur. Specifically, by

requiring a CSE to post margin to its counterparties, the margin

requirements ensure that a CSE has adequate eligible collateral to

enter into an uncleared swap. In this way, margin serves as a first

line of defense to protect a CSE as a whole from risk arising from

uncleared swaps.

The source of counterparty credit risk to a CSE, however, is not

confined to its uncleared swaps with U.S. counterparties. Risk arising

from uncleared swaps involving non-U.S. counterparties can potentially

have a substantial adverse effect on a CSE–including a non-U.S. CSE–

and therefore the stability of the U.S. financial system because CSEs

have a sufficient nexus to the U.S. financial system to require

registration as a CSE. Given the function of margin, the Commission

believes that margin should be treated as an entity-level requirement

in the cross-border context, and thus not take into account the

domicile of CSE counterparties or where the trade is executed.

The Commission also believes that treating margin as an entity-

level requirement is consistent with the role of margin in a CSE’s

overall risk management program. Margin, by design, is complementary to

capital.44 That is, margin and capital requirements serve different

but equally important risk mitigation functions that are best

implemented at the entity-level. Unlike margin, capital is difficult to

rapidly adjust in response to changing risk exposures; thus, capital

can be viewed as a backstop, in the event that the margin is not enough

to cover all of the losses that resulted from the counterparty default.

Standing alone, either capital or margin may not be enough to prevent a

CSE from failing, but together, they are designed to reduce the

probability of default by the CSE and limit the amount of leverage that

can be undertaken by CSEs (and other market participants), which

ultimately mitigates the possibility of a systemic event.45

—————————————————————————

44 See BCBS and IOSCO, Margin requirements for non-centrally

cleared derivatives (Sept. 2013) at 3, available at http://www.bis.org/publ/bcbs261.pdf.

45 Section 4s(e) of the CEA, 7 U.S.C. 6s(e), directs the

Commission to adopt capital requirements for SDs and MSPs. The

Commission proposed capital rules in 2011. See Capital Requirements

for Swap Dealers and Major Swap Participants, Notice of proposed

rulemaking, 76 FR 27802 (May 12, 2011).

—————————————————————————

At the same time, the Commission recognizes that a CSE’s uncleared

swaps with a particular counterparty may implicate the supervisory

interests of foreign regulators and it is important to calibrate the

cross-border application of the margin requirements to mitigate, to the

extent possible and consistent with the Commission’s regulatory

interests, the potential for conflicts or duplication with other

jurisdictions. Therefore, the Proposed Rule, while applying margin

[[Page 41382]]

requirements to a CSE as a whole, also permits a U.S. CSE or non-U.S.

CSE to avail itself of substituted compliance (to the extent applicable

under the Proposed Rule) by complying with the margin requirements of

the relevant foreign jurisdiction in lieu of compliance with the

Commission’s margin requirements, provided that the Commission finds

that such jurisdiction’s margin requirements are comparable to the

Commission’s margin requirements, as further discussed in section II.D.

below.

In addition, the Proposed Rule provides for a limited exclusion of

uncleared swaps between non-U.S. CSEs and non-U.S. counterparties (the

“Exclusion”) in certain circumstances. The Commission recognizes that

the supervisory interest of foreign regulators in certain uncleared

swaps between non-U.S. CSEs and their non-U.S. counterparties may equal

or exceed the supervisory interest of the United States. The Proposed

Rule takes into account the interests of other jurisdictions and

balances those interests with the supervisory interests of the United

States in order to calibrate the application of margin rules to non-

U.S. CSEs’ swaps with non-U.S. counterparties. Accordingly, the

Commission believes that it would be appropriate to not apply the

Commission’s margin rules to uncleared swaps meeting the criteria for

the Exclusion, which is described in section II.C.3. below.

B. Key Definitions

The Proposed Rule uses certain key definitions to establish a

proposed framework for the application of margin requirements in a

cross-border context. Specifically, the Proposed Rule defines the terms

“U.S. person,” “guarantee,” and “Foreign Consolidated Subsidiary”

in order to identify those persons or transactions that, because of

their substantial connection or impact on the U.S. market, raise or

implicate greater supervisory interest relative to other CSEs,

counterparties, and uncleared swaps that are subject to the

Commission’s margin rules. These definitions are discussed below.

1. U.S. Person

Generally speaking, the term “U.S. person” would be defined to

include those individuals or entities whose activities have a

significant nexus to the U.S. market by virtue of their organization or

domicile in the United States or the depth of their connection to the

U.S. market, even if domiciled or organized outside the United States.

The proposed definition generally follows the traditional, territorial

approach to defining a U.S. person, and the Commission believes that

this definition provides an objective and clear basis for determining

those individuals or entities that should be identified as a U.S.

person.46

—————————————————————————

46 In addition, the Commission notes that the proposed

definition of “U.S. person” is similar to the definition of “U.S.

person” used by the SEC in the context of cross-border security-

based swaps. In the SEC’s August 2014 release adopting rules and

providing guidance regarding the application of Title VII of the

Dodd-Frank Act to cross-border security-based swap activities and

persons engaged in those activities, the SEC defined the term “U.S.

person” in Rule 240.3a71-3(a)(4)(i) under the Securities Exchange

Act of 1934 to mean, except as provided in paragraph (a)(4)(iii) of

the rule, any person that is (1) A natural person resident in the

United States (Rule 240.3a71-3(a)(4)(i)(A)); (2) A partnership,

corporation, trust, investment vehicle, or other legal person

organized, incorporated, or established under the laws of the United

States or having its principal place of business in the United

States (Rule 240.3a71-3(a)(4)(i)(B)); (3) An account (whether

discretionary or non-discretionary) of a U.S. person (Rule 240.3a71-

3(a)(4)(i)(C)); or (4) An estate of a decedent who was a resident of

the United States at the time of death(Rule 240.3a71-3(a)(4)(i)(D)).

Paragraph (a)(4)(ii) of SEC Rule 240.3a71-3 also defines, for

purposes of that section, “principal place of business” to mean

the location from which the officers, partners, or managers of the

legal person primarily direct, control, and coordinate the

activities of the legal person. With respect to an externally

managed investment vehicle, this location is the office from which

the manager of the vehicle primarily directs, controls, and

coordinates the investment activities of the vehicle.

Paragraph (a)(4)(iii) of SEC Rule 240.3a71-3 states that the

term “U.S. person” does not include the International Monetary

Fund, the International Bank for Reconstruction and Development, the

Inter-American Development Bank, the Asian Development Bank, the

African Development Bank, the United Nations, and their agencies and

pension plans, and any other similar international organizations,

their agencies and pension plans.

Paragraph (a)(4)(iv) of SEC Rule 240.3a71-3 states that a person

shall not be required to consider its counterparty to a security-

based swap to be a U.S. person if such person receives a

representation from the counterparty that the counterparty does not

satisfy the criteria set forth in paragraph (a)(4)(i) of that

section, unless such person knows or has reason to know that the

representation is not accurate; for the purposes of this final rule

a person would have reason to know the representation is not

accurate if a reasonable person should know, under all of the facts

of which the person is aware, that it is not accurate.

See Application of “Security-Based Swap Dealer” and “Major

Security-Based Swap Participant” Definitions to Cross-Border

Security-Based Swap Activities; Final rule; interpretation

(Republication), 79 FR 47371 (Aug. 12, 2014).

—————————————————————————

The Proposed Rule would define a “U.S. person” for purposes of

the cross-border application of the margin rules to mean:

(1) Any natural person who is a resident of the United States

(Proposed Rule Sec. 23.160(a)(10)(i));

(2) Any estate of a decedent who was a resident of the United

States at the time of death (Proposed Rule Sec. 23.160(a)(10)(ii));

(3) Any corporation, partnership, limited liability company,

business or other trust, association, joint-stock company, fund or any

form of entity similar to any of the foregoing (other than an entity

described in paragraph (a)(10)(iv) or (v) of proposed Sec. 23.160) (a

legal entity), in each case that is organized or incorporated under the

laws of the United States or having its principal place of business in

the United States, including any branch of the legal entity (Proposed

Rule Sec. 23.160(a)(10)(iii));

(4) Any pension plan for the employees, officers or principals of a

legal entity described in paragraph (a)(10)(iii) of proposed Sec.

23.160, unless the pension plan is primarily for foreign employees of

such entity (Proposed Rule Sec. 23.160(a)(10)(iv));

(5) Any trust governed by the laws of a state or other jurisdiction

in the United States, if a court within the United States is able to

exercise primary supervision over the administration of the trust

(Proposed Rule Sec. 23.160(a)(10)(v));

(6) Any legal entity (other than a limited liability company,

limited liability partnership or similar entity where all of the owners

of the entity have limited liability) owned by one or more persons

described in paragraphs (a)(10)(i) through (a)(10)(v) of proposed Sec.

23.160 who bear(s) unlimited responsibility for the obligations and

liabilities of the legal entity, including any branch of the legal

entity (Proposed Rule Sec. 23.160(a)(10)(vi)); and

(7) Any individual account or joint account (discretionary or not)

where the beneficial owner (or one of the beneficial owners in the case

of a joint account) is a person described in paragraphs (a)(10)(i)

through (a)(10)(vi) of proposed Sec. 23.160 (Proposed Rule Sec.

23.160(a)(10)(vii)).47

—————————————————————————

47 See Sec. 23.160(a)(10) of the Proposed Rule.

—————————————————————————

A non-U.S. person is defined to be any person that is not a U.S.

person.48

—————————————————————————

48 See Sec. 23.160(a)(5) of the Proposed Rule.

—————————————————————————

The proposed definition is generally consistent with the definition

of this term set forth in the Guidance, with certain exceptions

discussed below.

Prongs (1), (2), (3), (4), (5), and (7) (Proposed Rule Sec.

23.160(a)(10)(i), (ii), (iii), (iv), (v), and (vii)) identify certain

persons as a “U.S. person” by virtue of their domicile or

organization within the United States. The Commission has traditionally

looked to where a legal entity is organized or incorporated (or in the

case of a natural person, where he or she resides) to determine whether

it

[[Page 41383]]

is a U.S. person.49 In the Commission’s view, these persons–by

virtue of their decision to organize or locate in the United States and

because they are likely to have significant financial and legal

relationships in the United States–are appropriately included within

the definition of “U.S. person” for purposes of the proposed cross-

border margin framework.

—————————————————————————

49 See, e.g., 17 CFR 4.7(a)(1)(iv) (defining “Non-United

States person” for purposes of part 4 of the Commission regulations

relating to commodity pool operators).

—————————————————————————

Under prong (3) (Proposed Rule Sec. 23.160(a)(10)(iii)),

consistent with its traditional approach, the Commission proposes to

define “U.S. person” also to include persons that are organized or

incorporated outside the United States, but have their principal place

of business in the United States. For purposes of this prong, the

Commission proposes to interpret “principal place of business” to

mean the location from which the officers, partners, or managers of the

legal person primarily direct, control, and coordinate the activities

of the legal person. This interpretation is consistent with the Supreme

Court’s decision in Hertz Corp. v. Friend, which described a

corporation’s principal place of business, for purposes of diversity

jurisdiction, as the “place where the corporation’s high level

officers direct, control, and coordinate the corporation’s

activities.” 50

—————————————————————————

50 See Hertz Corp. v. Friend, 559 U.S. 77, 80 (2010).

—————————————————————————

The Commission is of the view that the application of the principal

place of business concept to a fund may require consideration of

additional factors beyond those applicable to operating companies. In

the case of a fund, the Commission notes that the senior personnel that

direct, control, and coordinate a fund’s activities are generally not

the persons who are named as directors or officers of the fund, but

rather are persons who work for the fund’s investment adviser or the

fund’s promoter. Therefore, consistent with the Guidance, the

Commission generally would consider the principal place of business of

a fund to be in the United States if the senior personnel responsible

for either (1) the formation and promotion of the fund or (2) the

implementation of the fund’s investment strategy are located in the

United States, depending on the facts and circumstances that are

relevant to determining the center of direction, control and

coordination of the fund.51

—————————————————————————

51 See the Guidance, 78 FR 45309-45312, for guidance on

application of the principal place of business test to funds and

other collective investment vehicles in the context of cross-border

swaps, including examples of how the Commission’s approach could

apply to a consideration of whether the “principal place of

business” of a fund is in the United States in particular

hypothetical situations. However, because of variations in the

structure of collective investment vehicles as well as the factors

that are relevant to the consideration of whether a collective

investment vehicle has its principal place of business in the United

States under the Guidance, these examples were included in the

Guidance for illustrative purposes only.

—————————————————————————

Prong (6) (Proposed Rule Sec. 23.160(a)(10)(vi)) of the proposed

definition of “U.S. person” would include certain legal entities

owned by one or more U.S. person(s) and for which such person(s) bear

unlimited responsibility for the obligations and liabilities of the

legal entity. As noted above, the Guidance included a similar concept

in the definition of the term “U.S. person;” however the definition

contained in the Guidance would generally characterize a legal entity

as a U.S. person if the entity were “directly or indirectly majority-

owned” by one or more persons falling within the term “U.S. person”

and such U.S. person(s) bears unlimited responsibility for the

obligations and liabilities of the legal entity. Where a U.S. person

serves as a financial backstop for all of a legal entity’s obligations

and liabilities, creditors and counterparties look to the U.S. person

when assessing the risk in dealing with the entity, regardless of the

amount of equity owned by the U.S. person. Under such circumstances,

because the U.S. person has unlimited responsibility for all of the

legal entity’s obligations, the Commission believes that the legal

entity should be deemed to be a U.S. person.

The Proposed Rule would not include the U.S. majority-ownership

prong that was included in the Guidance (50% U.S. person ownership of a

fund or other collective investment vehicle).52 Some commenters have

argued that a majority ownership test for funds should not be included

on the basis that ownership alone is not indicative of whether the

activities of a non-U.S. fund with a non-U.S.-based manager has a

direct and significant effect on the U.S. financial system, and that it

is difficult to determine the identity of the beneficial owner of a

fund in certain fund structures (e.g., fund-of-funds or master-feeder).

Alternatively, an argument for retaining the majority-ownership test

would be that many of these funds have large U.S. investors, who can be

adversely impacted in the event of a counterparty default. On balance,

the Commission believes the majority-ownership test should not be

included in the definition of U.S. person for purposes of the margin

rules. Non-U.S. funds with U.S. majority-ownership, even if treated as

a non-U.S. person, would be excluded from the Commission’s margin rules

only in limited circumstances (namely, when these funds trade with a

non-U.S. CSE that is not a consolidated subsidiary of a U.S. entity or

a U.S. branch of a non-U.S. CSE). This, coupled with the implementation

issues raised by commenters, persuades the Commission not to propose to

define those funds that are majority-owned by U.S. persons (and that

would otherwise not fall within the definition of a “U.S. person”),

as U.S. persons.

—————————————————————————

52 The Commission’s definition of the term “U.S. person” as

used in the Guidance included a prong (iv) which covered “any

commodity pool, pooled account, or collective investment vehicle

(whether or not it is organized or incorporated in the United

States) of which a majority ownership is held, directly or

indirectly, by a U.S. person(s).”

—————————————————————————

The proposed definition of “U.S. person” determines a legal

person’s status at the entity level and thus includes any foreign

operations that are part of the U.S. legal person, regardless of their

location. Consistent with this approach, the definition of “U.S.

person” under the Proposed Rule would include a foreign branch of a

U.S. person.

Under the proposed definition, the status of a legal person as a

U.S. person would not affect whether a separately incorporated or

organized legal person in the affiliated corporate group is a U.S.

person. Therefore, an affiliate or a subsidiary of a U.S. person that

is organized or incorporated in a non-U.S. jurisdiction would not be

deemed a “U.S. person” solely by virtue of its relationship with a

U.S. person.

The proposed “U.S. person” definition does not include the

prefatory phrase “includes, but is not limited to” that was included

in the Guidance. The Commission believes that this prefatory phrase

should not be included in order to provide legal certainty regarding

the application of U.S. margin requirements to cross-border swaps.

The Commission understands that the information necessary for a

swap counterparty to accurately assess the status of its counterparties

as U.S. persons may not be available, or may be available only through

overly burdensome due diligence. For this reason, the Commission

believes that a swap counterparty generally should be permitted to

reasonably rely on its counterparty’s written representation in

determining whether the counterparty is within the definition of the

term “U.S. person.” In this context, the Commission’s policy is to

interpret the “reasonable” standard to be satisfied

[[Page 41384]]

when a party to a swap conducts reasonable due diligence on its

counterparties, with what is reasonable in a particular situation to

depend on the relevant facts and circumstances.53

—————————————————————————

53 The Commission notes that under the External Business

Conduct Rules, a SD or MSP generally meets its due diligence

obligations if it reasonably relies on counterparty representations,

absent indications to the contrary. As in the case of the External

Business Rules, the Commission believes that allowing for reasonable

reliance on counterparty representations encourages objectivity and

avoids subjective evaluations, which in turn facilitates a more

consistent and foreseeable determination of whether a person is

within the Commission’s interpretation of the term “U.S. person.”

—————————————————————————

Under the Proposed Rule, a “non-U.S. person” is any person that

is not a “U.S. person” (as defined in the Proposed Rule).54

References in this preamble to a “U.S. counterparty” are to a swap

counterparty that is a “U.S. person” under the Proposed Rule, and

references to a “non-U.S. counterparty” are to a swap counterparty

that is a “non-U.S. person” under the Proposed Rule.55

—————————————————————————

54 See Sec. 23.160(a)(5) of the Proposed Rule.

55 Under the Proposed Rule, a “U.S. CSE” is a CSE that is a

U.S. person. The term “U.S. CSE” includes a foreign branch of a

U.S. CSE. A “non-U.S. CSE” is any CSE that is not a U.S. person.

—————————————————————————

Request for Comment. The Commission requests comment on all aspects

of the proposed definition of “U.S. person,” including the following:

1. Does the proposed definition of “U.S. person” appropriately

identify all individuals or entities that should be designated as U.S.

persons? Is the proposed definition too narrow or broad? Why?

2. Should the definition of “U.S. person” include the U.S.

majority-ownership prong for funds and other collective investment

vehicles, as set forth in the Guidance? Please explain.

3. Should the definition of “U.S. person” include certain legal

entities owned by one or more persons described in prongs (1), (2),

(3), (4), or (5) (Proposed Rule Sec. 23.160(a)(10)(i), (ii), (iii),

(iv) or (v)) of the proposed U.S. person definition who bear(s)

unlimited responsibility for the obligations and liabilities of the

legal entity? Please explain.

4. Should the definition of “U.S. person” be identical to the

definition of “U.S. person” that the SEC adopted in its August 2014

rulemaking? For example:

a. Should the definition of “U.S. person” exclude certain

designated (and any similar) international organizations, their

agencies and pension plans, with headquarters in the United States?

b. Should the Commission define the term “principal place of

business” as the location from which the officers, partners, or

managers of a legal person primarily direct, control, and coordinate

the activities of the legal person, and specify that in the case of an

externally managed investment vehicle, this location is the office from

which the manager of the vehicle primarily directs, controls, and

coordinates the investment activities of the vehicle?

c. Should the Commission delete prong (6) (Proposed Rule Sec.

23.160(a)(10)(vi)) of the proposed definition of “U.S. person” which

includes certain legal entities owned by one or more U.S. person(s) and

for which such person(s) bear unlimited responsibility for the

obligations and liabilities of the legal entity and instead treat such

arrangements as recourse guarantees?

d. Should any other changes be made to the proposed definition of

“U.S. person” to conform it to the definition adopted by the SEC?

2. Guarantees

Under the Proposed Rule, uncleared swaps of non-U.S. CSEs, where

the non-U.S. CSE’s obligations under the uncleared swap are guaranteed

by a U.S. person, would be treated the same as uncleared swaps of a

U.S. CSE. The Commission believes that this treatment is appropriate

because the swap of a non-U.S. CSE whose obligations under the swap are

guaranteed by a U.S. person is identical, in relevant respects, to a

swap entered directly by a U.S. person. That is, by virtue of the

guarantee, the U.S. guarantor is responsible for the swap it guarantees

in a manner similar to a direct counterparty to the swap. The U.S.

person guarantor effectively acts jointly with the non-U.S. person

whose swap it guarantees to engage in swaps transactions. The

counterparty, pursuant to the recourse guarantee, looks to both the

direct non-U.S. counterparty and its U.S. guarantor in entering into

the swap.

The Proposed Rule would define the term “guarantee” as an

arrangement pursuant to which one party to a swap transaction with a

non-U.S. counterparty has rights of recourse against a U.S. person

guarantor (whether such guarantor is affiliated with the non-U.S.

counterparty or is an unaffiliated third party) with respect to the

non-U.S. counterparty’s obligations under the relevant swap

transaction. Under the Commission’s proposal, a party to a swap

transaction has rights of recourse against the U.S. person guarantor if

the party has a conditional or unconditional legally enforceable right,

in whole or in part, to receive payments from, or otherwise collect

from, the U.S. person in connection with the non-U.S. person’s

obligations under the swap.56 Accordingly, the term “guarantee”

would apply whenever a party to the swap has a legally enforceable

right of recourse against the U.S. guarantor of a non-U.S.

counterparty’s obligations under the relevant swap, regardless of

whether such right of recourse is conditioned upon the non-U.S.

counterparty’s insolvency or failure to meet its obligations under the

relevant swap, and regardless of whether the counterparty seeking to

enforce the guarantee is required to make a demand for payment or

performance from the non-U.S. counterparty before proceeding against

the U.S. guarantor.

