[Federal Register Volume 84, Number 244 (Thursday, December 19, 2019)]
[Proposed Rules]
[Pages 69664-69685]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-27116]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 23, and 140
RIN 3038-AD54
Capital Requirements of Swap Dealers and Major Swap Participants
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rule; reopening of comment period; request for
additional comment.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is re-opening the comment period and requesting additional
comment (including potential modifications to proposed rule language)
on proposed regulations and amendments to existing regulations to
implement sections 4s(e) and (f) of the Commodity Exchange Act
(``CEA''), as added by section 731 of the Wall Street Reform and
Consumer Protection Act (``Dodd-Frank Act'') previously published in
2011 and re-proposed in 2016. Section 4s(e) requires the Commission to
adopt capital requirements for swap dealers (``SDs'') and major swap
participants (``MSPs'') that are not subject to capital rules of a
prudential regulator. Section 4s(f) requires the Commission to adopt
financial reporting and recordkeeping requirements for SDs and MSPs.
The Commission is reopening the comment period and soliciting further
comment on all aspects of the SD and MSP capital and associated
financial reporting proposal from 2016, as well