—————————————————————————

56 See Sec. 23.160(a)(2) of the Proposed Rule.

—————————————————————————

Under the Proposed Rule, the terms of the guarantee need not

necessarily be included within the swap documentation or even otherwise

reduced to writing (so long as legally enforceable rights are created

under the laws of the relevant jurisdiction), provided that a swap

counterparty has a conditional or unconditional legally enforceable

right, in whole or in part, to receive payments from, or otherwise

collect from, the U.S. person in connection with the non-U.S. person’s

obligations under the swap.57

—————————————————————————

57 Further, the definition of “guarantee” is intended to

encompass any swap of a non-U.S. person where the counterparty to

the swap has rights of recourse, regardless of the form of the

arrangement, against at least one U.S. person (either individually

or jointly or severally with others) for the non-U.S. person’s

obligations under the swap.

—————————————————————————

Further, the Commission’s proposed definition of guarantee would

not be affected by whether the U.S. guarantor is an affiliate of the

non-U.S. CSE because, in each case, the swap counterparty has a

conditional or unconditional legally enforceable right, in whole or in

part, to receive payments from, or otherwise collect from, the U.S.

person in connection with the non-U.S. person’s obligations under the

swap.

The Commission notes that the definition of “guarantee” in the

Proposed Rule is narrower in scope than the one used in the

Guidance.58 In proposing this definition, the Commission is cognizant

that many other types of financial arrangements or support, other than

a guarantee as defined in the Proposed Rule, may be provided by a U.S.

person to a non-U.S. CSE (e.g., keepwells and liquidity puts,

[[Page 41385]]

certain types of indemnity agreements, master trust agreements,

liability or loss transfer or sharing agreements). The Commission

understands that these other financial arrangements or support transfer

risk directly back to the U.S. financial system, with possible

significant adverse effects, in a manner similar to a guarantee with a

direct recourse to a U.S. person. The Commission, however, believes

that application of a narrower definition of guarantee for purposes of

identifying those uncleared swaps that should be treated like uncleared

swaps of a U.S. CSEs would reduce the potential for conflict with the

non-U.S. CSE’s home regulator. Moreover, the Commission believes that a

non-U.S. CSE that has been provided with financial arrangements or

support from a U.S. person that do not fall within the term

“guarantee” as defined in the Proposed Rule in many cases is likely

to meet the definition of a “Foreign Consolidated Subsidiary” and

therefore, as discussed in the next section, would be subject to the

Commission’s margin requirements, with substituted compliance (but not

the Exclusion) available. Therefore, the Commission believes that a

narrow definition of guarantee would achieve a more workable framework

for non-U.S. CSEs, without undermining protection of U.S. persons and

U.S. financial system.

—————————————————————————

58 In the Guidance, the Commission interpreted the term

“guarantee” generally to include not only traditional guarantees

of payment or performance of the related swaps, but also other

formal arrangements that, in view of all the facts and

circumstances, support the non-U.S. person’s ability to pay or

perform its swap obligations with respect to its swaps.

—————————————————————————

The Commission is aware that some non-U.S. CSEs removed guarantees

in order to fall outside the scope of certain Dodd-Frank requirements.

The proposed coverage of foreign subsidiaries of a U.S. person as a

“Foreign Consolidated Subsidiary,” which is discussed in the next

section, and whose swaps would not be eligible for the Exclusion under

any circumstances (as discussed in section II.C.3. below), would

address the concern that even without a guarantee, as defined under the

Guidance or in the Proposed Rule, foreign subsidiaries of a U.S. person

with a substantial nexus to the U.S. financial system are adequately

covered by the margin requirements.

Request for Comment. The Commission seeks comment on all aspects of

the proposed definition of “guarantee,” including the following:

1. Should the broader use of the term “guarantee” in the Guidance

be used instead of the proposed definition, and if so, why? Would an

alternative definition be more effective in light of the purpose of the

margin requirements, and if so, why?

2. Is the Commission’s assumption that a non-U.S. CSE is likely to

meet the definition of a “Foreign Consolidated Subsidiary” when it

has been provided with financial arrangements or support from a U.S.

person that do not fall within the term “guarantee” (as defined in

the Proposed Rule) correct? If not, why not?

3. Is it appropriate to distinguish, for purposes of the Proposed

Rule, between those arrangements under which a party to the swap has a

legally enforceable right of recourse against the U.S. guarantor and

those arrangements where there is not direct recourse against a U.S.

guarantor?

3. Foreign Consolidated Subsidiaries

The Proposed Rule uses the term “Foreign Consolidated Subsidiary”

in order to identify swaps of those non-U.S. CSEs whose obligations

under the relevant uncleared swap are not guaranteed by a U.S. person

but that raise substantial supervisory concern in the United States, as

a result of the possible negative impact on their U.S. parent entities

and the U.S. financial system. Consolidated financial statements report

the financial position, results of operations and statement of cash

flows of a parent entity together with subsidiaries in which the parent

entity has a controlling financial interest (which are required to be

consolidated under U.S. generally accepted accounting principles

(“GAAP”)). In the Commission’s view, the fact that an entity is

included in the consolidated financial statements of another is an

indication of potential risk to the other entity that offers a clear

and objective standard for the application of margin requirements.

Specifically, the Proposed Rule defines the term “Foreign

Consolidated Subsidiary” as a non-U.S. CSE in which an ultimate parent

entity 59 that is a U.S. person has a controlling interest, in

accordance with U.S. GAAP, such that the U.S. ultimate parent entity

includes the non-U.S. CSE’s operating results, financial position and

statement of cash flows in the U.S. ultimate parent entity’s

consolidated financial statements, in accordance with U.S. GAAP.

—————————————————————————

59 Under the Proposed Rule, the term “ultimate parent

entity” means the parent entity in a consolidated group in which

none of the other entities in the consolidated group has a

controlling interest, in accordance with U.S. GAAP.

—————————————————————————

In the case of Foreign Consolidated Subsidiaries whose obligations

under the relevant swap are not guaranteed by a U.S. person,

substituted compliance would be broadly available under the Proposed

Rule to the same extent as other non-U.S. CSEs whose obligations under

the relevant swap are not guaranteed by a U.S. person, even though the

financial position, operating results, and statement of cash flows of

the Foreign Consolidated Subsidiary have a direct impact on the

financial position, risk profile and market value of the consolidated

group (which includes a U.S. parent entity); however, the Exclusion

would not be available for swaps with a Foreign Consolidated Subsidiary

because their swap activities have a direct impact on the financial

position, risk profile, and market value of a U.S. parent entity that

consolidates the Foreign Consolidated Subsidiary’s financial statements

and a potential spill-over effect on the U.S. financial system.60

—————————————————————————

60 The Exclusion under the Proposed Rule is discussed in

section II.C.3. below.

—————————————————————————

The Commission believes that not extending the Exclusion to Foreign

Consolidated Subsidiaries under the Proposed Rule would be appropriate

because the U.S. parent entity that consolidates the Foreign

Consolidated Subsidiary’s financial statements may have an incentive to

provide support to a Foreign Consolidated Subsidiary, or the Foreign

Consolidated Subsidiary may pose financial risk to the U.S. parent

entity. In addition, market participants (including counterparties) may

have the expectation that the parent entity will provide support to the

Foreign Consolidated Subsidiary although, whether the U.S. parent

entity actually steps in to fulfill the obligations of the Foreign

Consolidated Subsidiary would depend on a business judgment rather than

a legal obligation.61 Notably, although consolidation has a direct

impact on the U.S. parent entity, the U.S. parent entity stands in a

different legal position than a U.S. guarantor because, in the absence

of a direct recourse guarantee, the U.S. parent entity has no legal

obligation to pay or perform under the relevant swap if the Foreign

Consolidated Subsidiary defaults on its swap obligations. Therefore,

the Commission believes that, in the absence of a direct recourse

[[Page 41386]]

guarantee from a U.S. person, uncleared swaps with a Foreign

Consolidated Subsidiary should not be treated the same as swaps with a

U.S. CSE or a non-U.S. CSE whose obligations under the relevant swap

are guaranteed by a U.S. person.

—————————————————————————

61 For example, when General Electric announced on April 10,

2015 that it would guarantee repayment of approximately $210 billion

of debt from GE Capital, the prices of some GE Capital bonds

reportedly went up as much as 1.5% even though previously the parent

company had provided other support but not an unconditional

guarantee. According to an article in the Wall Street Journal,

Russell Solomon, an analyst at Moody’s Investors Service, stated:

“We’ve always assumed that GE would support GE Capital almost no

matter what . . . But now this says they’ll support it no matter

what.” Similarly, the article reports that Standard & Poor’s Rating

Services stated that General Electric’s decision to back GE Capital

debt “strengthens our view of GE’s support, by buttressing the

parent’s proven willingness and ability to support its subsidiary

with a contractual obligation to do so.” See Mike Cherney and Katy

Burne, WSJ, Apr. 10, 2015, available at http://www.wsj.com/articles/ges-move-alters-the-bond-market-1428707800.

—————————————————————————

The Commission considered proposing a “control” test similar to

that proposed by the Prudential Regulators. The “control test” in the

Prudential Regulators’ proposal is based solely on an entity’s

ownership level and control of the election of the board,62 which may

or may not clearly identify, depending on the facts and circumstances,

those non-U.S. CSEs that are likely to raise greater supervisory

concerns than other non-U.S. CSEs (in each case whose obligations under

the relevant swap are not guaranteed by a U.S. person). Therefore, the

Commission is using a “consolidation test” rather than a “control

test” in the proposed definition of a “Foreign Consolidated

Subsidiary” in order to provide a clear, bright-line test for

identifying those non-U.S. CSEs whose uncleared swaps are likely to

raise greater supervisory concerns.

—————————————————————————

62 Under the Prudential Regulators’ proposal, the term

“control” of another company means: (1) Ownership, control, or

power to vote 25 percent or more of a class of voting securities of

the company, directly or indirectly or acting through one or more

other persons; (2) ownership or control of 25 percent or more of the

total equity of the company, directly or indirectly or acting

through one or more other persons; or (3) control in any manner of

the election of a majority of the directors or trustees of the

company.

—————————————————————————

Request for Comment. The Commission seeks comment on all aspects of

the Proposed Rule’s definition of “Foreign Consolidated Subsidiary,”

including:

1. Does the proposed definition of a “Foreign Consolidated

Subsidiary” appropriately capture those non-U.S. CSEs that should not

be eligible for the Exclusion? If not, please explain and provide an

alternative(s).

2. The consolidation test in the definition of a “Foreign

Consolidated Subsidiary” is intended to provide a clear, bright-line

test for identifying those non-U.S. CSEs whose uncleared swaps are

likely to raise greater supervisory concerns relative to other non-

guaranteed non-U.S. CSEs. Should the proposed consolidation test be

used in lieu of the control test proposed by the Prudential Regulators?

Why or why not? Should the Commission use both a consolidation test and

a control test? If so, please explain. Would any other tests or

criteria be more appropriate? If so, please explain what tests or

criteria should be used and why they are more appropriate.

3. Under the definition of Foreign Consolidated Subsidiary, the

Commission is using U.S. GAAP as the standard for purposes of

determining whether an entity consolidates another entity. In reviewing

registration data of CSEs, the Commission believes that this definition

balances the goals of the statute and the burdens placed on the

industry; however, should the Commission also consider including in the

definition of Foreign Consolidated Subsidiary, non-U.S. CSEs whose U.S.

ultimate parent entity uses a different standard than U.S. GAAP in

determining whether a parent entity must consolidate an entity for

financial reporting purposes? If so, please explain why.

4. Should the Commission also include in the definition of

“Foreign Consolidated Subsidiary” those non-U.S. CSEs whose U.S.

ultimate parent entity is not required to prepare consolidated

financial statements under any accounting standard or for any other

reason (e.g., the U.S. ultimate parent entity is not a public company

under federal securities laws and is not required to prepare

consolidated financial statements by private investors or debtholders

as a condition to investing or financing), but which would consolidate

the non-U.S. CSE if it were required to prepare consolidated financial

statements in accordance with U.S. GAAP? If so, please explain why?

5. Under the definition of Foreign Consolidated Subsidiary, the

Commission is only including non-U.S. CSEs whose financial statements

are consolidated by an ultimate parent entity that is a U.S. person.

Should the Commission also include immediate and intermediate parent

entities of the non-U.S. CSE in the definition? If so, please explain

why?

C. Applicability of Margin Requirements to Cross-Border Uncleared Swaps

The following section describes the application of the Commission’s

margin rules to cross-border swaps between CSEs and various types of

counterparties, as well as when the Exclusion from the Commission’s

margin requirements would be applicable. Table A to this release (see

below) illustrates how the Proposed Rule would apply to specific

transactions between various types of counterparties, and should be

read in conjunction with the rest of the preamble and the text of the

Proposed Rule.

1. Uncleared Swaps of U.S. CSEs or Non-U.S. CSEs Whose Obligations

Under the Relevant Swap Are Guaranteed by a U.S. Person

Under the Proposed Rule, the Commission’s margin rules 63 would

apply to all uncleared swaps of U.S. CSEs,64 with no exclusions. By

their nature, U.S. CSEs have a significant impact on the U.S. swaps

market, and the Commission therefore has a strong interest in ensuring

their viability. However, substituted compliance would be available

with respect to initial margin posted to (but not collected from) any

non-U.S. counterparty (including a non-U.S. CSE) whose obligations

under the uncleared swap are not guaranteed by a U.S. person. The

Commission proposes to provide substituted compliance in this situation

(assuming that the non-U.S. counterparty is subject to comparable

margin requirements in a foreign jurisdiction) because the swap

counterparty is a non-U.S. person and where its swap obligations are

not guaranteed by a U.S. person, the foreign regulator may have equal

or greater interest in the collection of margin by the non-U.S.

counterparty. However, substituted compliance would not apply to the

collection of margin by the U.S. CSE from the non-U.S. counterparty, as

the Commission has a significant regulatory interest in the collection

of margin by the U.S. CSE, which protects the U.S. CSE and the U.S.

financial system from counterparty credit risk.

—————————————————————————

63 The Commission’s Proposed Margin Rules are set forth in

proposed Sec. Sec. 23.150 through 23.159 of part 23 of the

Commission’s regulations, proposed as 17 CFR 23.150 through 23.159.

64 Foreign branches of a U.S. CSE are treated as part of the

related principal entity and hence an uncleared swap executed by or

through a foreign branch would be treated as an uncleared swap of a

U.S. CSE.

—————————————————————————

The same treatment that applies to U.S. CSEs would also apply to a

non-U.S. CSE whose obligations under the relevant swap are guaranteed

by a U.S. person. The Commission believes that this result is

appropriate because the economics of the transaction are no different

from a trade entered directly by the U.S. guarantor, as discussed in

section II.B.2. above. In addition, the Commission believes that

treating uncleared swaps of these entities differently from those of

U.S. CSEs would lead to unwarranted competitive distortions. That is,

the non-U.S. CSE that enters into a swap with a direct recourse

guarantee from a U.S. person would be positioned to benefit from more

competitive pricing when dealing with non-U.S. counterparties (as

compared to U.S. CSEs) to the extent

[[Page 41387]]

that either substituted compliance or the Exclusion would be available.

The Commission believes that requiring U.S. CSEs and non-U.S. CSEs

whose obligations under the relevant swap are guaranteed by a U.S.

person to comply with its margin requirements, with only limited

substituted compliance for margin posted to (but not collected from)

any non-U.S. counterparty (including a non-U.S. CSE) whose obligations

under the uncleared swap are not guaranteed by a U.S. person, would

help ensure their safety and soundness and support the stability of the

U.S. financial markets, reducing the likelihood of another financial

crisis affecting the U.S. economy.

Request for Comment. The Commission requests comments on all

aspects of the proposed treatment of uncleared swaps of U.S. CSEs and/

or non-U.S. CSEs whose obligations under the relevant swap are

guaranteed by a U.S. person, including:

1. Is the Proposed Rule’s treatment of U.S. CSEs and non-U.S. CSEs

whose obligations under the swap are guaranteed by a U.S. person

appropriate? If not, please explain. If a different treatment should

apply to U.S. CSEs or non-U.S. CSEs whose obligations under the swap

are guaranteed by a U.S. person, please describe the alternative

treatment that should apply and explain why.

2. What are the competitive implications of the proposed treatment

of uncleared swaps of non-U.S. CSEs whose obligations under the swap

are guaranteed by a U.S. person?

3. Does the proposed treatment of non-U.S. CSEs whose obligations

under the swap are guaranteed by a U.S. person appropriately take into

account the supervisory interest of a non-U.S. CSE’s home jurisdiction?

2. Uncleared Swaps of Non-U.S. CSEs (Including Foreign Consolidated

Subsidiaries) Whose Obligations Under the Relevant Swap Are Not

Guaranteed by a U.S. Person

Under the Proposed Rule, non-U.S. CSEs (including Foreign

Consolidated Subsidiaries) whose obligations under the relevant

uncleared swap are not guaranteed by a U.S. person may avail themselves

of substituted compliance to a greater extent than if their obligations

under the swap were guaranteed by a U.S. person. The Commission

believes that this approach is appropriate since a non-U.S. CSE whose

swap obligations are not guaranteed by a U.S. person (including a

Foreign Consolidated Subsidiary), on balance, may implicate equal or

greater supervisory concerns on the part of a foreign regulator

relative to the supervisory interest of the Commission (in comparison

to U.S. CSEs or non-U.S. CSEs whose obligations under the relevant swap

are guaranteed by a U.S. person, because the Commission has a

significant regulatory interest in uncleared swaps of these CSEs).

Under the Proposed Rule, where the obligations of a non-U.S. CSE

(including a Foreign Consolidated Subsidiary) under the relevant swap

are not guaranteed by a U.S. person, substituted compliance would be

available with respect to its uncleared swaps with any counterparty,

except where the counterparty is a U.S. CSE or a non-U.S. CSE whose

obligations under the relevant swap are guaranteed by a U.S.

person.65

—————————————————————————

65 With respect to uncleared swaps with a U.S. CSE or a non-

U.S. CSE whose obligations under the relevant swap are guaranteed by

a U.S. person, substituted compliance would only be available for

initial margin collected by the non-U.S. CSE whose obligations under

the relevant swap are not guaranteed by a U.S. person, as discussed

in section II.C.1.

—————————————————————————

Further, uncleared swaps entered into by Foreign Consolidated

Subsidiaries would not be eligible for the Exclusion under the Proposed

Rule. As described above, the financial position, operating results,

and statement of cash flows of a Foreign Consolidated Subsidiary are

incorporated into the financial statements of the U.S. ultimate parent

entity and therefore, likely have a direct impact on the consolidated

entity’s financial position, risk profile, and market value. Under

these circumstances, and given the importance of margin in mitigating

counterparty credit risk, the Commission has greater supervisory

concerns with respect to the uncleared swaps of a Foreign Consolidated

Subsidiary than other non-U.S. CSEs. Therefore, the Commission believes

that extending the Exclusion to a Foreign Consolidated Subsidiary would

not further the goal of ensuring the safety and soundness of a CSE and

the stability of U.S. financial markets. The Commission is also

concerned that extending the Exclusion to Foreign Consolidated

Subsidiaries would encourage a U.S. entity to use their non-U.S.

subsidiaries to conduct their swap activities with non-U.S.

counterparties, possibly bifurcating the U.S. entity’s U.S. and non-

U.S.-facing businesses, and potentially resulting in separate pools of

liquidity.

Request for Comment. The Commission requests comments on all

aspects of the proposed treatment of uncleared swaps of non-U.S. CSEs

(including Foreign Consolidated Subsidiaries) whose obligations under

the relevant swap are not guaranteed by a U.S. person, including:

1. The Proposed Rule makes substituted compliance more broadly

available to a Foreign Consolidated Subsidiary whose obligations under

the relevant swap are not guaranteed by a U.S. person than a non-U.S.

CSE (including a Foreign Consolidated Subsidiary) whose obligations

under the relevant swap are guaranteed by a U.S. person. Should Foreign

Consolidated Subsidiaries be treated the same as non-U.S. CSEs that are

guaranteed by a U.S. person and if not, what treatment is appropriate?

2. What are the competitive implications of the proposed treatment

of Foreign Consolidated Subsidiaries (relative to other non-U.S. CSEs)?

Does the proposed treatment appropriately take into account the

supervisory interest of a non-U.S. CSE’s home jurisdiction?

3. Exclusion for Uncleared Swaps of Non-U.S. CSEs Where Neither

Counterparty’s Obligations Under the Relevant Swap Are Guaranteed by a

U.S. Person and Neither Counterparty Is a Foreign Consolidated

Subsidiary Nor a U.S. Branch of a Non-U.S. CSE

Under the Proposed Rule, an uncleared swap entered into by a non-

U.S. CSE with a non-U.S. person counterparty (including a non-U.S. CSE)

would be excluded from the Commission’s margin rules, provided that

neither counterparty’s obligations under the relevant swap are

guaranteed by a U.S. person and neither counterparty is a Foreign

Consolidated Subsidiary nor a U.S. branch of a non-U.S. CSE.66

—————————————————————————

66 See Sec. 23.160(b)(2)(ii) of the Proposed Rule.

—————————————————————————

As discussed above, the Commission believes that, given the

importance of margin to the safety and soundness of a CSE, as a general

matter, margin requirements should apply to the uncleared swaps of a

CSE, without regard to the domicile of the counterparty or where the

trade is executed. At the same time, the Commission believes that it is

appropriate to make a limited exception to this principle of firm-wide

application of margin requirements in the cross-border context,

consistent with section 4s(e) of the CEA 67 and comity principles, so

as to exclude a narrow class of uncleared swaps involving a

[[Page 41388]]

non-U.S. CSE and a non-U.S. counterparty.

—————————————————————————

67 Section 4s(e)(3)(A) of the CEA, 7 U.S.C. 6s(e)(3)(A). The

section calls for, among other things, that margin requirements “be

appropriate for the risks associated with the non-cleared swaps held

as a swap dealer or major market participant.”

—————————————————————————

The Commission notes that a non-U.S. CSE that can avail itself of

the Exclusion would still be subject to the Commission’s margin rules

with respect to all uncleared swaps not meeting the criteria for the

Exclusion, albeit with the possibility of substituted compliance. The

non-US CSE would also be subject to the Commission’s capital

requirements, which, as proposed, would impose a capital charge for

uncollateralized exposures.68 Additionally, any excluded swaps would

most likely be covered by the margin requirements of another

jurisdiction that adheres to the BCBS-IOSCO framework.69

—————————————————————————

68 See Capital Requirements of Swap Dealers and Major Swap

Participants, Notice of proposed rulemaking, 76 FR 27802 (May 12,

2011).

69 The non-U.S. CSE that qualifies for the exclusion would be

eligible for substituted compliance, with respect to all margin

requirements, if its counterparty to the uncleared swap is a U.S.

person that is not a CSE. If the uncleared swap is with a U.S. CSE,

substituted compliance would only be available with respect to

initial margin posed by the U.S. CSE counterparty.

—————————————————————————

The Commission also recognizes that the supervisory interest of

foreign regulators in the uncleared swaps of non-U.S. CSEs (and their

non-U.S. counterparties) that are eligible for the Exclusion may equal

or exceed the supervisory interest of the United States in such

uncleared swaps. Both counterparties are domiciled outside the United

States and likely would be subject to the supervision of a foreign

regulator. As discussed above, the Commission believes that a workable

cross-border framework must take into account the interests of other

jurisdictions and balance those interests with the supervisory

interests of the United States in order to calibrate the application of

margin rules to non-U.S. CSEs’ swaps with non-U.S. counterparties. Such

an approach would help mitigate the potential for conflicts with other

jurisdictions and ultimately promote global harmonization. For all of

the foregoing reasons, the Commission believes that it would be

appropriate to not apply the Commission’s margin rules to uncleared

swaps meeting the criteria for the Exclusion.

The Commission acknowledges that similar mitigating factors and

comity considerations may apply to Foreign Consolidated Subsidiaries,

but as discussed above, a Foreign Consolidated Subsidiary’s financial

position, operating results, and statement of cash flows are directly

reflected in its U.S. Ultimate Parent entity’s financial statements,

which implicates greater supervisory concerns. Therefore, the

Commission believes that it has a greater regulatory interest in

Foreign Consolidated Subsidiaries than other non-U.S. CSEs (that are

not guaranteed by a U.S. person), and that the uncleared swaps of

Foreign Consolidated subsidiaries should not be excluded from the

margin requirements.

Further, the Commission believes that the uncleared swaps of a U.S.

branch of a non-U.S. CSE should not be excluded from the margin

requirements for the reasons discussed in the next section.

Request for Comment. The Commission is requesting comments on all

aspects of the proposed Exclusion, including:

1. In light of the mitigating factors cited above and the

Commission’s supervisory interest in the safety and soundness of all

CSEs and the critical role that margin plays in helping ensure the

safety and soundness of CSEs, is the proposed Exclusion appropriate,

and if not, please explain why not? Is the scope of the Exclusion

appropriate, or should it be broader or narrower, and if so, why?

2. Under the Proposed Rule, uncleared swaps with a Foreign

Consolidated Subsidiary would not be eligible for the Exclusion from

the Commission’s margin requirements. Should Foreign Consolidated

Subsidiaries be eligible for the Exclusion and if so, why?

4. U.S. Branches of Non-U.S. CSEs

The Proposed Rule treats uncleared swaps executed through or by a

U.S. branch of a non-U.S. CSE the same as those swaps of a non-U.S.

CSE, except that the Exclusion from the margin rules would not be

available to a U.S. branch of a non-U.S. CSE.

Generally speaking, because the risks posed by uncleared swaps are

borne by a CSE as a whole, it should not matter if the transaction is

entered by or through a U.S. branch or office within the United States.

Nevertheless, the Commission believes that extending the Exclusion (to

the extent than the Exclusion might otherwise apply to the non-U.S.

CSE, as discussed above) would not be appropriate in the case of

uncleared swaps executed by or through a U.S. branch of a non-U.S. CSE.

The Commission notes that non-U.S. CSEs can conduct their swap

dealing business within the United States utilizing a number of

different legal structures, including a U.S. subsidiary or a U.S.

branch or office. Excluding uncleared swaps conducted by or through

U.S. branches of non-U.S. CSEs would give these non-U.S. CSEs an unfair

advantage when dealing with non-U.S. clients relative to U.S. CSEs

(including those CSEs that are subsidiaries of foreign entities). That

is, a U.S. branch of a non-U.S. CSE that is permitted to operate

outside of the Commission’s margin requirements would be able to offer

a more competitive price to non-U.S. clients than a U.S. CSE. The

Commission believes that when a non-U.S. CSE is conducting its swap

activities within the United States through a branch or office located

in the United States, it should be subject to U.S. margin laws.

However, the Commission also believes that, consistent with comity

principles, substituted compliance should be available for uncleared

swaps executed by or through a U.S. branch of a non-U.S. CSE whose

obligations under the relevant swap are not guaranteed by a U.S. person

with any counterparty (except where the counterparty is a U.S. CSE or a

non-U.S. CSE whose obligations under the relevant swap are guaranteed

by a U.S. person).70

—————————————————————————

70 With respect to uncleared swaps with a U.S. CSE or a non-

U.S. CSE whose obligations under the relevant swap are guaranteed by

a U.S. person, substituted compliance would only be available for

initial margin collected by the U.S. branch of a non-U.S. CSE whose

obligations under the relevant swap are not guaranteed by a U.S.

person. See section II.C.1.

—————————————————————————

Request for Comment. The Commission seeks comment on the Proposed

Rule’s treatment of uncleared swaps conducted by or through a “U.S.

branch of a non-U.S. CSE.” In particular, the Commission requests

comment on the following questions:

1. How should the Commission determine whether a swap is executed

through or by a U.S. branch of a non-U.S. CSE for purposes of applying

the Commission’s margin rules on a cross-border basis? Should the

Commission base the determination of whether the swap activity is

conducted at a U.S. branch of a non-U.S. CSE for purposes of applying

the Commission’s margin rules on a cross-border basis on the same

analysis as is used in the Volcker rule? 71

—————————————————————————

71 Under the Volcker rule, personnel that arrange, negotiate,

or execute a purchase or sale conducted under the exemption for

trading activity of a foreign banking entity must be located outside

of the United States. See Prohibitions and Restrictions on

Proprietary Trading and Certain Interests in, and Relationships

With, Hedge Funds and Private Equity Funds; Final Rule, 79 FR 5808

(Jan. 31, 2014). Thus, for example, personnel in the United States

cannot solicit or sell to or arrange for trades conducted under this

exemption. Personnel in the United States also cannot serve as

decision makers in transactions conducted under this exemption.

Personnel that engage in back-office functions, such as clearing and

settlement of trades, would not be considered to arrange, negotiate,

or execute a purchase or sale for purposes of this provision. Id. at

5927, n.1526.

—————————————————————————

2. The Commission seeks comment on the proposed treatment of U.S.

branches

[[Page 41389]]

of non-U.S. CSEs, including whether these branches should be eligible

for the Exclusion in light of the policy objectives outlined above. If

the Exclusion should be available, please explain why. The Commission

also seeks comment regarding whether the scope of substituted

compliance for U.S. branches of non-U.S. CSEs under the Proposed Rule

is appropriate. If not, please explain why.

D. Substituted Compliance

As noted above, consistent with CEA section 2(i) and comity

principles, the Commission would allow CSEs to comply with comparable

margin requirements in a foreign jurisdiction under certain

circumstances. In this release, we are proposing to establish a

standard of review that will apply to Commission determinations

regarding whether some or all of the relevant foreign jurisdiction’s

margin requirements are comparable to the Commission’s corresponding

margin requirements, as well as procedures for requests for

comparability determinations, including eligibility requirements and

submission requirements.

Specifically, the Commission would permit a U.S. CSE or a non-U.S.

CSE, as applicable, to avail itself of substituted compliance (to the

extent applicable under the Proposed Rule) by complying with the margin

requirements of the relevant foreign jurisdiction in lieu of compliance

with the Commission’s margin requirements, provided that the Commission

finds that such jurisdiction’s margin requirements are comparable to

the Commission’s margin requirements. Failure to comply with the

applicable foreign margin requirements could result in a violation of

the Commission’s margin requirements. Further, all CSEs, regardless of

whether they rely on a comparability determination, would remain

subject to the Commission’s examination and enforcement authority.72

—————————————————————————

72 Under Commission regulations 23.203 and 23.606, all records

required by the CEA and the Commission’s regulations to be

maintained by a registered swap dealer or MSP shall be maintained in

accordance with Commission regulation 1.31 and shall be open for

inspection by representatives of the Commission, the United States

Department of Justice, or any applicable prudential regulator. The

Commission believes that, before a non-U.S. CSE should be permitted

to rely on substituted compliance, it should assure the Commission

that it can provide the Commission with prompt access to books and

records and submit to onsite inspection and examination. The

Commission further expects that access to books and records and the

ability to inspect and examine a non-U.S. CSE will be a condition to

any comparability determination.

—————————————————————————

The Commission is proposing a comparability standard that is

outcome-based with a focus on whether the margin requirements in the

foreign jurisdiction achieve the same regulatory objectives as the

CEA’s margin requirements. Under this outcome-based approach, the

Commission would not look to whether a foreign jurisdiction has

implemented specific rules and regulations that are identical to rules

and regulations adopted by the Commission. Rather, the Commission would

evaluate whether a foreign jurisdiction has rules and regulations that

achieve comparable outcomes. If it does, the Commission believes that a

comparability determination may be appropriate, even if there may be

differences in the specific elements of a particular regulatory

provision.73

—————————————————————————

73 As noted below, because the Commission would make

comparability determinations on an element-by-element basis, it is

possible that a foreign jurisdiction’s margin requirements would be

comparable with respect to some, but not all, elements of the margin

requirements.

—————————————————————————

In evaluating whether a foreign jurisdiction’s margin requirements

are comparable to the Commission’s margin requirements, the Commission

would consider whether the foreign jurisdiction’s margin rules are

consistent with international standards.74 That is, the Commission

would determine, considering all relevant facts and circumstances,

whether a foreign jurisdiction has adopted margin rules that adequately

address the BCBS-IOSCO framework. The Commission believes that

considering this factor is appropriate because BCBS and IOSCO

established this framework to ensure globally harmonized margin rules

for uncleared derivative transactions. Individual regulatory

authorities across major jurisdictions (including the EU, Japan, and

the United States) have started to develop their own margin rules

consistent with the final BCBS-IOSCO framework for non-centrally

cleared, bilateral derivatives.75 If the foreign jurisdiction’s

margin rules are not consistent with international standards, then the

Commission may not find the rules comparable. In providing information

to the Commission for a determination, applicants should include, among

other things, information describing any difference between the foreign

jurisdiction’s margin requirements and international standards.76

—————————————————————————

74 Under the Proposed Rule, the term “international

standards” means the margin policy framework for non-cleared,

bilateral derivatives issued by the Basel Committee on Banking

Supervision and the International Organization of Securities

Commissions in September 2013, as subsequently updated, revised, or

otherwise amended, or any other international standards, principles

or guidance relating to margin requirements for non-cleared,

bilateral derivatives that the Commission may in the future

recognize, to the extent that they are consistent with United States

law (including the margin requirements in the Commodity Exchange

Act). See Sec. 23.160(a)(3) of the Proposed Rule. For further

information regarding the margin policy framework for non-cleared,

bilateral derivatives issued by the Basel Committee on Banking

Supervision and the International Organization of Securities in

September 2013, see note 12, supra.

75 See note 13, supra.

76 See Sec. 23.160(c)(2)(iii) of the Proposed Rule.

—————————————————————————

Under the proposal, once the Commission has determined that a

foreign jurisdiction’s margin requirements adhere to the BCBS-IOSCO

framework, the Commission would evaluate the various elements of the

foreign jurisdiction’s margin requirements.77 Because the Commission

is not proposing to make a binary determination of comparability (i.e.,

all or nothing), but instead would make comparability determinations on

an element-by-element basis, it is possible that a foreign margin

system would be comparable with respect to some, but not all, elements

of the margin requirements. For instance, a foreign jurisdiction may

impose variation margin requirements on a non-U.S. CSE’s uncleared

swaps with financial end-users that achieve outcomes comparable to the

Commission’s margin requirements, but the same foreign jurisdiction may

not achieve comparable regulatory outcomes with respect to segregation

and rehypothecation requirements. By assessing each of the relevant

elements separately, the Commission would have the flexibility to

determine, with respect to one element of the requirements, that the

outcomes are comparable, but not another. The elements that the

Commission would be analyzing, among others, would include, but not be

limited to: (i) The transactions subject to the foreign jurisdiction’s

margin requirements; (ii) the entities subject to the foreign

jurisdiction’s margin requirements; (iii) the methodologies for

calculating the amounts of initial and variation margin; (iv) the

process and standards for approving models for calculating initial and

variation margin models; (v) the timing and manner in which initial and

variation margin must be collected and/or paid; (vi) any threshold

levels or amounts; (vii) risk management controls for the calculation

of initial and variation margin; (viii) eligible collateral for initial

and variation margin; (ix) the requirements of custodial arrangements,

including

[[Page 41390]]

rehypothecation and the segregation of margin; (x) documentation

requirements relating to margin; and (xi) the cross-border application

of the foreign jurisdiction’s margin regime.

—————————————————————————

77 See Sec. 23.160(c)(2) of the Proposed Rule.

—————————————————————————

Moreover, the Commission would expect that the applicant, at a

minimum, describe how the foreign jurisdiction’s margin requirements

addresses each of the above-referenced elements, and identify the

specific legal and regulatory provisions that correspond to each

element (and, if necessary, whether the foreign jurisdiction’s margin

requirements do not address a particular element), and describe the

objectives of the foreign jurisdiction’s margin requirements. Further,

the applicant would be required to furnish copies of the foreign

jurisdiction’s margin requirements (including an English translation of

any foreign language document) and any other information or

documentation that the Commission deems appropriate.

In addition, in paragraph (c)(3) of the Proposed Rule,78 the

Commission sets out its standard of review that would take into

consideration all other relevant factors, including but not limited to,

the scope and objectives of the foreign jurisdiction’s margin

requirement(s) for uncleared swaps; how the foreign jurisdiction’s

margin requirements compare to international standards; whether the

foreign jurisdiction’s margin requirements achieve comparable outcomes

to the Commission’s corresponding margin requirements; the ability of

the relevant regulatory authority or authorities to supervise and

enforce compliance with the foreign jurisdiction’s margin requirements;

and any other facts and circumstances the Commission deems

relevant.79

—————————————————————————

78 See Sec. 23.160(c)(3) of the Proposed Rule.

79 The submission should include a description of the ability

of the relevant foreign regulatory authority or authorities to

supervise and enforce compliance with the foreign jurisdiction’s

margin requirements, including the powers of the foreign regulatory

authority or authorities to supervise, investigate, and discipline

entities for compliance with the margin requirements and the ongoing

efforts of the regulatory authority or authorities to detect, deter,

and ensure compliance with the margin requirements. See Sec.

23.160(c)(2)(iv) of the Proposed Rule.

—————————————————————————

The Proposed Rule provides that any CSE that is eligible for

substituted compliance may apply, either individually or collectively.

In addition, the Proposed Rule provides that a foreign regulatory

authority that has direct supervisory authority over one or more

covered swap entities and that is responsible for administering the

relevant foreign jurisdiction’s margin requirements may submit a

request for a comparability determination with respect to some or all

of the Commission’s margin requirements. Persons requesting a

comparability determination may want to coordinate their application

with other market participants and their home regulators to simplify

and streamline the process. Once a comparability determination is made

for a jurisdiction, it will apply for all entities or transactions in

that jurisdiction to the extent provided in the Proposed Rule and the

determination, subject to any conditions specified by the Commission.

The Commission expects that the comparability determination process

would require close consultation, cooperation, and coordination with

other appropriate U.S. regulators and relevant foreign regulators.

Further, the Commission expects that, in connection with a

comparability determination, the foreign regulator(s) would enter into,

or would have entered into, an appropriate memorandum of understanding

(“MOU”) or similar arrangement with the Commission.

In issuing a Comparability Determination, the Commission may impose

any terms and conditions it deems appropriate.80 Further, the

Proposed Rule would provide that the Commission may, on its own

initiative, further condition, modify, suspend, terminate, or otherwise

restrict a comparability determination in the Commission’s discretion.

This could result, for example, from a situation where, after the

Commission issues a comparability determination, the basis of that

determination ceases to be true. In this regard, the Commission would

require an applicant to notify the Commission of any material changes

to information submitted in support of a comparability determination

(including, but not limited to, changes in the relevant foreign

jurisdiction’s supervisory or regulatory regime) as the Commission’s

comparability determination may no longer be valid.81

—————————————————————————

80 The violation of such terms and conditions may constitute a

violation of the Commission’s margin requirements and/or result in

the modification or revocation of the comparability determination.

81 The Commission expects to impose this obligation as one of

the conditions to the issuance of a comparability determination.

—————————————————————————

Request for Comment. The Commission is seeking comments on all

aspects of the proposed standard of review that will apply to

Commission determinations regarding whether some or all of the relevant

foreign jurisdiction’s margin requirements are comparable to the

Commission’s corresponding margin requirements, as well as proposed

procedures for requests for comparability determinations, including

eligibility requirements and submission requirements. Among other

things, commenters may wish to submit comments on the following

questions:

1. Please provide comments on the appropriate standard of review

for comparability determinations and the degree of comparability and

comprehensiveness that should be applied to comparability

determinations.

2. Are the proposed procedures, including eligibility requirements

and submission requirements, for comparability determinations

appropriate?

3. Many foreign jurisdictions are in the process of implementing

margin reform. Should the Commission develop an interim process that

takes into account a different implementation timeline? Please provide

details and address competitive implications for U.S. CSEs and non-U.S.

CSEs that are required to comply with the Commission’s margin

regulations.

4. In the Guidance, the Commission discussed “a de minimis”

exemption with respect to transaction-level requirements for foreign

branches of U.S. swap dealers located in “emerging markets” that, in

the aggregate, constitute less than 5 percent of the firm’s notional

swaps.82 The Proposed Rule does not contain an exemption for CSEs

operating in “emerging markets.” Should the Commission develop an

exemption for emerging markets? If so, what should be the eligibility

criteria or conditions? For example, should the Commission provide an

exemption where a non-U.S. CSE is operating in a jurisdiction that does

not permit the related collateral to be held outside that jurisdiction

and/or that lacks legal or operational infrastructure relating to

proper segregation of initial margin? Should the Commission require the

CSE to collect initial and variation margin from its counterparty in

eligible emerging market jurisdictions, but only require the CSE to

post variation margin? Should the Commission limit the type of eligible

collateral that could be used in eligible emerging market

jurisdictions? Which jurisdictions, if any, should qualify as

“emerging markets” for purposes of the exemption? What should be the

process for determining that the qualifying criteria are met? Please

provide quantitative data, to the extent practical.

—————————————————————————

82 See the Guidance, 78 FR 45351.

—————————————————————————

5. As some emerging market jurisdictions’ laws may not support

legally enforceable netting

[[Page 41391]]

arrangements, which would then, under the Proposed Margin Rules and

under certain circumstances, require that a CSE and its counterparty

post and collect gross margin, should the Commission, if it does not

provide for an emerging markets exception, permit the CSE and its

counterparty to collect/post variation margin on a net basis? If so,

what conditions, if any, should the Commission place on this

requirement to ensure that CSEs and the U.S. financial system are

adequately protected?

6. Is the scope of substituted compliance under the Proposed Rule

appropriate? Should additional or fewer transactions be eligible for

substituted compliance, and if so, how should the Proposed Rule be

modified?

E. General Request for Comments

In addition to the specific requests for comments included above,

the Commission seeks comment on all aspects of the Proposed Rule.

Commenters are encouraged to address, among other things, the scope and

application of the Proposed Rule, costs and benefits of the Proposed

Rule, alternatives to the Proposed Rule, practical implications for

CSEs and other market participants and the market generally related to

the Proposed Rule, whether the Proposed Rule sufficiently supports the

statutory goals of ensuring the safety and soundness of the CSE and

protecting the financial system against the risks associated with

uncleared swaps, and whether the Proposed Rule sufficiently takes into

account principles of international comity. In particular, the

Commission requests comment on the following:

1. Does the Proposed Rule’s approach to the cross-border

application of margin requirements satisfy the Commission’s statutory

requirements, including the requirement to help ensure the safety and

soundness of CSEs, and the requirement that the Commission, the

Prudential Regulators, and the SEC, to the maximum extent practicable,

establish and maintain comparable minimum initial and variation margin

requirements?

2. Would it be more appropriate to apply the margin requirements at

the entity-level, without any exclusion? If yes, please explain.

3. Would it be more appropriate to apply the margin requirements at

a transaction-level? If yes, please explain.

4. Is the scope of the Proposed Rule appropriate, or should it be

changed, and if so, how?

5. Would an alternative approach to the Proposed Rule better

achieve the Commission’s statutory requirements or otherwise be

preferable or more appropriate? If yes, please explain.

6. Does the Commission’s Proposed Rule strike the right balance

between the Commission’s supervisory interest in offsetting the risk to

CSEs and the financial system arising from the use of uncleared swaps

and international comity principles? If not, please explain.

III. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (“RFA”) requires that agencies

consider whether the regulations they propose will have a significant

economic impact on a substantial number of small entities.83 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.84 The proposed regulation

establishes a mechanism for CSEs 85 to satisfy margin requirements by

complying with comparable margin requirements in the relevant foreign

jurisdiction as described in paragraph (c) of the Proposed Rule,86

but only to the extent that the Commission makes a determination that

complying with the laws of such foreign jurisdiction is comparable to

complying with the corresponding margin requirement(s) for which the

determination is sought.

—————————————————————————

83 5 U.S.C. 601 et seq.

84 47 FR 18618 (Apr. 30, 1982).

85 Section 23.151 of the Proposed Margin Rules defines CSEs as

a SD or MSP for which there is no prudential regulator.

86 See Sec. 23.160(c) of the Proposed Rule.

—————————————————————————

The Commission previously has determined that SDs and MSPs are not

small entities for purposes of the RFA.87 Thus, the Commission is of

the view that there will not be any small entities directly impacted by

this rule.

—————————————————————————

87 See 77 FR 30596, 30701 (May 23, 2012).

—————————————————————————

The Commission notes that under the Proposed Margin Rules, SDs and

MSPs would only be required to collect and post margin on uncleared

swaps when the counterparties to the uncleared swaps are either other

SDs and MSPs or financial end users. As noted above, SDs and MSPs are

not small entities for RFA purposes. Furthermore, any financial end

users that may be indirectly 88 impacted by the Proposed Rule would

be similar to eligible contract participants (“ECPs”), and, as such,

they would not be small entities.89 Further, to the extent that there

are any foreign financial entities that would not be considered ECPs,

the Commission expects that there would not be a substantial number of

these entities significantly impacted by the Proposed Rule. As noted

above, most foreign financial entities would likely be ECPs to the

extent they would trade in uncleared swaps. The Commission expects that

only a small number of foreign financial entities that are not ECPs, if

any, would trade in uncleared swaps.

—————————————————————————

88 The RFA focuses on direct impact to small entities and not

on indirect impacts on these businesses, which may be tenuous and

difficult to discern. See Mid-Tex Elec. Coop., Inc. v. FERC, 773

F.2d 327, 340 (D.C. Cir. 1985); Am. Trucking Assns. v. EPA, 175 F.3d

1027, 1043 (D.C. Cir. 1985).

89 As noted in paragraph (1)(xii) of the definition of

“financial end user” in Sec. 23.151 of the Proposed Margin Rules,

a financial end-user includes a person that would be a financial

entity described in paragraphs (1)(i)-(xi) of that definition, if it

were organized under the laws of the United States or any State

thereof. The Commission believes that this prong of the definition

of financial end-user would capture the same type of U.S. financial

end-users that are ECPs, but for them being foreign financial

entities. Therefore, for purposes of the Commission’s RFA analysis,

these foreign financial end-users will be considered ECPs and

therefore, like ECPs in the U.S., not small entities.

—————————————————————————

Accordingly, the Commission finds that there will not be a

substantial number of small entities impacted by the Proposed Rule.

Therefore, the Chairman, on behalf of the Commission, hereby certifies

pursuant to 5 U.S.C. 605(b) that the proposed regulations will not have

a significant economic impact on a substantial number of small

entities.

B. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 (“PRA”) imposes certain

requirements on Federal agencies, including the Commission, in

connection with their conducting or sponsoring any collection of

information, as defined by the PRA. This proposed rulemaking would

result in the collection of information requirements within the meaning

of the PRA, as discussed below. The proposed rulemaking contains

collections of information for which the Commission has not previously

received control numbers from the Office of Management and Budget

(“OMB”). If adopted, responses to this collection of information

would be required to obtain or retain benefits. An agency may not

conduct or sponsor, and a person is not required to respond to, a

collection of information unless it displays a currently valid control

number. The Commission has submitted to OMB an information collection

request to obtain an OMB control number for the collections contained

in this proposal.

Section 731 of the Dodd-Frank Act, amended the CEA,90 to add, as

section

[[Page 41392]]

4s(e) thereof, provisions concerning the setting of initial and

variation margin requirements for SDs and MSPs. Each SD and MSP for

which there is a Prudential Regulator, as defined in section 1a(39) of

the CEA, must meet margin requirements established by the applicable

Prudential Regulator, and each CSE must comply with the Commission’s

regulations governing margin. With regard to the cross-border

application of the swap provisions enacted by Title VII of the Dodd-

Frank Act, section 2(i) of the CEA provides the Commission with express

authority over activities outside the United States relating to swaps

when certain conditions are met. Section 2(i) of the CEA provides that

the provisions of the CEA relating to swaps enacted by Title VII of the

Dodd-Frank Act (including Commission rules and regulations promulgated

thereunder) shall not apply to activities outside the United States

unless those activities (1) have a direct and significant connection

with activities in, or effect on, commerce of the United States or (2)

contravene such rules or regulations as the Commission may prescribe or

promulgate as are necessary or appropriate to prevent the evasion of

any provision of Title VII.91 Because margin requirements are

critical to ensuring the safety and soundness of a CSE and supporting

the stability of the U.S. financial markets, the Commission believes

that its margin rules should apply on a cross-border basis in a manner

that effectively addresses risks to the registered CSE and the U.S.

financial system.

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90 7 U.S.C. 1 et seq.

91 7 U.S.C. 2(i).

—————————————————————————

As noted above, the Proposed Rule would establish margin

requirements for uncleared swaps of CSEs on a firm-wide, entity-level

basis (with substituted compliance available in certain circumstances),

except as to a narrow class of uncleared swaps between a non-U.S. CSE

and a non-U.S. counterparty that fall within the Exclusion. The

Proposed Rule would establish a procedural framework in which the

Commission would consider permitting compliance with comparable margin

requirements in a foreign jurisdiction to substitute for compliance

with the Commission’s margin requirements in certain circumstances. The

Commission would consider whether the requirements of such foreign

jurisdiction with respect to margin of uncleared swaps are comparable

to the Commission’s margin requirements.

Specifically, the Proposed Rule would provide that a CSE who is

eligible for substituted compliance may submit a request, individually

or collectively, for a comparability determination.92 Persons

requesting a comparability determination may coordinate their

application with other market participants and their home regulators to

simplify and streamline the process. Once a comparability determination

is made for a jurisdiction, it would apply for all entities or

transactions in that jurisdiction to the extent provided in the

determination, as approved by the Commission. In providing information

to the Commission for a comparability determination, applicants must

include, at a minimum, information describing any differences between

the relevant foreign jurisdiction’s margin requirements and

international standards,93 and the specific provisions of the foreign

jurisdiction that govern: (i) The transactions subject to the foreign

jurisdiction’s margin requirements; (ii) the entities subject to the

foreign jurisdiction’s margin requirements; (iii) the methodologies for

calculating the amounts of initial and variation margin; (iv) the

process and standards for approving models for calculating initial and

variation margin models; (v) the timing and manner in which initial and

variation margin must be collected and/or paid; (vi) any threshold

levels or amounts; (vii) risk management controls for the calculation

of initial and variation margin; (viii) eligible collateral for initial

and variation margin; (ix) the requirements of custodial arrangements,

including rehypothecation and the segregation of margin; (x)

documentation requirements relating to margin; and (xi) the cross-

border application of the foreign jurisdiction’s margin regime.94

—————————————————————————

92 A CSE may apply for a comparability determination only if

the uncleared swap activities of the CSE are directly supervised by

the authorities administering the foreign regulatory framework for

uncleared swaps. Also, a foreign regulatory agency may make a

request for a comparability determination only if that agency has

direct supervisory authority to administer the foreign regulatory

framework for uncleared swaps in the requested foreign jurisdiction.

93 See note 74, supra, for a discussion of the definition of

“international standards” under the Proposed Rule. See also Sec.

23.160(a)(3) of the Proposed Rule.

94 See Sec. 23.160(c)(2) of the Proposed Rule for submission

requirements.

—————————————————————————

In addition, the Commission would expect the applicant, at a

minimum, to describe how the foreign jurisdiction’s margin requirements

addresses each of the above-referenced elements, and identify the

specific legal and regulatory provisions that correspond to each

element (and, if necessary, whether the relevant foreign jurisdiction’s

margin requirements do not address a particular element). Further, the

applicant must describe the objectives of the foreign jurisdiction’s

margin requirements, the ability of the relevant regulatory authority

or authorities to supervise and enforce compliance with the foreign

jurisdiction’s margin requirements, including the powers of the foreign

regulatory authority or authorities to supervise, investigate, and

discipline entities for compliance with the margin requirements and the

ongoing efforts of the regulatory authority or authorities to detect,

deter, and ensure compliance with the margin requirements. Finally, the

applicant must furnish copies of the foreign jurisdiction’s margin

requirements (including an English translation of any foreign language

document) and any other information and documentation that the

Commission deems appropriate.95

—————————————————————————

95 See Sec. 23.160(c)(2)(v) and (vi) of the Proposed Rule.

—————————————————————————

In issuing a Comparability Determination, the Commission may impose

any terms and conditions it deems appropriate.96 In addition, the

Proposed Rule would provide that the Commission may, on its own

initiative, further condition, modify, suspend, terminate, or otherwise

restrict a comparability determination in the Commission’s discretion.

This could result, for example, from a situation where, after the

Commission issues a comparability determination, the basis of that

determination ceases to be true. In this regard, the Commission would

require an applicant to notify the Commission of any material changes

to information submitted in support of a comparability determination

(including, but not limited to, changes in the foreign jurisdiction’s

supervisory or regulatory regime) as the Commission’s comparability

determination may no longer be valid.97

—————————————————————————

96 The violation of such terms and conditions may constitute a

violation of the Commission’s margin requirements and/or result in

the modification or revocation of the comparability determination.

97 The Commission expects to impose this obligation as one of

the conditions to the issuance of a comparability determination.

—————————————————————————

The collection of information that is proposed by this rulemaking

is necessary to implement sections 4s(e) of the CEA, which mandates

that the Commission adopt rules establishing minimum initial and

variation margin requirements for CSEs on all swaps that are not

cleared by a registered derivatives clearing organization, and section

2(i) of the CEA, which provides that the provisions of the CEA relating

to swaps that were enacted by Title VII of the Dodd-Frank Act

(including any rule prescribed or regulation promulgated thereunder)

apply to

[[Page 41393]]

activities outside the United States that have a direct and significant

connection with activities in, or effect on, commerce of the United

States.98 The information collection would be necessary for the

Commission to consider whether the requirements of the foreign rules

are comparable to the applicable requirements of the Commission’s

rules.

—————————————————————————

98 Section 2(i) of the CEA provides that the provisions of the

CEA relating to swaps that were enacted by Title VII of the Dodd-

Frank Act (including any rule prescribed or regulation promulgated

thereunder), shall not apply to activities outside the United States

unless those activities (1) have a direct and significant connection

with activities in, or effect on, commerce of the United States or

(2) contravene such rules or regulations as the Commission may

prescribe or promulgate as are necessary or appropriate to prevent

the evasion of any provision of Title VII of the CEA.

—————————————————————————

As noted above, any CSE who is eligible for substituted compliance

may make a request for a comparability determination. Currently, there

are approximately 102 CSEs provisionally registered with the

Commission. The Commission further estimates that of the approximately

102 CSEs, approximately 61 CSEs would be subject to the Commission’s

margin rules as they are not subject to a Prudential Regulator.

However, the Commission notes that any foreign regulatory agency that

has direct supervisory authority over one or more CSEs and that is

responsible to administer the relevant foreign jurisdiction’s margin

requirements may apply for a comparability determination. Further, once

a comparability determination is made for a jurisdiction, it would

apply for all entities or transactions in that jurisdiction to the

extent provided in the determination, as approved by the Commission.

The Commission estimates that it will receive requests for a

comparability determination from 17 jurisdictions, consisting of the 16

jurisdictions within the G20, plus Switzerland,99 and that each

request would impose an average of 10 burden hours.

—————————————————————————

99 Because the Commission’s proposed margin requirements are

based on the BCBS-IOSCO framework and one of the factors that the

Commission will consider in making its determination is the

comparability to these international standards, the Commission

estimates that in all likelihood, it will receive applications from

all 16 jurisdictions within the G20, plus Switzerland.

—————————————————————————

Based upon the above, the estimated hour burden for collection is

calculated as follows:

Number of respondents: 17.

Frequency of collection: Once.

Estimated annual responses per registrant: 1.

Estimated aggregate number of annual responses: 17.

Estimated annual hour burden per registrant: 10 hours.

Estimated aggregate annual hour burden: 170 hours (17 registrants x

10 hours per registrant).

Information Collection Comments. The Commission invites the public

and other Federal agencies to comment on any aspect of the reporting

burdens discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the

Commission solicits comments in order to: (1) Evaluate whether the

proposed collection of information is necessary for the proper

performance of the functions of the Commission, including whether the

information will have practical utility; (2) evaluate the accuracy of

the Commission’s estimate of the burden of the proposed collection of

information; (3) determine whether there are ways to enhance the

quality, utility, and clarity of the information to be collected; and

(4) minimize the burden of the collection of information on those who

are to respond, including through the use of automated collection

techniques or other forms of information technology.

Comments may be submitted directly to the Office of Information and

Regulatory Affairs, by fax at (202) 395-6566 or by email at

[email protected]. Please provide the Commission with a copy

of submitted comments so that all comments can be summarized and

addressed in the final rule preamble. Refer to the ADDRESSES section of

this notice of proposed rulemaking for comment submission instructions

to the Commission. A copy of the supporting statements for the

collections of information discussed above may be obtained by visiting

RegInfo.gov. OMB is required to make a decision concerning the

collection of information between 30 and 60 days after publication of

this document in the Federal Register. Therefore, a comment is best

assured of having its full effect if OMB receives it within 30 days of

publication.

C. Cost-Benefit Considerations

1. Introduction

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.100 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. The Commission considers the costs and benefits

resulting from its discretionary determinations with respect to the

section 15(a) factors.

—————————————————————————

100 7 U.S.C. 19(a).

—————————————————————————

In promulgating the Proposed Margin Rules,101 the Commission

considered the costs and benefits associated with its choices regarding

the scope and extent to which it would apply its proposed margin

requirements to uncleared swaps of a CSE, including those related to

the setting of the material swap exposure for financial entities, and

related substantive requirements, such as the determination of eligible

collateral and acceptable custodial arrangements. In addition, in light

of the fact that section 4s(e), by its terms, applies to uncleared

swaps of all CSEs, regardless of the domicile of the CSE (or its

counterparties), the costs and benefits discussed in the Proposed

Margin Rules’ Federal Register release relate both to the domestic and

cross-border application of the margin rule.102 The cost and benefit

considerations (“CBC”) set out in this proposal are intended to

augment the CBC set forth in the Proposed Margin Rules’ Federal

Register release and address cost and benefit considerations related to

the Commission’s choices regarding the extent to which it would

recognize compliance with comparable foreign requirements as an

alternative means of compliance with the Commission’s margin rules

(“substituted compliance”) and the extent to which it would exclude

uncleared swaps from the Commission’s margin rules. Further, in

considering the relevant costs and benefits of the Proposed Margin

Rules, the Commission used as its baseline the swaps market as it

existed at the time of the Proposed Margin Rules’ Federal Register

release; because this Proposed Rule addresses the cross-border

application of the Proposed Margin Rules, the Commission is using as

its baseline the swaps market as it would operate once the Proposed

Margin Rules were fully implemented.

—————————————————————————

101 The Commission’s Proposed Margin Rules are set forth in

proposed Sec. Sec. 23.150 through 23.159 of part 23 of the

Commission’s regulations, proposed as 17 CFR 23.150 through 23.159.

See Margin Requirements for Uncleared Swaps for Swap Dealers and

Major Swap Participants, 79 FR 59898 (Oct. 3, 2014).

102 See Margin Requirements for Uncleared Swaps for Swap

Dealers and Major Swap Participants, 79 FR 59920-59926 (Oct. 3,

2014).

—————————————————————————

As discussed in section I.B. above, in developing the proposed

cross-border framework in the Proposed Rule, the

[[Page 41394]]

Commission is mindful of the global and highly interconnected nature of

the swaps market–and that risk exposures overseas can quickly manifest

in the United States and pose substantial threat to the U.S. financial

system. At the same time, the Commission also recognizes that

competitive distortions and market inefficiencies can result–and the

benefits of the BCBS-IOSCO framework lost–if due consideration is not

given to comity principles. The Commission has also carefully

considered the impact of its choices in determining whether (and, if

so, under what circumstances) substituted compliance would be available

or whether (and, if so, under what circumstances) swaps would be deemed

excluded, including the effect of its choices on efficiency,

competition, market integrity and transparency.

The Commission is aware of the potentially significant trade-offs

inherent in its policy decisions. For instance, the Commission’s choice

not to exclude from its margin requirements certain foreign-facing

swaps involving U.S. CSEs and non-U.S. CSEs whose obligations under the

relevant swap are guaranteed by a U.S. person may make it more costly

for such firms to conduct their swaps business, particularly in foreign

jurisdictions, and put them at a competitive disadvantage relative to

non-U.S. CSEs whose obligations under the relevant swap are not

guaranteed by a U.S. person. It could also make foreign counterparties

less willing to deal with U.S. CSEs and non-U.S. CSEs whose obligations

under the relevant swap are guaranteed by a U.S. person. On the other

hand, full application of the margin requirements to these CSEs may

enhance the safety and soundness of these CSEs and consequently, the

U.S. financial system. In addition, the extent, if any, to which either

of the aforementioned disadvantages would arise depends on whether

competitors of such CSEs must comply with comparable margin

requirements. In developing the proposed cross-border framework in the

Proposed Rule, the Commission has attempted to appropriately consider

competing concerns in seeking to effectively address the risk posed to

the safety and soundness of CSEs, while creating a workable framework

that mitigates the potential for undue market distortions and that

promotes global harmonization.

The Commission’s consideration of the costs and benefits associated

with the proposed framework is complicated by the fact that other

jurisdictions may adopt requirements with different scope or on

different timelines. Currently, no foreign jurisdiction has finalized

rules for margin of uncleared swaps. However, the EU 103 and Japan

104 have proposed such rules, each of which are based on the BCBS-

IOSCO framework.105 The extent to which, if at all, foreign

jurisdictions will follow the BCBS-IOSCO framework and the differences

between the requirements implemented overseas and the Commission’s

margin requirements will affect the costs and benefits related to the

Proposed Rule. Thus, for example, if a margin rule in a particular

foreign jurisdiction is less rigorous than the Commission’s margin

rule, those CSEs (U.S. and non-U.S. CSEs) that are subject to the

Commission’s margin rule may be competitively disadvantaged relative to

those dealers that are eligible for Exclusion from the Commission’s

margin rule for certain swaps or are outside the Commission’s

jurisdiction.106

—————————————————————————

103 See European Banking Authority, European Securities and

Markets Authority, and European Insurance and Occupational Pensions

Authority, Consultation Paper on draft regulatory technical

standards on risk-mitigation techniques for OTC-derivative contracts

not cleared by a CCP under Article 11(15) of Regulation (EU) No 648/

2012 (for the European Market Infrastructure Regulation) (April 14,

2014), available at https://www.eba.europa.eu/documents/10180/655149/JC+CP+2014+03+%28CP+on+risk+mitigation+for+OTC+derivatives%29.pdf, and Second Consultation Paper on draft regulatory technical

standards on risk-mitigation techniques for OTC-derivative contracts

not cleared by a CCP under Article 11(15) of Regulation (EU) No 648/

2012 (for the European Market Infrastructure Regulation) (Jun. 10,

2015), available at https://www.eba.europa.eu/documents/10180/1106136/JC-CP-2015-002+JC+CP+on+Risk+Management+Techniques+for+OTC+derivatives+.pdf.

104 See Financial Services Agency of Japan, draft amendments

to the “Cabinet Office Ordinance on Financial Instruments

Business” and “Comprehensive Guidelines for Supervision” with

regard to margin requirements for non-centrally cleared derivatives

(July 3, 2014). Available in Japanese at http://www.fsa.go.jp/news/26/syouken/20140703-3.html.

105 See Margin Requirements for Non-centrally Cleared

Derivatives, Sept. 2013, available at http://www.bis.org/publ/bcbs261.pdf. The Commission is not incorporating the details of the

EU and Japanese proposals in this CBC, because they have not been

adopted and would be subject to change upon adoption.

106 As discussed in section I.B. above, in the interest of

promoting global harmonization, the Commission has consulted and

coordinated with the Prudential Regulators and foreign regulatory

authorities. In addition, the Commission staff has participated in

numerous bilateral and multilateral discussions with foreign

regulatory authorities discussing national efforts to implement

margin reform and the possibility of conflicts and overlaps between

U.S. and foreign regulatory regimes. Although at this time foreign

jurisdictions do not yet have their margin regimes in place, the

Commission has participated in ongoing, collaborative discussions

with regulatory authorities in the EU and Japan regarding their

cross-border approaches to the margin rules, including the

anticipated scope of application of margin requirements in their

jurisdiction to cross-border swaps, their plans for recognizing

foreign margin regimes, and their anticipated timelines. The

Commission expects that these discussions will continue as it

finalizes and then implements its margin rules, and as other

jurisdictions develop their own margin rules and approaches to

cross-border applications.

—————————————————————————

In sum, given that foreign jurisdictions do not yet have in place

their margin rules, it is not possible to fully evaluate the costs and

benefits associated with the Proposed Rule, and in particular, the

implications for the safety and soundness of CSEs and competition.

However, to the extent that a foreign regime’s margin requirements are

comparable, any differences between the Commission’s margin

requirements and foreign margin requirements would be insignificant

and, therefore, mitigate the potential for undue risk to the CSE and

competitive distortions. However, if a foreign regime’s margin

requirements are not deemed comparable, this may put a CSE at a

competitive disadvantage when competing with non-U.S. firms that are

not registered with the Commission because these non-CFTC registered

dealers would have a cost advantage that could affect their pricing

terms to clients.

In the sections that follow, the Commission considers: (i) Costs

and benefits associated with the proposed definition of U.S. person;

(ii) the proposed framework for substituted compliance; (iii) the

proposed exclusion from the margin rule; (iv) the submission of

requests for a comparability determination; and (v) alternatives

considered and the cost and benefit of such alternatives. Wherever

reasonably feasible, the Commission has endeavored to quantify the

costs and benefits of this proposed rulemaking. In a number of

instances, the Commission currently lacks the data and information

required to precisely estimate costs and benefits. Where it was not

feasible to quantify (e.g., because of the lack of accurate data or

appropriate metrics), the Commission has endeavored to consider the

costs and benefits of these rules in qualitative terms.

2. Proposed Rule

The Proposed Rule sets forth a definition of “U.S. person,”

describing the circumstances under which substituted compliance or the

exclusion would be available, and would establish a process for the

submission of requests for a comparability determination. In addition

to issues related to financial integrity of markets, competition and

market distortions noted above, the U.S. person definition and

comparability determination process entail monetary costs for CSEs and

market participants because a market participant may have

[[Page 41395]]

to expend resources to determine whether it (or its counterparty) is a

U.S. person. A CSE seeking to rely on substituted compliance could

incur costs in connection with the submission of a request for a

comparability determination, although this would not be the case in

circumstances where the relevant jurisdiction has itself attained a

comparability finding from the Commission. In this section, we describe

the most significant considerations that we have taken into account in

formulating the Proposed Rule.

a. U.S. Person

Under the Proposed Rule, the term “U.S. person” would be defined

so as to identify activities having a substantial nexus to the U.S.

market because they are undertaken by individuals or entities organized

or domiciled in the United States or because of other connections to

the U.S. market. The definition is intended to identify those

individuals and entities whose swap activities have a substantial nexus

to U.S. markets even when they transact in swaps with a non-U.S. CSE.

As noted in section II.B.1. above, this proposed definition generally

follows the traditional, territorial approach to defining a U.S.

person. The chief benefit of this territorial approach is that it is

objective and clear–and the Commission believes that the industry has

largely followed a similar definition of “U.S. person” included in

the Guidance.

The Commission considered including the U.S. majority-ownership

prong that was included in the Guidance (50% U.S. person ownership of a

fund or other collective investment vehicle), but has determined not to

propose it.107 The Commission understands that unlike other corporate

structures, certain types of funds, specifically fund-of-funds and

master-feeder structures, would require an adviser or administrator to

look through to other fund entities in the fund structure, in

ascertaining whether a beneficial owner of the fund is a U.S. person.

The Commission further understands that this may be difficult to

determine in some cases. In addition, the Commission believes that

other elements of the U.S. person definition would in many

circumstances cover these funds as a “U.S. person.”

—————————————————————————

107 The Commission’s definition of the term “U.S. person” as

used in the Guidance included a prong (iv) which covered “any

commodity pool, pooled account, or collective investment vehicle

(whether or not it is organized or incorporated in the United

States) of which a majority ownership is held, directly or

indirectly, by a U.S. person(s).”

—————————————————————————

Even if a non-U.S. fund with U.S. majority-ownership is treated as

a non-U.S. person, such fund would be excluded from the Commission’s

margin rules only in limited circumstances (namely, when the fund

trades with a non-U.S. CSE that is not a consolidated subsidiary of a

U.S. entity or a U.S. branch of a non-U.S. CSE). Additionally, any

excluded swaps would most likely be covered by another jurisdiction

that adheres to the BCBS-IOSCO standards. The Commission anticipates

that non-U.S. CSEs will generally be required, in their home

jurisdiction, to collect margin from these non-U.S. funds.108

Therefore, non-U.S. CSEs would generally be protected in the event of a

default by a non-U.S. fund even if the uncleared swap with the non-U.S.

fund falls within the Exclusion.109 Accordingly, the Commission

believes that treatment of non-U.S. funds with U.S. majority-ownership

as non-U.S. persons will not have a substantial impact on the safety

and soundness of CSEs or the stability of the U.S. financial system; at

the same time, the Commission believes that excluding the majority-

ownership prong would alleviate any burden associated with determining

whether a fund qualifies as a U.S. person under this criterion.

—————————————————————————

108 At this time, we do not have information as to what

portion of the funds that would have been covered by the U.S.

majority-ownership prong are hedge funds.

109 Further, as noted earlier, a non-U.S. CSE that can avail

itself of the Exclusion would still be subject to the Commission’s

margin rules with respect to all uncleared swaps not meeting the

criteria for the Exclusion, albeit with the possibility of

substituted compliance. The Commission further believes that the

possibility of a cascading event affecting U.S. counterparties and

the U.S. market more broadly as a result of a default by the non-

U.S. CSE would also be mitigated because the non-U.S. CSE would be

subject to U.S. margin requirements (with the possibility of

substituted compliance to the extent applicable) when entering into

a swap with U.S. counterparties.

—————————————————————————

As noted in section II.B.1. above, prong (6) (Proposed Rule Sec.

23.160(a)(10)(vi)) of the proposed “U.S. person” definition would

capture certain legal entities owned by one or more U.S. person(s) and

for which such person(s) bear unlimited responsibility for the

obligations and liabilities of the legal entity. In the case of the

Guidance, the “U.S. person” definition would generally characterize a

legal entity as a U.S. person if the entity were “directly or

indirectly majority-owned” by one or more persons falling within the

term “U.S. person” and such U.S. person(s) bears unlimited

responsibility for the obligations and liabilities of the legal entity.

Because this prong of the proposed definition of “U.S. person” is

broader in scope, the Commission believes that this may result in more

legal entities meeting the U.S. person definition. In addition, to the

extent that this prong of the proposed definition of “U.S. person”

expands the number of market participants that would be deemed to be a

“U.S. person,” the Commission believes that the benefits that would

have been provided to otherwise non-U.S. CSEs from being able to avail

themselves of substituted compliance and the Exclusion would not be

realized.

The proposed “U.S. person” definition does not include the

prefatory phrase “includes, but is not limited to” that was included

in the Guidance. The Commission believes that this prefatory phrase

should not be included in the Proposed Rule in order to provide legal

certainty regarding the application of U.S. margin requirements to

cross-border swaps.

Finally, the Commission believes that the definition of “U.S.

person” provides a clear and objective basis upon which to identify a

U.S. person, and that identifying whether a counterparty is a “U.S.

person” should be relatively straightforward because, as noted above,

the Commission believes that a swap counterparty generally should be

permitted to reasonably rely on its counterparty’s written

representation in determining whether the counterparty is within the

definition of the term “U.S. person.”

b. Availability of Substituted Compliance and Exclusion

i. Uncleared Swaps of U.S. CSEs or of Non-U.S. CSEs Whose Obligations

Under the Relevant Swap Are Guaranteed by a U.S. Person

As set out in Table A to this release, under the Proposed Rule, the

Commission’s margin rules would generally apply to all uncleared swaps

of U.S. CSEs. For U.S. CSEs, substituted compliance would only be

available with respect to the requirement to post initial margin and

only if the counterparty is a non-U.S. person (including a non-U.S.

CSE) whose obligations under the uncleared swap are not guaranteed by a

U.S. person. Uncleared swaps with U.S. CSEs would never qualify for the

Exclusion. Under the Proposed Rule, non-U.S. CSEs whose obligations

under the relevant swap are guaranteed by a U.S. person would receive

the same treatment as U.S. CSEs.110 The Commission believes

[[Page 41396]]

that this result is appropriate because a swap of an entity guaranteed

by that U.S. person will have economic and financial implications that

are likely to be very similar to the economic and financial

implications of a swap entered into directly by the U.S. guarantor, as

discussed in section II.B.2. above.

—————————————————————————

110 As discussed in section II.B.2, under the Proposed Rule

the Commission is defining a guarantee narrower than in the

Guidance, and in doing so, the Commission has broadened the

availability of substituted compliance and the Exclusion to certain

non-U.S. CSEs that would not have the ability to avail themselves of

these if the broader definition of guarantee used in the Guidance

were used in the Proposed Rule instead of the narrower definition.

However, the Commission believes that as a result of its decision to

define certain non-U.S. CSEs as Foreign Consolidated Subsidiaries,

some of these same non-U.S. CSEs that would have been able to avail

themselves of substituted compliance and the Exclusion, as a result

of the narrow definition of a guarantee, would not be eligible for

the Exclusion (but would benefit from the full application of

substituted compliance instead of a limited application). The costs

and benefits related to substituted compliance and the Exclusion are

set out in this section and below.

—————————————————————————

The Commission understands that the Proposed Rule may place U.S.

CSEs and non-U.S. CSEs whose obligations under the relevant swap are

guaranteed by a U.S. person at a disadvantage when competing with

either non-U.S. CSEs that are able to rely on the Exclusion or with

non-CFTC registered dealers for foreign clients, though whether such a

disadvantage exists would depend on whether these competitors are

subject to comparable margin rules in other jurisdictions. For example,

the ability of a non-U.S. CSE that is not guaranteed by a U.S. person

(and that is not a Foreign Consolidated Subsidiary or a U.S. branch of

a non-U.S. CSE) to rely on the Exclusion could allow it to gain a cost

advantage over a U.S. CSE or a non-U.S. CSE that is guaranteed by a

U.S. person and thus offer better pricing terms to foreign clients,

unless it is subject to another jurisdiction’s margin rules that are

comparable. U.S. CSEs and non-U.S. CSEs whose obligations under the

relevant swap are guaranteed by a U.S. person may also be at a

disadvantage when competing for clients with non-U.S. CSEs that are

able to rely on substituted compliance more broadly if the clients

believe complying with the foreign jurisdiction’s margin requirements

would be less burdensome or costly than when transacting with a U.S.

CSE under the Proposed Rule, as the amount posted by the non-U.S.

counterparty would need to comply with U.S. margin requirements.

However, the Commission believes that the requirement that the relevant

foreign jurisdiction’s margin requirements have comparable outcomes

should operate to narrow any competitive disadvantage, thereby

diminishing opportunities for regulatory arbitrage.111

—————————————————————————

111 The Commission notes that of the approximately 61 CSEs

that would be subject to the Commission’s margin rules, 21 are non-

U.S. CSEs. Of those 21 non-U.S. CSEs, 20 are domiciled in

jurisdictions that participated in the development of the BCBS-IOSCO

framework. Although harmonization among these jurisdictions may

mitigate some competitive disadvantages, the associated costs and

benefits cannot be reasonably determined as no jurisdictions have

finalized their margin rules.

—————————————————————————

In addition, because the Proposed Rule provides for limited

substituted compliance for U.S. CSEs and non-U.S. CSEs whose

obligations under the relevant swap are guaranteed by a U.S. person

(relative to other CSEs), those CSEs may be subject to conflicting or

duplicative regulations, and consequently, would incur costs associated

with developing multiple sets of policies and procedures and

operational infrastructures. The Commission recognizes that such costs

would vary for firms depending on the nature and scope of the

individual firm’s business, and costs relative to other competitors

would depend on whether the competitors are subject to other

jurisdictions’ margin rules. The Commission requests data from

commenters to assist the Commission in considering the quantitative

effect of the limited substituted compliance for U.S. CSEs and non-U.S.

CSEs whose obligations under the relevant swap are guaranteed by a U.S.

person.

On the other hand, the Commission believes that requiring U.S. CSEs

and non-U.S. CSEs whose obligations under the relevant swap are

guaranteed by a U.S. person to comply with its margin requirements

would foster the stability of the U.S. financial markets. By their

nature, U.S. CSEs and non-U.S. CSEs whose swap obligations are

guaranteed by a U.S. person have a significant impact on the U.S.

financial markets, and the Commission therefore has a strong interest

in ensuring their viability. As discussed in section II.C.1. above, the

Commission believes that requiring U.S. CSEs and non-U.S. CSEs whose

swap obligations are guaranteed by a U.S. person to comply with the

Commission’s margin requirements, with only limited substituted

compliance, is important to maintaining well-functioning U.S. financial

markets and ensuring the sound risk management practices of key market

participants in the U.S. swaps market.

ii. Uncleared Swaps of Non-U.S. CSEs Whose Obligations Under the

Relevant Swap Are Not Guaranteed by a U.S. Person

As set out in Table A to this release, under the Proposed Rule,

non-U.S. CSEs whose obligations under the relevant uncleared swap are

not guaranteed by a U.S. person, including Foreign Consolidated

Subsidiaries, are eligible for substituted compliance to a greater

extent relative to U.S. CSEs or non-U.S. CSEs whose obligations under

the relevant uncleared swap are guaranteed by a U.S. person. A subset

of these non-U.S. CSEs may qualify for the Exclusion, as described in

section II.C.3. above. As noted in section II.C.2., the Commission

believes that the proposed approach is appropriate since a non-U.S. CSE

whose swap obligations are not guaranteed by a U.S. person (including a

Foreign Consolidated Subsidiary), may implicate equal or greater

supervisory concerns on the part of a foreign regulator relative to the

Commission’s supervisory interests (in comparison to U.S. CSEs or non-

U.S. CSEs whose obligations under the relevant swap are guaranteed by a

U.S. person, because the Commission has a significant regulatory

interest in uncleared swaps of these CSEs).

Substituted compliance would benefit such non-U.S. CSEs by allowing

them to avoid conflicting or duplicative regulations and choose the

most appropriate set of rules when transacting with each other.

Furthermore, eligible non-U.S. CSEs could further benefit from

developing one enterprise-wide set of compliance and operational

infrastructures.112 And

[[Page 41397]]

because substituted compliance is contingent on the Commission’s

determination that the relevant jurisdiction’s margin rules are

comparable, the potential for undue risk to the CSE and competitive

distortions between those registrants that are eligible for substituted

compliance and those that are not would be mitigated. However, if the

foreign jurisdiction’s margin requirements are not deemed comparable,

these CSEs will be at a disadvantage to non-CFTC registered dealers

when competing for client business.

—————————————————————————

112 The Commission notes that the costs of developing the

margin infrastructure needed to comply with Commission margin

requirements in the context of cross-border transactions, as well as

the costs of complying with the Commission’s margin requirements

more generally in the context of cross-border transactions, could

vary significantly for different CSEs based on factors specific to

each firm (e.g., organizational structure, status as a U.S. CSE or

non-U.S. CSE (including whether the firm is a Foreign Consolidated

Subsidiary or a U.S. branch of a non-U.S. CSE), jurisdictions in

which uncleared swaps activities are conducted, applicable margin

requirements in the U.S. and other jurisdictions, the location and

status of counterparties, existence of an appropriate MOU or similar

arrangement with the relevant jurisdictions, existence of

Comparability Determinations in the relevant jurisdictions and any

conditions in such determinations, and firm policies and procedures

for the posting and collection of margin). The Commission further

notes that currently no foreign jurisdiction has finalized rules for

margin of uncleared swaps. However, the EU and Japan have proposed

such rules, each of which are based on the BCBS-IOSCO framework.

Accordingly, the Commission lacks the data and information required

to reasonably estimate costs related to developing the appropriate

margin infrastructure or the costs of complying with the

Commission’s margin requirements generally in the context of cross-

border transactions.

—————————————————————————

iii. Exclusion for Uncleared Swaps of Non-U.S. CSEs Where Neither

Counterparty’s Obligations Under the Relevant Swap Are Guaranteed by a

U.S. Person and Neither Counterparty Is a Foreign Consolidated

Subsidiary Nor a U.S. Branch of a Non-U.S. CSE

As discussed in section II.C.3., under the Proposed Rule, the

Commission would exclude from its margin rules uncleared swaps entered

into by a non-U.S. CSE with a non-U.S. person counterparty (including a

non-U.S. CSE), provided that neither counterparty’s obligations under

the relevant swap are guaranteed by a U.S. person and neither

counterparty is a Foreign Consolidated Subsidiary nor a U.S. branch of

a non-U.S. CSE. As discussed in section II.C.3. above, the Commission

believes that it would be appropriate to tailor the application of

margin requirements in the cross-border context, consistent with

section 4s(e) of the CEA 113 and comity principles, so as to exclude

this narrow class of uncleared swaps involving a non-U.S. CSE and a

non-U.S. counterparty.

—————————————————————————

113 Section 4s(e)(3)(A) of the CEA, 7 U.S.C. 6s(e)(3)(A). The

section provides, among other things, that margin requirements “be

appropriate for the risks associated with the non-cleared swaps held

as a swap dealer or major market participant.”

—————————————————————————

The Commission believes that such non-U.S. CSEs may benefit from

the Exclusion because it allows them to avoid conflicting or

duplicative regulations where a transaction would be subject to more

than one uncleared swap margin regime. On the other hand, to the extent

a non-U.S. CSE would be able to rely on the margin requirements of a

foreign jurisdiction, as opposed to the Commission’s margin

requirements, and such other margin requirements are not comparable,

the Exclusion could result in a less rigorous margin regime for such

CSE. This, in turn, could create competitive disparities between non-

U.S. CSEs relying on the Exclusion and other CSEs that are not eligible

for the Exclusion. That is, the Exclusion could allow these non-U.S.

CSEs to offer better pricing to their non-U.S. clients, which would

give them a competitive advantage relative to those CSEs that are not

eligible for the Exclusion (e.g., U.S. CSEs, non-U.S. CSEs whose

obligations under the relevant swap are not guaranteed by a U.S.

person, or Foreign Consolidated Subsidiaries). However, whether these

competitive effects occur will also depend on whether the relevant

foreign jurisdiction has comparable margin rules. In addition, non-U.S.

CSEs that are eligible for the Exclusion could be in a better position

to compete with non-CFTC registered dealers in the relevant foreign

jurisdiction for foreign clients.

As noted above, at this time, given that foreign jurisdictions do

not yet have in place their margin regimes, it is not possible to fully

evaluate the Proposed Rule’s eventual implications for the safety and

soundness of CSEs and competition. Assuming, however, for the sake of

analysis that the relevant foreign jurisdiction does not have

comparable margin requirements, the Commission preliminarily believes

that the Exclusion would not result in a significant diminution in the

safety and soundness of the non-U.S. CSE, as discussed in section

II.C.3. above. This is based on several considerations. First, the

potential adverse effect on a non-U.S. CSE would be substantially

mitigated by the Commission’s capital requirements.114 Additionally,

any excluded swaps would most likely be covered by another jurisdiction

that adheres to the BCBS-IOSCO standards because the Commission

believes that most swaps are currently undertaken in jurisdictions that

already have agreed to adhere to the BCBS-IOSCO margin standards.

—————————————————————————

114 See section II.A.1.

—————————————————————————

Further, a non-U.S. CSE that can avail itself of the Exclusion

would still be subject to the Commission’s margin rules with respect to

all uncleared swaps not meeting the criteria for the Exclusion, albeit

with the possibility of substituted compliance. The Commission further

believes that the possibility of a cascading event affecting U.S.

counterparties and the U.S. financial markets more broadly as a result

of a default by the non-U.S. CSE would also be mitigated because the

non-U.S. CSE would be subject to U.S. margin requirements (with the

possibility of substituted compliance to the extent applicable) when

entering into a swap with U.S. counterparties.

iv. Foreign Consolidated Subsidiaries

Under the Proposed Rule, substituted compliance is more broadly

available to a Foreign Consolidated Subsidiary whose obligations under

the relevant swap are not guaranteed by a U.S. person than a U.S. CSE

or a non-U.S. CSE whose obligations under the relevant swap are

guaranteed by a U.S. person. Further, a Foreign Consolidated Subsidiary

would be able to avail itself of substituted compliance to the same

extent as other non-U.S. CSEs, but would not be eligible for the

Exclusion. A Foreign Consolidated Subsidiary’s financial position,

operating results, and statement of cash flows are directly reflected

in its ultimate U.S. parent entity’s financial statements. Given the

nature of a Foreign Consolidated Subsidiary’s direct relationship to a

U.S. person, the Commission believes that the uncleared swaps of

Foreign Consolidated Subsidiaries should not be excluded from the

margin requirements, as discussed in section II.C.3. above.

The unavailability of the Exclusion could disadvantage Foreign

Consolidated Subsidiaries relative to other non-U.S. CSEs that would be

eligible for the Exclusion (i.e., non-U.S. CSEs where neither

counterparty’s obligations under the relevant swap are guaranteed by a

U.S. person and neither counterparty is a Foreign Consolidated

Subsidiary nor a U.S. branch of a non-U.S. CSE) or non-CFTC registered

dealers within a foreign jurisdiction. Non-U.S. CSEs that rely on the

Exclusion or non-CFTC registered dealers could realize a cost advantage

over Foreign Consolidated Subsidiaries and thus have the potential to

offer better pricing terms to foreign clients. The competitive

disparity between non-U.S. CSEs that rely on the Exclusion and Foreign

Consolidated Subsidiaries, however, may be somewhat mitigated to the

extent that the relevant foreign jurisdiction implements the BCBS-IOSCO

framework.

v. U.S. Branch of a Non-U.S. CSE

Under the Proposed Rule, the Exclusion from the margin rules would

not be available to a U.S. branch of a non-U.S. CSE. The Commission

believes that when a non-U.S. CSE conducts its swap activities within

the United States through a branch or office located in the United

States, it should be subject to U.S. margin requirements, but with the

possibility of substituted compliance, consistent with comity

principles. The Commission believes that the Proposed Rule’s Exclusion

should not be available in this case, because U.S. branches of non-U.S.

CSEs are operating within the

[[Page 41398]]

U.S. market and competing with U.S. CSEs for business, including from

non-U.S. counterparties.

If a U.S. branch of a non-U.S. CSE were permitted to use the

Exclusion it could be able to offer more competitive terms to non-U.S.

clients than U.S. CSEs, and thereby gain an unwarranted advantage when

dealing with non-U.S. clients relative to other CSEs operating within

the United States (i.e., U.S. CSEs). On the other hand, for the same

reason, the Proposed Rule could put non-U.S. CSEs that conduct swaps

business through their U.S. branches at a disadvantage relative to

either non-U.S. CSEs that are eligible for the Exclusion or non-CFTC

registered dealers that conduct swaps business overseas. However, to

the extent that the U.S. branch of a non-U.S. CSE is able to rely on

substituted compliance, the competitive disparities relative to those

non-U.S. CSEs that are eligible for the Exclusion should be reduced to

the extent that the relevant foreign jurisdiction implements BCBS-IOSCO

framework standards.115

—————————————————————————

115 Non-U.S. CSEs are also likely to conduct swaps business

with U.S. clients from locations outside the United States;

nevertheless, U.S. branches are likely to have greater U.S. client-

orientation relative to such foreign operations.

—————————————————————————

The unavailability of the Exclusion could also result in the U.S.

branch of a non-U.S. CSE being subject to conflicting or duplicative

margin requirements. However, the Commission believes that overall any

resulting costs may not be significant to the extent that the U.S.

branch is able to avail itself of substituted compliance in that

jurisdiction.

c. Alternatives

The Commission believes that the Proposed Rule effectively

addresses the risk posed to the safety and soundness of CSEs, while

creating a workable framework that reduces the potential for undue

market disruptions and promotes global harmonization by taking into

account the interests of other jurisdictions and balancing those

interests with the supervisory interests of the United States.

The Commission has determined not to propose the Guidance Approach

because it believes that if the Guidance Approach were adopted, too

many swaps would be excluded from the margin rules to ensure the safety

and soundness of CSEs and the U.S. financial system. In particular,

under the Guidance Approach, uncleared swaps between a non-U.S. CSE and

a non-U.S. person whose uncleared swap obligations are not guaranteed

by a U.S. person would be excluded from the Commission’s margin rules

without regard to whether the non-U.S CSE is guaranteed or its

financial statements are consolidated with a U.S. parent entity under

U.S. generally accepted accounting principles.

The Commission has also determined not to propose the Entity-Level

Approach. On the one hand, the Entity-Level Approach (where the margin

requirements would apply to all uncleared swaps of a CSE, with no

possibility of any exclusion) is arguably appropriate because margin

requirements are critical in ensuring the safety and soundness of a CSE

and in supporting the stability of the U.S. financial markets. As a

result of CSEs engaging in a level of uncleared swap activity that is

significant enough to warrant U.S. registration, their uncleared swaps

have a direct and significant nexus to the U.S. financial system,

irrespective of whether their counterparty is a U.S. or non-U.S.

entity. However, the Commission believes that the Entity-Level Approach

does not adequately consider the relative supervisory interests of U.S.

and foreign regulators.

d. Comparability Determinations

As noted in section II.D. above, any CSE who is eligible for

substituted compliance may make a request for a comparability

determination. Currently, there are approximately 102 CSEs

provisionally registered with the Commission. The Commission further

estimates that of the 102 CSEs that are registered, approximately 61

CSEs would be subject to the Commission’s margin rules, as they are not

supervised by a Prudential Regulator. However, the Commission notes

that any foreign regulatory agency that has direct supervisory

authority to administer the foreign regulatory framework for margin of

uncleared swaps in the requested foreign jurisdiction may apply for a

comparability determination. Further, once a comparability

determination is made for a jurisdiction, it would apply for all

entities or transactions in that jurisdiction to the extent provided in

the determination, as approved by the Commission.

The Commission assumes that a CSE or foreign regulatory agency will

apply for a comparability determination only if the anticipated

benefits warrant the costs attendant to submission of a request for a

comparability determination. Although there is uncertainty regarding

the number of requests that would be made under the Proposed Rule, the

Commission estimates that it would receive applications for

comparability determinations from 17 jurisdictions representing 61

separate registrants, and that each request would impose an average of

10 burden hours per registrant.116

—————————————————————————

116 See note 99, supra.

—————————————————————————

Based upon the above, the Commission estimates that the preparation

and filing of submission requests for comparability determinations

should take no more than 170 hours annually in the aggregate (17

registrants x 10 hours). The Commission further estimates that the

total aggregate cost of preparing such submission requests would be

$64,600, based on an estimated cost of $380 per hour for an in-house

attorney.117

—————————————————————————

117 Although different registrants may choose to staff

preparation of the comparability determination request with

different personnel, Commission staff estimates that, on average, an

initial request could be prepared and submitted with 10 hours of an

in-house attorney’s time. To estimate the hourly cost of an in-house

attorney’s attorney time, Commission staff reviewed data in SIFMA’s

Report on Management and Professional Earnings in the Securities

Industry 2013, modified by Commission staff to account for an 1800-

hour work-year and multiplied by a factor of 5.35 to account for

firm size, employee benefits and overhead. Commission staff believes

that use of a 5.35 multiplier here is appropriate because some

persons may retain outside advisors to assist in making the

determinations under the rules.

—————————————————————————

3. Section 15(a) Factors

As discussed above, the Proposed Rule is intended to apply the

Proposed Margin Rules on a cross-border basis in a manner that

effectively addresses risks to U.S. persons and the U.S. financial

system, while mitigating the potential for conflicts and duplications

that could lead to market distortions and undue competitive

disparities. The discussion that follows supplements the related cost

and benefit considerations addressed in the preceding section and

addresses the overall effect of the Proposed Rule in terms of the

factors set forth in section 15(a) of the CEA.

a. Protection of Market Participants and the Public

CEA section 15(a)(2)(A) requires the Commission to evaluate the

costs and benefits of a proposed regulation in light of considerations

of protection of market participants and the public. CEA section

4s(e)(2)(A) requires the Commission to develop rules designed to ensure

the safety and soundness of CSEs and the U.S. financial system. In

developing the Proposed Rule, the Commission’s primary focus was on the

relationship or trade-offs between the benefits associated with

applying the Commission’s margin requirement and the costs associated

with extending substituted compliance or the

[[Page 41399]]

Exclusion. On the one hand, full application of the Commission’s margin

requirements would help to ensure the safety and soundness of CSEs and

the U.S. financial system by reducing counterparty credit risk and the

threat of contagion; on the other hand, extending substituted

compliance or the Exclusion to CSEs would reduce the potential for

conflicting or duplicative requirements, which would, in turn, reduce

market distortions and promote global harmonization. Substituted

compliance in particular should not reduce the safety and soundness

benefit of the Proposed Rule because substituted compliance will not be

available unless the Commission determines that foreign margin

regulations are comparable to the Commission’s margin regulations.

Granting the Exclusion to certain CSEs should not significantly

undermine these purposes, because other requirements and circumstances

discussed above should mitigate the risk those CSEs pose to the U.S.

financial system.

b. Efficiency, Competitiveness, and Financial Integrity

CEA section 15(a)(2)(B) requires the Commission to evaluate the

costs and benefits of a proposed regulation in light of efficiency,

competitiveness and financial integrity considerations.

i. Efficiency

The availability of substituted compliance to CSEs following

comparable margin requirements in a foreign jurisdiction may

incentivize global implementation of the BCBS-IOSCO framework. Greater

harmonization across markets lessens the potential for conflicting or

duplicative requirements, which, in turn, would promote greater

operational efficiencies as a CSE would be able to avoid creating

individualized compliance and operational infrastructures to account

for the unique requirements of each jurisdiction in which it conducts

swaps business. Also, to the extent that margin regimes across

jurisdictions are comparable, substituted compliance should help to

mitigate regulatory arbitrage.

ii. Competitiveness

Under the Proposed Rule, the availability of substituted compliance

would turn primarily on the nature of the non-U.S. CSE’s relationship

to a U.S. person and the national status of the non-U.S. CSE’s

counterparty. For example, in the case of a non-U.S. CSE whose swap

obligations are not guaranteed by a U.S. person, substituted compliance

would be available for any swap with a counterparty that is not a U.S.

CSE or a non-U.S. CSE whose swap obligations are guaranteed by a U.S.

person. Further, under the Proposed Rule, an uncleared swap entered

into by a non-U.S. CSE with a non-U.S. person counterparty (including a

non-U.S. CSE) would be excluded from the Commission’s margin rules,

provided that neither counterparty’s obligations under the relevant

swap are guaranteed by a U.S. person and neither counterparty is a

Foreign Consolidated Subsidiary nor a U.S. branch of a non-U.S. CSE.

The availability of substituted compliance and/or the Exclusion

could create competitive disparities between those CSEs that are

eligible for substituted compliance and/or the Exclusion relative to

those that are not eligible. In addition, as the Exclusion is not

provided to all CSEs, those that are not permitted to use the Exclusion

may be at a competitive disadvantage when competing in foreign

jurisdictions that do not have comparable margin rules to that of the

Commission relative to non-CFTC registered dealers for foreign

clients.118 Because the Proposed Rule offers to U.S. CSEs (and non-

U.S. CSEs with respect to swaps whose obligations are guaranteed by a

U.S. person) only a minimal degree of substituted compliance and no

Exclusion, these CSEs may be particularly impacted. As discussed in

section II.C.1., however, the Commission believes that the Proposed

Margin Rules should apply to the maximum degree to such CSEs in order

to ensure the safety and soundness of U.S. CSEs (and U.S. guarantor)

and the U.S. financial system. Furthermore, to the extent that that a

relevant foreign jurisdiction’s margin rules are comparable to that of

the Commission’s margin rules, such competitive disparities could be

reduced.

—————————————————————————

118 The Commission notes, however, that of the approximately

61 CSEs that would be subject to the Commission’s margin rules, 21

are non-U.S. CSEs. Of those 21 non-U.S. CSEs, 20 are domiciled in

jurisdictions that participated in the development of the BCBS-IOSCO

framework, which may mitigate possible regulatory arbitrage between

these dealers.

—————————————————————————

iii. Financial Integrity of Markets

The safety and soundness of CSEs are critical to the financial

integrity of markets. Further, as discussed in section II.A. above,

margin serves as a first line of defense to protect a CSE as a whole in

the event of a default by a counterparty. Together with capital, margin

represents a key element in a CSE’s overall risk management program,

which ultimately mitigates the possibility of a systemic event.

At the same time, the Commission recognizes that a CSE’s uncleared

swaps with a particular counterparty may implicate the supervisory

interests of foreign regulators, and it is important to calibrate the

cross-border application of the margin requirements to mitigate, to the

extent possible, consistent with the Commission’s regulatory interests,

the potential for conflict or duplication with other jurisdictions.

Therefore, the Proposed Rule also allows for substituted compliance and

an Exclusion in certain circumstances.

The Commission believes that the Proposed Rule strikes the right

balance between the two competing considerations to ensure that

substituted compliance and the Exclusion are not extended in a way that

could pose substantial risk to the integrity of the U.S. financial

system. Substituted compliance is predicated on the Commission’s

determination that the relevant foreign jurisdiction has comparable

margin rules; if the Commission does not find a foreign jurisdiction’s

rules comparable, the CSE would then need to comply with the

Commission’s rules. Even in instances where the Exclusion would be

available, the Commission has taken into account that the risk to the

integrity of the financial markets would be mitigated by the

Commission’s expectation that: (1) The Proposed Margin Rules would

cover many of the swaps of the non-U.S. CSEs (eligible for the

Exclusion) with other counterparties, namely, all U.S. counterparties;

(2) the Exclusion would be limited to a narrow set of swaps by non-U.S.

CSEs; (3) the capital requirements would apply on an entity-level basis

to all CSEs; and (4) the excluded swaps will most likely be covered by

another foreign regulator’s margin rules that are based on the BCBS-

IOSCO framework.

c. Price Discovery

CEA section 15(a)(2)(C) requires the Commission to evaluate the

costs and benefits of a proposed regulation in light of price discovery

considerations. The Commission generally believes that substituted

compliance, by reducing the potential for conflicting or duplicative

regulations, could reduce impediments to transact uncleared swaps on a

cross-border basis. This, in turn, may enhance liquidity as more market

participants would be willing to enter into uncleared swaps, thereby

possibly improving price discovery–and ultimately reducing market

fragmentation. Alternatively, if substituted compliance or the

Exclusion were not made available, it would

[[Page 41400]]

incentivize CSEs to consider setting up their swap operations outside

the Commission’s jurisdiction, and as a result, increase the potential

for market fragmentation.

d. Sound Risk Management Practices

CEA section 15(a)(2)(D) requires the Commission to evaluate the

costs and benefits of a proposed regulation in light of sound risk

management practices. Margin is a critical element of a firm’s sound

risk management program that, among other things, can prevent the

accumulation of counterparty credit risk. As international regulators

and the Commission harmonize their margin regulations for uncleared

swaps, market participants may be able to manage their risk more

effectively on an enterprise-wide basis. On the other hand, to the

extent that a CSE relies on the Exclusion for eligible swaps and the

relevant foreign jurisdiction does not have comparable margin

requirements, the Proposed Rule could lead to weaker risk management

practices.

e. Other Public Interest Considerations

CEA section 15(a)(2)(E) requires the Commission to evaluate the

costs and benefits of a proposed regulation in light of other public

interest considerations. The Commission has not identified any

additional public interest considerations related to the costs and

benefits of the Proposed Rule.

4. General Request for Comment

The Commission requests comment on all aspects of the costs and

benefits relating to the cross-border application of the Proposed Rule,

including the nature and extent of the costs and benefits discussed

above and any other costs and benefits that could result from adoption

of the Proposed Rule. Commenters are encouraged to discuss the costs

and benefits to U.S. CSEs and non-U.S. CSEs covered by the Proposed

Rule, as well as any costs and benefits to other market participants,

the swap markets, or the general public, and to the extent such costs

and benefits can be quantified, monetary and other estimates thereof.

The Commission requests that commenters provide any data or other

information that would be useful in estimating the quantifiable costs

and benefits of this rulemaking. Among other things, commenters may

wish to submit comments on the following questions:

1. Are the Commission’s assumptions about the costs and benefits of

the Proposed Rule accurate? If not, please explain and provide any data

or other information that you have quantifying or qualifying the costs

and benefits of the Proposed Rule.

2. Did the Commission consider all of the appropriate costs and

benefits related to the Proposed Rule? If not, what additional costs

and benefits should the Commission consider? Please explain why these

additional costs and benefits should be considered and provide any data

or other information that you have quantifying or qualifying the costs

and benefits of these additional costs of the Proposed Rule.

3. Please provide any data or other information relating to costs

associated with the definition of “U.S. person” in the Proposed Rule,

and in particular, as the proposed definition relates to the definition

of “U.S. person” that was included in the Guidance.

4. Will allowing substituted compliance or the Exclusion for swaps

between certain categories of non-U.S. persons lead to fragmentation

(e.g., creating separate or multiple swap markets) of the liquidity in

swaps markets for uncleared swaps to the detriment of price discovery?

Is swap market fragmentation detrimental to various market participants

when there is post-trade price transparency of swaps? Commenters are

encouraged to quantify when practicable. Does the Proposed Rule have

any significant effects on price discovery? Indeed, to what extent are

the impacts on price discovery the result of other requirements, such

as the margin for uncleared swaps or the trade execution mandate, and

not the Proposed Rule per se?

List of Subjects in 17 CFR Part 23

Swaps, Swap dealers, Major swap participants, Capital and margin

requirements.

For the reasons discussed in the preamble, the Commodity Futures

Trading Commission proposes to amend 17 CFR chapter I as set forth

below:

PART 23–SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

0

1. The authority citation for part 23 is revised 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. Add subpart E to part 23 to read as follows:

Subpart E–Capital and Margin Requirements for Swap Dealers and Major

Swap Participants

Sec.

23.100-23.149 [Reserved]

23.150-23.159 [Reserved]

23.160 Cross-border application.

23.161-23.199 [Reserved]

Subpart E–Capital and Margin Requirements for Swap Dealers and

Major Swap Participants

Sec. Sec. 23.100-23.149 [Reserved]

Sec. Sec. 23.150-23.159 [Reserved]

Sec. 23.160 Cross-border application.

(a) Definitions. For purposes of this section only:

(1) Foreign Consolidated Subsidiary means a non-U.S. CSE in which

an ultimate parent entity that is a U.S. person has a controlling

financial interest, in accordance with U.S. GAAP, such that the U.S.

ultimate parent entity includes the non-U.S. CSE’s operating results,

financial position and statement of cash flows in the U.S. ultimate

parent entity’s consolidated financial statements, in accordance with

U.S. GAAP.

(2) Guarantee means an arrangement pursuant to which one party to a

swap transaction with a non-U.S. person counterparty has rights of

recourse against a U.S. person, with respect to the non-U.S. person

counterparty’s obligations under the swap transaction. For these

purposes, a party to a swap transaction has rights of recourse against

a U.S. person if the party has a conditional or unconditional legally

enforceable right to receive or otherwise collect, in whole or in part,

payments from the U.S. person in connection with the non-U.S. person

counterparty’s obligations under the swap.

(3) International standards means the margin policy framework for

non-cleared, bilateral derivatives issued by the Basel Committee on

Banking Supervision and the International Organization of Securities in

September 2013, as subsequently updated, revised, or otherwise amended,

or any other international standards, principles or guidance relating

to margin requirements for non-cleared, bilateral derivatives that the

Commission may in the future recognize, to the extent that they are

consistent with United States law (including the margin requirements in

the Commodity Exchange Act).

(4) Non-U.S. CSE means a covered swap entity that is not a U.S.

person. The term “non-U.S. CSE” includes a “Foreign Consolidated

Subsidiary” or a U.S. branch of a non-U.S. CSE.

(5) Non-U.S. person means any person that is not a U.S. person.

(6) Ultimate parent entity means the parent entity in a

consolidated group in which none of the other entities in the

[[Page 41401]]

consolidated group has a controlling interest, in accordance with U.S.

GAAP.

(7) United States means the United States of America, its

territories and possessions, any State of the United States, and the

District of Columbia.

(8) U.S. CSE means a covered swap entity that is a U.S. person.

(9) U.S. GAAP means U.S. generally accepted accounting principles.

(10) U.S. person means:

(i) A natural person who is a resident of the United States;

(ii) An estate of a decedent who was a resident of the United

States at the time of death;

(iii) A corporation, partnership, limited liability company,

business or other trust, association, joint-stock company, fund or any

form of entity similar to any of the foregoing (other than an entity

described in paragraph (a)(10)(iv) or (v) of this section) (a “legal

entity”), in each case that is organized or incorporated under the

laws of the United States or having its principal place of business in

the United States, including any branch of such legal entity;

(iv) A pension plan for the employees, officers or principals of a

legal entity described in paragraph (a)(10)(iii) of this section,

unless the pension plan is primarily for foreign employees of such

entity;

(v) A trust governed by the laws of a state or other jurisdiction

in the United States, if a court within the United States is able to

exercise primary supervision over the administration of the trust;

(vi) A legal entity (other than a limited liability company,

limited liability partnership or similar entity where all of the owners

of the entity have limited liability) that is owned by one or more

persons described in paragraphs (a)(10)(i) through (v) of this section

and for which such person(s) bears unlimited responsibility for the

obligations and liabilities of the legal entity, including any branch

of the legal entity; or

(vii) An individual account or joint account (discretionary or not)

where the beneficial owner (or one of the beneficial owners in the case

of a joint account) is a person described in paragraphs (a)(10)(i)

through (vi) of this section.

(b) Applicability of margin requirements–(1) Uncleared swaps of

U.S. CSEs or Non-U.S. CSEs whose obligations under the relevant swap

are guaranteed by a U.S. person–(i) Applicability of U.S. margin

requirements; availability of substituted compliance for requirement to

post initial margin. With respect to each uncleared swap entered into

by a U.S. CSE or a non-U.S. CSE whose obligations under the swap are

guaranteed by a U.S. person, the U.S. CSE or non-U.S. CSE whose

obligations under the swap are guaranteed by a U.S. person shall comply

with the requirements of Sec. Sec. 23.150 through 23.159, provided

that the U.S. CSE or non-U.S. CSE whose obligations under the swap are

guaranteed by a U.S. person may satisfy its requirement to post initial

margin to certain counterparties to the extent provided in paragraph

(b)(1)(ii) of this section.

(ii) Compliance with foreign initial margin collection requirement.

A covered swap entity that is covered by paragraph (b)(1)(i) of this

section may satisfy its requirement to post initial margin under this

part by posting initial margin in the form and amount, and at such

times, that its counterparty is required to collect initial margin

pursuant to a foreign jurisdiction’s margin requirements, but only to

the extent that:

(A) The counterparty is neither a U.S. person nor a non-U.S. person

whose obligations under the relevant swap are guaranteed by a U.S.

person;

(B) The counterparty is subject to such foreign jurisdiction’s

margin requirements; and

(C) The Commission has issued a comparability determination under

paragraph (c) of this section (“Comparability Determination”) with

respect to such foreign jurisdiction’s requirements regarding the

posting of initial margin by the covered swap entity (that is covered

in paragraph (b)(1) of this section).

(2) Uncleared swaps of Non-U.S. CSEs whose obligations under the

relevant swap are not guaranteed by a U.S. person–(i) Applicability of

U.S. margin requirements except where an exclusion applies;

Availability of substituted compliance. With respect to each uncleared

swap entered into by a non-U.S. CSE whose obligations under the

relevant swap are not guaranteed by a U.S. person, the non-U.S. CSE

shall comply with the requirements of Sec. Sec. 23.150 through 23.159

except to the extent that an exclusion is available under paragraph

(b)(2)(ii) of this section, provided that a non-U.S. CSE whose

obligations under the relevant swap are not guaranteed by a U.S. person

may satisfy its margin requirements under this part to the extent

provided in paragraphs (b)(2)(iii) and (iv) of this section.

(ii) Exclusion. A non-U.S. CSE shall not be required to comply with

the requirements of Sec. Sec. 23.150 through 23.159 with respect to

each uncleared swap it enters into to the extent:

(A) The non-U.S. CSE’s obligations under the relevant swap are not

guaranteed by a U.S. person;

(B) The non-U.S. CSE is not a U.S. branch of a non-U.S. CSE; and

(C) The non-U.S. CSE is not a Foreign Consolidated Subsidiary with

a non-U.S. person counterparty (excluding a Foreign Consolidated

Subsidiary or the U.S. branch of a non-U.S. CSE), whose obligations

under the relevant swap are not guaranteed by a U.S. person.

(iii) Availability of substituted compliance where the counterparty

is not a U.S. CSE or a non-U.S. CSE whose obligations under the

relevant swap are guaranteed by a U.S. person. Except to the extent

that an exclusion is available under paragraph (b)(2)(ii) of this

section, with respect to each uncleared swap entered into by a non-U.S.

CSE whose obligations under the relevant swap are not guaranteed by a

U.S. person with a counterparty (except where the counterparty is

either a U.S. CSE or a non-U.S. CSE whose obligations under the

relevant swap are guaranteed by a U.S. person), the non-U.S. CSE whose

obligations under the relevant swap are not guaranteed by a U.S. person

may satisfy margin requirements under this part by complying with the

margin requirements of a foreign jurisdiction to which such non-U.S.

CSE (whose obligations under the relevant swap are not guaranteed by a

U.S. person) is subject, but only to the extent that the Commission has

issued a Comparability Determination under paragraph (c) of this

section for such foreign jurisdiction.

(iv) Availability of substituted compliance where the counterparty

is a U.S. CSE or a non-U.S. CSE whose obligations under the relevant

swap are guaranteed by a U.S. person. With respect to each uncleared

swap entered into by a non-U.S. CSE whose obligations under the

relevant swap are not guaranteed by a U.S. person with a counterparty

that is a U.S. CSE or a non-U.S. CSE whose obligations under the

relevant swap are guaranteed by a U.S. person, the non-U.S. CSE (whose

obligations under the relevant swap are not guaranteed by a U.S.

person) may satisfy its requirement to collect initial margin under

this part by collecting initial margin in the form and amount, and at

such times and under such arrangements, that the non-U.S. CSE (whose

obligations under the relevant swap are not guaranteed by a U.S.

Person) is required to collect initial margin pursuant to a foreign

jurisdiction’s margin requirements, provided that:

[[Page 41402]]

(A) The non-U.S. CSE (whose obligations under the relevant swap are

not guaranteed by a U.S. person) is subject to the foreign

jurisdiction’s regulatory requirements; and

(B) The Commission has issued a Comparability Determination with

respect to such foreign jurisdiction’s margin requirements.

(c) Comparability determinations–(1) Eligibility requirements. The

following persons may, either individually or collectively, request a

Comparability Determination with respect to some or all of the

Commission’s margin requirements:

(i) A covered swap entity that is eligible for substituted

compliance under this section; or

(ii) A foreign regulatory authority that has direct supervisory

authority over one or more covered swap entities and that is

responsible for administering the relevant foreign jurisdiction’s

margin requirements.

(2) Submission requirements. Persons requesting a Comparability

Determination should provide the Commission (either by hard copy or

electronically):

(i) A description of the objectives of the relevant foreign

jurisdiction’s margin requirements;

(ii) A description of how the relevant foreign jurisdiction’s

margin requirements address, at minimum, each of the following elements

of the Commission’s margin requirements. Such description should

identify the specific legal and regulatory provisions that correspond

to each element and, if necessary, whether the relevant foreign

jurisdiction’s margin requirements do not address a particular element:

(A) The transactions subject to the foreign jurisdiction’s margin

requirements;

(B) The entities subject to the foreign jurisdiction’s margin

requirements;

(C) The methodologies for calculating the amounts of initial and

variation margin;

(D) The process and standards for approving models for calculating

initial and variation margin models;

(E) The timing and manner in which initial and variation margin

must be collected and/or paid;

(F) Any threshold levels or amounts;

(G) Risk management controls for the calculation of initial and

variation margin;

(H) Eligible collateral for initial and variation margin;

(I) The requirements of custodial arrangements, including

rehypothecation and the segregation of margin;

(J) Documentation requirements relating to margin; and

(K) The cross-border application of the foreign jurisdiction’s

margin regime.

(iii) A description of the differences between the relevant foreign

jurisdiction’s margin requirements and the International Standards;

(iv) A description of the ability of the relevant foreign

regulatory authority or authorities to supervise and enforce compliance

with the relevant foreign jurisdiction’s margin requirements. Such

description should discuss the powers of the foreign regulatory

authority or authorities to supervise, investigate, and discipline

entities for compliance with the margin requirements and the ongoing

efforts of the regulatory authority or authorities to detect, deter,

and ensure compliance with the margin requirements; and

(v) Copies of the foreign jurisdiction’s margin requirements

(including an English translation of any foreign language document);

(vi) Any other information and documentation that the Commission

deems appropriate.

(3) Standard of review. The Commission will issue a Comparability

Determination to the extent that it determines that some or all of the

relevant foreign jurisdiction’s margin requirements are comparable to

the Commission’s corresponding margin requirements. In determining

whether the requirements are comparable, the Commission will consider

all relevant factors, including:

(i) The scope and objectives of the relevant foreign jurisdiction’s

margin requirements;

(ii) How the relevant foreign jurisdiction’s margin requirements

compare to the International Standards;

(iii) Whether the relevant foreign jurisdiction’s margin

requirements achieve comparable outcomes to the Commission’s

corresponding margin requirements;

(iv) The ability of the relevant regulatory authority or

authorities to supervise and enforce compliance with the relevant

foreign jurisdiction’s margin requirements; and

(v) Any other facts and circumstances the Commission deems

relevant.

(4) Reliance. Any covered swap entity that, in accordance with a

Comparability Determination, complies with a foreign jurisdiction’s

margin requirements would be deemed to be in compliance with the

Commission’s corresponding margin requirements. Accordingly, the

failure of such a covered swap entity to comply with the foreign

jurisdiction’s margin requirements may constitute a violation of the

Commission’s margin requirements. All covered swap entities, regardless

of whether they rely on a Comparability Determination, remain subject

to the Commission’s examination and enforcement authority.

(5) Conditions. In issuing a Comparability Determination, the

Commission may impose any terms and conditions it deems appropriate.

The violation of such terms and conditions may constitute a violation

of the Commission’s margin requirements and/or result in the

modification or revocation of the Comparability Determination.

(6) Modifications. The Commission reserves the right to further

condition, modify, suspend, terminate or otherwise restrict a

Comparability Determination in the Commission’s discretion.

(7) Delegation of authority. The Commission hereby delegates to the

Director of the Division of Swap Dealer and Intermediary Oversight, or

such other employee or employees as the Director may designate from

time to time, the authority to request information and/or documentation

in connection with the Commission’s issuance of a Comparability

Determination.

Sec. Sec. 23.161–23.199 [Reserved]

Note: The following table will not appear in the Code of Federal

Regulations.

Table A–Application of the Proposed Rule 1 2 3

—————————————————————————————————————-

CSE Counterparty Proposed approach

—————————————————————————————————————-

U.S. CSE or Non-U.S. CSE (including U.S. person (including U.S. CSE). U.S. (All).

U.S. branch of a non-U.S. CSE and a Non-U.S. person (including non-

Foreign Consolidated Subsidiary U.S. CSE, FCS, and U.S. branch of a non-

(“FCS”)) whose obligations under U.S. CSE) whose obligations under the

the relevant swap are guaranteed by relevant swap are guaranteed by a U.S.

a U.S. person. person.

[[Page 41403]]

 

Non-U.S. person (including non- U.S. (Initial Margin

U.S. CSE, FCS and U.S. branch of a non- collected by CSE in column

U.S. CSE) whose obligations under the 1).

relevant swap are not guaranteed by a Substituted Compliance

U.S. person. (Initial Margin posted by

CSE in column 1).

U.S. (Variation Margin).

FCS whose obligations under the U.S. CSE. U.S. (Initial Margin posted

relevant swap are not guaranteed by Non-U.S. CSE (including U.S. by CSE in column 1).

a U.S. person or U.S. branch of a branch of a non-U.S. CSE and FCS) whose Substituted Compliance

non-U.S. CSE whose obligations under obligations under the relevant swap are (Initial Margin collected by

the relevant swap are not guaranteed guaranteed by a U.S. person. CSE in column 1).

by a U.S. person. U.S. (Variation Margin).

U.S. person (except as noted Substituted Compliance (All).

above for a CSE).

Non-U.S. person whose obligations

under the swap are guaranteed by a U.S.

person (except a non-U.S. CSE, U.S.

branch of a non-U.S. CSE, and FCS whose

obligations are guaranteed, as noted

above).

Non-U.S. person (including non-

U.S. CSE, U.S. branch of a non-U.S. CSE,

and a FCS) whose obligations under the

relevant swap are not guaranteed by a

U.S. person.

Non-U.S. CSE (that is not a FCS or a U.S. CSE. U.S. (Initial Margin posted

U.S. branch of a non-U.S. CSE) whose Non-U.S. CSE (including U.S. by CSE in column 1).

obligations under the relevant swap branch of a non-U.S. CSE and FCS) whose Substituted Compliance

are not guaranteed by a U.S. person. obligations under the swap are guaranteed (Initial Margin collected by

by a U.S. person. CSE in column 1).

U.S. (Variation Margin).

U.S. person (except as noted Substituted Compliance (All).

above for a CSE).

Non-U.S. person whose obligations

under the swap are guaranteed by a U.S.

person (except a non-U.S. CSE whose

obligations are guaranteed, as noted

above).

U.S. branch of a Non-U.S. CSE or

FCS, in each case whose obligations under

the relevant swap are not guaranteed by a

U.S. person.

Non-U.S. person (including a non- Excluded.

U.S. CSE, but not a FCS or a U.S. branch

of a non-U.S. CSE) whose obligations

under the relevant swap are not

guaranteed by a U.S. person.

—————————————————————————————————————-

1 This table should be read in conjunction with the rest of the preamble and the text of the Proposed Rule.

2 The term “U.S. person” is defined in Sec. 23.160(a)(10) of the Proposed Rule. A “non-U.S. person” is

any person that is not a “U.S. person.” The term swap means an uncleared swap and is defined in Sec.

23.151 of the Proposed Margin Rules. See Margin Requirements for Uncleared Swaps for Swap Dealers and Major

Swap Participants, 79 FR 59898 (Oct. 3, 2014).

3 As used in this table, the term “Foreign Consolidated Subsidiary” or “FCS” refers to a non-U.S. CSE in

which an ultimate parent entity that is a U.S. person has a controlling financial interest, in accordance with

U.S. GAAP, such that the U.S. ultimate parent entity includes the non-U.S. CSE’s operating results, financial

position and statement of cash flows in the U.S. ultimate parent entity’s consolidated financial statements,

in accordance with U.S. GAAP. The term “ultimate parent entity” means the parent entity in a consolidated

group in which none of the other entities in the consolidated group has a controlling interest, in accordance

with U.S. GAAP.

Issued in Washington, DC, on July 2, 2015, by the Commission.

Christopher J. Kirkpatrick,

Secretary of the Commission.

Note: The following appendices will not appear in the Code of

Federal Regulations.

Appendices to Margin Requirements for Uncleared Swaps for Swap Dealers

and Major Swap Participants–Cross-Border Application of the Margin

Requirements–Commission Voting Summary, Chairman’s Statement, and

Commissioners’ Statements

Appendix 1–Commission Voting Summary

On this matter, Chairman Massad and Commissioners Wetjen, Bowen,

and Giancarlo voted in the affirmative. No Commissioner voted in the

negative.

Appendix 2–Statement of Chairman Timothy G. Massad

Today the Commission voted unanimously to issue a proposal on

the cross-border application of our previously proposed rules on

margin for uncleared swaps. I thank my fellow Commissioners for

their work and input on this proposal, and I also want to thank our

staff for their hard work.

The proposed rule on margin for uncleared swaps, which we issued

last fall, is one of the most important rules for the regulation of

the over-the-counter swaps market.

That is because there will always be a large part of the swaps

market that is not cleared through central counterparties. Although

we are mandating clearing for certain swaps, we should not mandate

clearing for all swaps. Some products are not appropriate for such

[[Page 41404]]

a mandate because of their risk or liquidity characteristics.

Margin can be an effective tool for addressing counterparty

credit risk arising from uncleared swaps. Our rule will make sure

that registered swap dealers post and collect margin in their

transactions with other registered swap dealers and financial

institutions that are above certain thresholds. That helps lower the

risk to the financial system and the overall economy. I also note

that the requirements do not apply to commercial end users.

We saw what happened in 2008 when there was a build-up of

excessive risk in bilateral swaps. That risk intensified and

accelerated the financial crisis like gasoline poured on a fire. And

that crisis cost our economy eight million jobs and untold suffering

for American families.

Moreover, we saw how that risk could be created offshore,

outside our borders, but still jeopardize our financial stability

and our economy.

The excessive swap risk taken on by AIG was initiated from its

overseas operation. In order to prevent the failure of AIG, our

government had to commit over $180 billion.

We got all that money back, but that is a painful example of why

the cross-border application of the margin rule is important.

The proposal we are issuing today addresses the possibility that

risk created offshore can flow back into the U.S. And so it applies

to activities of non-U.S. swap dealers that are registered with us.

At the same time, our proposal recognizes the importance of

harmonizing rules with other jurisdictions.

If a transaction by an offshore swap dealer is guaranteed by a

U.S. person, such as the parent of the dealer, the risk of that

transaction can flow back into the U.S. But the same can occur even

if the transaction is not guaranteed by the U.S. parent. Our

proposal addresses that. By doing so, I believe our proposal is a

good way to address the risk that can arise from uncleared swaps in

that situation.

The proposal draws a line as to when we should take this

offshore risk into account that is both reasonable and clear. The

line we are proposing is this: If the financial results and position

of the non-U.S. swap dealer are consolidated in the financial

statements of the U.S. parent, then we should take that into

account, whether or not there is an explicit guarantee.

This is how the proposal works: U.S. swap dealers would be

required to comply with the rule in all their transactions, but in

their transactions with certain non-U.S. counterparties, they would

be entitled to substituted compliance with respect to margin they

post, but not the margin they collect. Non-U.S. swap dealers whose

swap obligations are guaranteed by a U.S. person would be treated

the same way. Substituted compliance would be available in the case

of the laws of those jurisdictions which we have deemed comparable.

For non-U.S. swap dealers registered with us, whose obligations

are not guaranteed by a U.S. person, they must still comply, but

they would be entitled to substituted compliance to a greater

extent. Generally, they could avail themselves of full substituted

compliance unless the counterparty was a U.S. swap dealer or a swap

dealer guaranteed by a U.S. person. And, transactions between a non-

U.S. swap dealer (but not conducted through its U.S. branch) and a

non-U.S. counterparty would be excluded from the margin rules, if

neither party’s obligations under the relevant swap are guaranteed

by a U.S. person nor consolidated in the financial statements of its

U.S. parent.

Limiting the exclusion from our rule to only those transactions

where neither party is guaranteed or consolidated with a U.S. person

helps address the concern that there is risk to the U.S. even if

there is no explicit guarantee.

Lastly, when foreign banks conduct their swaps business within

the U.S. through their branches located in the U.S., in direct

competition with U.S. swap dealers, the exclusion would not apply.

However, U.S. branches would be eligible for substituted compliance,

which would reduce the potential for conflicts with foreign

jurisdictions.

The broad scope of substituted compliance recognizes that we

must work together with other jurisdictions to regulate this market,

and we should design our rules to avoid conflict and duplication as

much as possible. And the proposal may reduce competitive

disparities that would otherwise result from different sets of rules

applying to swap dealers engaged in essentially the same activity.

The proposal we are making today is very similar to the approach

proposed last fall by the prudential regulators. That is

appropriate, because the law requires us and the prudential

regulators to harmonize our margin rules as much as possible. It

also makes sense when you look at the composition of the registered

swap dealers. There are approximately 100 swap dealers registered

with us. Approximately 40 of those will be subject to the margin

rules of the prudential regulators, while approximately 60 will be

subject to our rules. About two thirds of those 60 swap dealers that

will be subject to our margin rule have affiliates who will be

subject to the margin rules of the prudential regulators. For

example, of the approximately 60 swap dealers subject to our margin

rules, over half are subsidiaries of just five major U.S. bank

holding companies. Each of those large bank holding companies has

other subsidiaries that are, subject to the margin rules of the

prudential regulators. Therefore, if our margin rules are

substantially different from the margin rules of the prudential

regulators, then we have created incentives for firms to move

activity from one entity to another solely to take advantage of

potential differences in the rules. That is an outcome we should try

very hard to avoid.

We also wish to coordinate our rules with the margin rules of

other jurisdictions. That is why our proposal today provides for

substituted compliance. In addition, at my direction, our staff is

actively engaged with their counterparts in other jurisdictions to

try to harmonize the rules as much as possible. Although much work

remains to be done, and the Commission must take final action, I am

hopeful that our final rules will be similar on many critical issues

to those currently being developed in other major jurisdictions.

I would also like to say a word about our Cross-Border Guidance,

which discussed how the Commission would generally apply Dodd-Frank

requirements to cross-border swap activities. In doing so, the

Commission recognized that the market is complex and dynamic and

that a flexible approach is necessary. As stated in the Guidance,

“the Commission will continue to follow developments as foreign

regulatory regimes and the global swaps market continue to evolve.

In this regard, the Commission will periodically review this

Guidance in light of future developments.” That is essentially what

we are doing here. With each area of our rules, the implications of

cross-border transactions for our policy objectives may vary. Margin

for uncleared swaps is intended to protect the safety and soundness

of swap dealers and ultimately, to ensure the stability of the U.S.

financial system. Therefore, it is appropriate to take into account

whether that risk flows back into the United States by virtue of a

guarantee by a U.S. person, or financial consolidation with a U.S.

person. But the approach we are proposing today for margin may not

be appropriate with respect to other areas of regulation–such as

swaps reporting or trading.

In conclusion, I believe the approach we are proposing today

combines the best elements of the various approaches proposed last

fall. It strikes the right balance between the Commission’s

supervisory interest in ensuring the safety and soundness of

registered swap dealers and the need to recognize principles of

international comity and reduce the potential for conflict with

foreign regulatory requirements.

Appendix 3–Statement of Commissioner Mark P. Wetjen

Today’s release lays out a proposed framework for the

application of the Commission’s margin rules to un-cleared swaps

(the “Margin Rule”) in cross-border transactions. Interestingly,

the release states that there was no consensus among those who filed

comments in response to the Commission’s Advance Notice of Proposed

Rulemaking (“ANPR”) last fall, which laid out three alternative,

cross-border approaches: The Guidance Approach, the Prudential

Regulators’ Approach, and the Entity Approach. To the extent,

therefore, that the release was designed to identify a consensus

view concerning which of these three approaches was best, it failed.

The comment letters, however, provided a great deal of useful

discussion that has aided the Commission’s thinking about the extra-

territorial application of its rules. Ultimately, the agency was

guided by those comments to propose today an approach that is

essentially an entity approach, but because of more availability of

substituted compliance, appears most similar to the Prudential

Regulators’ Approach in terms of its practical implementation.

I am comfortable supporting today’s release, but for the reasons

discussed below,

[[Page 41405]]

continue to harbor some doubts as to whether we have selected the

approach that best balances the Commission’s interests in protecting

the financial system and U.S. taxpayers, meeting its statutory

mandate to preserve an appropriate competitive landscape for

participants in the global swaps market, and adopting policies whose

costs to those affected do not exceed their benefits.1

—————————————————————————

1 See 7 U.S.C. 19(a).

—————————————————————————

The Commission’s Responsibilities Regarding the Margin Rule

To begin, it is important to understand the scope of the

Commission’s responsibilities with respect to implementing and

enforcing the Margin Rule. As was made plain by the proposal seeking

comment on the Margin Rule released last fall, the rulemaking is one

of the most important component parts of the risk-focused

requirements under Title VII of Dodd-Frank. The statute divides up

responsibilities for implementing and enforcing the Margin Rule

among this Commission, the U.S. prudential regulators, and the

Securities and Exchange Commission. Those responsibilities are

weighty, requiring, among others, the review and approval of margin

methodologies submitted by the covered swap entities under each

authority’s jurisdiction.

As of today, five U.S. bank holding companies regulated by the

Board of Governors of the Federal Reserve System (the “Board”)

have 17 U.S. registered swap dealers that would fall exclusively

within the CFTC’s jurisdiction for margin purposes. These same five

U.S. bank holding companies have 15 non-U.S. registered swap dealers

that would fall exclusively within the CFTC’s jurisdiction for

margin purposes (the “U.S. Foreign-Affiliate Dealers”). That is a

total of 32 registered swap dealers that the commission would have

to oversee, supervise, and enforce compliance with respect to the

Margin Rule.

There are another three non-U.S. parent entities regulated by

the Board, which altogether have four entities registered with the

Commission as swap dealers, due to the level of swap-dealing

activity they engage in with U.S. counterparties (“Non-U.S.

Dealers”). There are only three non-U.S. registered swap dealers

that do not have a parent entity regulated by the Board and that

would fall exclusively within the CFTC’s jurisdiction for margin

purposes (the “Truly Foreign Dealers”), or just a fraction of the

number of firms that are either based in the U.S. or controlled by a

U.S. regulated parent. This brings to 39 the total number of swap

dealers whose un-cleared swap activities would be subjected to the

Commission’s Margin Rule.

The Commission’s regulatory interests in each of these

categories of registered swap dealers is different, notwithstanding

the fact the Commission has responsibility over all of them. In most

respects, the Commission (and other U.S. policymakers and swap-

market stakeholders) should be primarily concerned about the U.S.

Foreign-Affiliate Dealers when thinking through and developing a

cross-border framework to determine when these entities should

follow U.S. law. This statement is based on the fact that concerns

about risk importation into the U.S. are much lower, relatively

speaking, when it comes to the activities of the Non-U.S. Dealers

and Truly Foreign Dealers (none of the Non-U.S. Dealers or Truly

Foreign Dealers would appear to meet the control test under the

prudential regulators’ September 2014 margin rule proposal).

Instead, these latter categories of swap dealers raise different

issues related to the Commission’s mandates to enhance market

integrity and promote fair competition.2

—————————————————————————

2 See section 3(b) of the Commodity Exchange Act (“CEA”), 7

U.S.C. 5(b).

—————————————————————————

Appropriately, when Non-U.S. Dealers and Truly Foreign Dealers

face other non-U.S. counterparties, they are excluded from having to

comply with the Margin Rule under the proposal, so long as neither

the registered swap dealer’s nor its counterparty’s obligations

benefit from a guarantee by a U.S. person. Under the Guidance

Approach, these Non-U.S. Dealers and Truly Foreign Dealers would be

excluded from the Margin Rule as well, so long as neither the swap

dealer’s nor its counterparty’s obligations benefit from a guarantee

by a U.S. person.

I review the scope and weight of these responsibilities here

because the context to deciding how much supervisory

responsibilities to assert over the cross-border swap activities of

entities located outside of the U.S. is important, both in

understanding the practical implications of claiming those

responsibilities as well as the potential effect on international

comity. The review of the different categories of swap-dealer

registrants also makes it clear to me that to pursue the Entity

Approach without allowing substituted compliance, as some commenters

suggested, is neither necessary for the Commission to meet its

statutory responsibilities nor advisable, not to mention

impractical.

When the Commission voted on the ANPR, I noted the potential

benefits of the proposal set forth by the Prudential Regulators’

Approach, which would effectively apply the margin rule as an

entity-level rule with certain exclusions for foreign swap

activities. At that time, however, I expressed my view that applying

the margin rule as a transaction-level requirement under the

Guidance Approach was the better option. In part, that view was

shaped by the practical reality that it would be difficult for the

Commission to meet its challenge to supervise U.S. swap dealers’

compliance with the margin rule, let alone the activities of the

U.S. Foreign-Affiliate Dealers and Truly Foreign Dealers.

Policy Advantages of Today’s Proposal

As it relates to the Truly Foreign Dealers, compliance

obligations under today’s proposal would be effectively the same as

under the cross-border guidance, so presumably no new burdens or

competitive considerations would be created here for those firms (as

discussed above). Additionally, as it relates to the U.S. Foreign-

Affiliate Dealers (some of which have affiliates not supervised by

the commission and engaged in swap activities), today’s proposal

could dis-incentivize firms from moving swap activity transacted by

an affiliated entity regulated by a U.S. prudential regulator, into

the U.S. Foreign-Affiliate Dealer. Such a market response is

conceivable given the fact there could be different compliance

obligations under the proposal as compared to the Guidance Approach

depending on whether the U.S. Foreign-Affiliate Dealer is a Foreign

Consolidated Subsidiary, and whether the dealer’s un-cleared swap is

supported by a guarantee. Presumably, there is swap activity of some

of these U.S. Foreign-Affiliate Dealers that would be required to

comply with the Margin Rule under today’s proposal, that would not

have been subjected to the Margin Rule under the Guidance Approach.

U.S. domestic regulators should not knowingly create an

opportunity for affiliates within a U.S. bank holding company to

move swap activity from one affiliate to another for no other reason

than to avoid application of U.S. law (even if there are legitimate

policy reasons that U.S. law would not apply). Indeed, this is why

the Dodd-Frank Act requires the relevant agencies implementing the

Margin Rule to coordinate their efforts as closely as possible.

Knowingly allowing such a result also would be inconsistent with the

Commission’s statutory duty to promote fair competition.3

—————————————————————————

3 See section 3(b) of the CEA, 7 U.S.C. 5(b).

—————————————————————————

Similarly, the Commission should be careful to avoid adopting a

significantly different cross-border approach from the U.S.

prudential regulators if it would incentivize affiliates of U.S.

Foreign-Affiliate Dealers to move their swap activity to the U.S.

Foreign-Affiliate Dealer in order to exploit the relative dearth of

resources available to the Commission for supervising and enforcing

compliance. The CFTC currently is under-staffed. Meeting the

challenge to monitor compliance with the complex and technical

requirements of the Margin Rule as it applies to the swap activity

conducted by U.S. Foreign-Affiliate Dealers today would be

difficult. A cross-border approach that is substantively similar to

the Prudential Regulators’ Approach may facilitate the Commission in

meeting its supervisory challenge.

Relatedly, I am also cognizant of market efforts to develop a

standard initial-margin methodology for un-cleared swaps, which I

believe would be supported by the hybrid approach set forth in

today’s proposal. I am in favor of these efforts because the use of

a standard initial margin methodology has the potential to reduce

dispute burdens by using a common approach for reconciliation,

promote the efficient use of limited market resources, and enhance

fairness and transparency in the global OTC derivatives markets. As

such, the Commission should, if possible, avoid adopting a cross-

border approach that would discourage the development of a standard

initial-margin methodology, or would otherwise encourage the

development of different margin methodologies across affiliated

entities and/or the broader marketplace. This outcome

[[Page 41406]]

would complicate the jobs of all supervisory authorities involved,

perhaps especially the U.S. prudential regulators.

Policy Advantages of the Guidance Approach

Generally speaking, the Commission in adopting its cross-border

guidance intended to strike a reasonable balance in assuring that

the swaps markets were brought under the new regulatory regime as

directed by Congress and consistent with section 2(i) of the CEA.4

We should not depart from those important policy judgments without a

compelling reason to do so.

—————————————————————————

4 See section 2(i) of the CEA, 7 U.S.C. 2(i).

—————————————————————————

One advantage of the Guidance Approach, therefore, is that it

would harmonize the Commission’s own cross-border policies as they

related to both cleared and un-cleared swap activity. Because many

firms under the Commission’s jurisdiction have incurred significant

costs by building systems and practices designed to follow the

Commission’s cross-border guidance, overall costs to registered swap

dealers might be lower if the Guidance Approach were adopted, which

obviously is relevant to the Commission’s mandate to consider the

benefits and costs of its policies. But of course, with harmony of

the Commission’s cross-border policies comes disharmony with the

U.S. prudential regulators.

Another advantage to the Guidance Approach is that it provides a

more elegant way for U.S. Foreign-Affiliate Dealers, Non-U.S.

Dealers and Truly Foreign Dealers to comply with their regulatory

obligations when the Commission has made a substituted-compliance

determination regarding another jurisdiction’s margin requirements.

Under the Guidance Approach, an affected swap dealer’s obligations

to post margin and collect margin would follow the same law or

regulation of another jurisdiction if the Commission had made such a

substituted-compliance determination; which is to say, margin

payments going in both directions would follow the same set of

rules. This outcome has the added benefit of being consistent with

the Basel Committee on Banking Supervision’s (“BCBS”) and the

Board of the International Organization of Securities Commissions’

(“IOSCO”) final margin policy framework for margin requirements

for non-centrally cleared derivatives (the “BCBS-IOSCO

Framework”), which states that when a transaction is subject to two

sets of rules, the regulators should endeavor to harmonize their

rules to the extent possible.5

—————————————————————————

5 See BCBS and IOSCO, Margin requirements for non-centrally

cleared derivatives (Sept. 2013) at 22, available at http://www.bis.org/publ/bcbs261.pdf. The BCBS-IOSCO Framework also provides

that regulators should recognize the equivalence and comparability

of their respective rules and apply only one set of rules to the

transaction.

—————————————————————————

Given the relatively broad agreement among key jurisdictions

about how the global framework for margin requirements ought to be

structured, such a result should be an acceptable way to address any

remaining concerns about risk from overseas activity transferring

back to the U.S. Again, those concerns primarily would arise from

the un-cleared swap activities of the U.S. Foreign-Affiliate

Dealers. The proposal, on the other hand, would require a non-U.S.

covered swap entity guaranteed by a U.S. person to follow U.S.

initial margin rules, but only permit substituted compliance for the

posting of initial margin when such non-U.S. covered swap entity

trades with a non-U.S. counterparty.

In this scenario, it would be possible for two separate laws to

apply to the same transaction. Under this framework, I question

whether market participants engaging in un-cleared swaps would have

the necessary legal certainty as to which margin requirements they

would face. While this framework is proposed ostensibly to help

ensure the safety and soundness of covered swap entities and to

support the stability of the U.S. financial markets, these goals

arguably will be accomplished only if the framework is workable. The

Guidance Approach would arguably provide greater certainty as to the

law applicable to a particular transaction, and render the

Commission’s policy more consistent with the BCBS-IOSCO

Framework.6

—————————————————————————

6 See id.

—————————————————————————

To that end, I look forward to hearing additional comments on

whether a swap between a non-U.S. covered swap entity and a non-U.S.

counterparty should receive substituted compliance for the entire

swap, rather than subject the swap to both U.S. and foreign margin

requirements. Ideally, such comments would give the Commission a

better understanding of the feasibility of designing systems to

assist the covered swap entity comply with two separate margin

requirements for the same transaction.

To the degree that the Commission should be concerned about

deferring to other regulators to supervise the posting and

collecting of margin for un-cleared swaps–as it would in the wake

of a substituted-compliance determination–context again is

important to remember here. As mentioned, there is relatively broad

agreement among key jurisdictions about how the global framework for

margin requirements should be structured, as a result of the

issuance of the BCBS-IOSCO Framework. It’s equally important to

remember that the Commission’s capital rule is treated as an entity-

level rule under the Commission’s cross-border guidance.7 As I

stated when the Commission released its proposal for the Margin

Rule, credit risks not addressed through the Margin Rule could be

addressed, at least in part, through indirect capital requirements

at the holding company level, and direct capital requirements at the

registrant level for those swap dealers relying on substituted

compliance (or otherwise).

—————————————————————————

7 See Interpretive Guidance and Policy Statement Regarding

Compliance with Certain Swap Regulations, 78 FR 45292 (July 26,

2013).

—————————————————————————

Yet another advantage to the Guidance Approach is that it might

better avoid further diminishments to liquidity that the marketplace

has experienced recently, as well as better avoid regulatory market

fragmentation that materialized after the Commission’s new swap-

execution framework went into effect. Several commenters expressed

strong concerns that the Entity Approach could further fragment the

swaps markets and impair liquidity, promote regulatory arbitrage,

and place the foreign affiliates of U.S. entities at a competitive

disadvantage beyond the circumstances they face in the cleared swap

environment under the Commission cross-border guidance. I have

recognized and spoken about market fragmentation for years, and so

do not take lightly such concerns being raised again in this

context.

Clarifications of the Commission’s Definition of “Guarantee” and

“U.S. Person”

The proposal includes two important clarifications for market

participants that I would like to acknowledge. First, I am

supportive of the proposed removal of the U.S. majority-ownership

prong from the U.S. person definition. For certain types of funds,

it is extremely difficult for advisors or administrators to

accurately determine whether, and how many of, the beneficial owners

of fund entities within the fund structure are U.S. persons. Given

this complexity and the other elements of the U.S. person definition

that would capture those funds that have a substantial nexus to the

U.S. markets, I believe this exclusion is necessary and appropriate.

I also support the release’s proposed definition of “guarantee”.

This clearer definition will help market participants better

identify those transactions that raise or implicate greater

supervisory interest by the Commission.

Conclusion

The questions asked in this proposal are intended to solicit

comment in hopes of further clarifying the most appropriate way for

the Commission to meet its regulatory objectives as well as finding

more consensus on the important issues raised in the release. As

discussed above, I am open to the approach taken in this proposal

and recognize its merits. I look forward to seeing whether comments

filed in response to today’s release can further build the case for

the Commission adopting the proposal, rather than the Guidance

Approach.

Appendix 4–Concurring Statement of Commissioner Sharon Y. Bowen

I’m pleased to support this new proposed rule on cross-border

application of uncleared margin requirements for swap dealers and

major swap participants. Margin requirements for uncleared swaps,

needless to say, are a core piece of the new regulatory regime we

are establishing as required by the Dodd-Frank Wall Street Reform

and Consumer Protection Act.

It is imperative that we get all aspects of our margin

requirements right, and that includes getting the cross-border

element of the requirements right. The swaps market is a global

one–the market has organically evolved to rely on the ability of

U.S. entities to trade with European entities as a matter of course.

It is incumbent on us that our rules not severely restrict this flow

of commerce, just as it is incumbent on us that our rules provide

rigorous regulations on this market for the protection of investors,

consumers, and the broader financial system.

[[Page 41407]]

To that end, I look forward to receiving comments on this

proposal from a wide swath of stakeholders, from market participants

to financial reform advocates. I hope we will receive comments on

whether this rule is workable, whether it is sufficiently robust,

and what changes would make the rule more effective on both of those

metrics.

Appendix 5–Statement of Commissioner J. Christopher Giancarlo

The Commission’s proposal for the cross-border application of

margin requirements for uncleared swaps is a highly complicated

labyrinth. I look forward to the jolt to U.S. economic growth that

will occur in the 3rd quarter of 2015 as a result of the thousands

of billable hours that will be expended by lawyers and other

professionals, who will have to read, interpret and respond to this

tangled regulatory construct.

I have many concerns and questions regarding the proposal,

including:

1. The shift from the transaction-level approach set forth in

the July 2013 Cross-Border Interpretive Guidance and Policy

Statement 1 (“Guidance”) to a hybrid approach and what this

means for the status of the Guidance moving forward;

—————————————————————————

1 Interpretive Guidance and Policy Statement Regarding

Compliance With Certain Swap Regulations, 78 FR 45292 (Jul. 26,

2013).

—————————————————————————

2. the revised definitions of “U.S. person” (defined for the

first time in an actual Commission rule) and “guarantee” and how

these new terms will be interpreted and applied by market

participants across their entire global operations;

3. the scope of when substituted compliance is allowed; and

4. the practical implications of permitting substituted

compliance, but disallowing the exclusion from CFTC margin

requirements (“Exclusion”) for non-U.S. covered swap entities

(“CSEs”) who qualify as Foreign Consolidated Subsidiaries.

My concerns extend to the standards set forth for determining

comparability. An appropriate framework for the cross-border

application of margin requirements for uncleared swaps is essential

if we are to preserve the global nature of the swaps market.

Congress recognized this when it instructed the CFTC, the SEC and

the prudential regulators to “coordinate with foreign regulatory

authorities on the establishment of consistent international

standards with respect to the regulation . . . of swaps.” 2

Towards that end, representatives of more than 20 regulatory

authorities, including the CFTC, participated in consultations with

the Basel Committee on Banking Supervision (“BCBS”) and the Board

of the International Organization of Securities Commissions

(“IOSCO”), which resulted in the issuance of a final BCBS-IOSCO

framework in September 2013 that establishes minimum margin

standards for uncleared swaps (“BCBS-IOSCO framework”).3

—————————————————————————

2 15 U.S.C. 8325(a) (added by section 752 of the Dodd-Frank

Act).

3 See Margin Requirements for Non-centrally Cleared

Derivatives (Sep. 2013), available at http://www.bis.org/publ/bcbs261.pdf, revised Mar. 2015, available at http://www.bis.org/bcbs/publ/d317.pdf.

—————————————————————————

Element seven of the BCBS-IOSCO framework discusses the cross-

border application of margin requirements and stresses the

importance of developing consistent requirements across

jurisdictions to ensure that implementation at a national

jurisdictional level is appropriately interactive:

that is, that each national jurisdiction’s rule is territorially

complementary such that (i) regulatory arbitrage opportunities are

limited, (ii) a level playing field is maintained, (iii) there is no

application of duplicative or conflicting margin requirements to the

same transaction or activity, and (iv) there is substantial

certainty as to which national jurisdiction’s rules apply. When a

transaction is subject to two sets of rules (duplicative

requirements), the home and the host regulators should endeavor to

(1) harmonize the rules to the extent possible or (2) apply only one

set of rules, by recognizing the equivalence and comparability of

their respective rules.4

—————————————————————————

4 Id. at 23.

—————————————————————————

Regulatory authorities in major financial centers continue to

collaborate in the development of their rules and I commend CFTC

staff for their continued dialogue with fellow domestic and foreign

regulators. Nevertheless, there are bound to be differences across

jurisdictions in the final rule sets that are ultimately adopted.

Comparability determinations allowing for substituted compliance

with the margin requirements of foreign jurisdictions will be

essential to achieving a workable cross-border framework. I am

concerned that the standards for making comparability determinations

outlined in the Commission’s proposal may be too restrictive.

The Commission states that it will employ an outcome-based

comparability standard focusing on whether the margin requirements

in a foreign jurisdiction achieve the same regulatory objectives as

the CFTC’s margin requirements and will not require specific rules

identical to the Commission’s rules. The Commission states further,

however, that it will make its outcome-based determinations on an

element-by-element basis that will include, but not be limited to,

analyzing: (i) The transactions subject to the foreign

jurisdiction’s margin requirements; (ii) the entities subject to the

foreign jurisdiction’s margin requirements; (iii) the methodologies

for calculating the amounts of initial and variation margin; (iv)

the process and standards for approving models for calculating

initial and variation margin models; (v) the timing and manner in

which initial and variation margin must be collected and/or paid;

(vi) any threshold levels or amount; (vii) risk management controls

for the calculation of initial and variation margin; (viii) eligible

collateral for initial and variation margin; (ix) the requirements

of custodial arrangements, including rehypothecation and segregation

of margin; (x) documentation requirements relating to margin; and

(xi) the cross-border application of the foreign jurisdiction’s

margin regime.

As proposed, the Commission will not be assessing whether the

foreign authority’s margin regime as a whole meets the broad

regulatory objectives of requiring margin for uncleared swaps.5

Rather, in looking at each element (and any other factor not

included in the foregoing list) the Commission may determine that a

foreign regime is comparable as to some elements, but not others, in

which case substituted compliance might be allowed, for example,

with respect to the methodologies for calculating initial and

variation margin, but not for the eligible collateral.

—————————————————————————

5 The regulatory objectives of requiring margin for uncleared

swaps, as stated in the Dodd-Frank Act, are to help insure the

safety and soundness of the swap dealer or major swap participant,

the financial integrity of the markets and the stability of the U.S.

financial system. Section 4s(e)(3)(A), (C), 7 U.S.C. 6s(e)(3)(A),

(C).

—————————————————————————

Depending on how it is put into practice, this element-by-

element approach may be difficult to distinguish from the rule-by-

rule analysis the Commission claims to eschew. We have seen this

before when the Commission made its comparability determinations for

certain foreign countries regarding certain transaction-level

requirements for swap dealers and major swap participants.6 There,

the Commission made its determinations on a “requirement-by-

requirement” basis, rather than on the basis of the foreign regime

as a whole.7 Former Commissioner Scott O’Malia observed in that

instance that this was a “rule-by-rule” analysis, which was

contrary to the recommendations of the OTC Derivatives Regulators

Group and afforded only limited substituted compliance relief.8

Will our “element-by-element” analysis be any different than the

“requirement-by-requirement” method the Commission employed then?

—————————————————————————

6 See, e.g., Comparability Determination for the European

Union: Certain Transaction-Level Requirements, 78 FR 78878 (Dec. 27,

2013).

7 Id. at 78881.

8 Id. at 78889.

—————————————————————————

I fear that the proposed element-by-element approach will be

outcome-based in name only. In a perfect world all G-20 countries

will adopt comparable margin requirements, but we cannot let the

perfect be the enemy of the good. For substituted compliance to

work, we must focus on broad objectives, not specific requirements.

I am also troubled by the provision of the proposed rule that

would not permit swaps executed “through or by” a U.S. branch of a

non-U.S. CSE to qualify for the Exclusion for non-U.S. CSEs who

qualify as Foreign Consolidated Subsidiaries. Under the proposal,

uncleared swaps entered into by a non-U.S. CSE with a non-U.S.

person counterparty (purely foreign-to-foreign swaps), where neither

counterparty is a Foreign Consolidated Subsidiary or guaranteed by a

U.S. person, would be excluded from the Commission’s margin rules.

The Exclusion is not available, however, if the swap is executed

“through or by” the U.S. branch of a non-U.S. CSE.9 The

[[Page 41408]]

request for comment following this discussion asks how the

Commission should determine whether a swap is executed “through or

by” a U.S. branch and suggests using the same analysis used in the

Commission’s Volcker Rule, which required that personnel that

“arrange, negotiate, or execute” a purchase or sale conducted

under the exemption for trading activity of a foreign banking entity

must be located outside the U.S.10

—————————————————————————

9 I note that the “through or by” language appears in the

preamble to the rule, not the rule text.

10 See Prohibitions and Restrictions on Proprietary Trading

and Certain Interests in, and Relationships With, Hedge Funds and

Private Equity Funds, 79 FR 5808, 5927 & n.1526 (Jan. 31, 2014).

—————————————————————————

Prior to its appearance in the Commission’s final Volcker Rule

this concept appeared in a hastily issued, November 2013 Staff

Advisory 13-69 (sometimes referred to in the industry as the

“elevator rule”) that imposed swaps transaction rules on trades

between non-U.S. persons whenever anyone on U.S. soil “arranged,

negotiated, or executed” the trade.11 The effective date of this

Staff Advisory has been delayed four times.12 As I have stated

before, the elevator rule is causing many overseas trading firms to

consider cutting off all activity with U.S.-based trade support

personnel to avoid subjecting themselves to the CFTC’s flawed swaps

trading rules. The Staff Advisory, if it goes into effect, will

jeopardize the role of bank sales personnel in U.S. financial

centers like Boston, Charlotte, Chicago, New Jersey and New York. It

will likely have a ripple effect on technology staff supporting U.S.

electronic trading systems, along with the thousands of jobs tied to

the vendors who provide food services, office support, custodial

services and transportation for the U.S. financial series industry.

With this proposal, rather than recognizing the myriad of

problematic issues arising from the Staff Advisory, the Commission

is proposing to expand its scope from trading rules to margin rules.

—————————————————————————

11 CFTC Staff Advisory No. 13-69 (Nov. 14, 2013), available at

http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-69.pdf.

12 CFTC Letter No. 14-140, Extension of No-Action Relief:

Transaction-Level Requirements for Non-U.S. Swap Dealers (Nov. 14,

2014), available at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-140.pdf.

—————————————————————————

Despite my many questions and concerns, I support issuing the

proposed rule only so that the public may provide thorough analysis

and thoughtful comment. My vote to issue the proposal for public

comment should not signal, however, my agreement with it. I look

forward to reviewing public comment.

[FR Doc. 2015-16718 Filed 7-13-15; 8:45 am]

BILLING CODE 6351-01-P

 

Last Updated: July 14, 2015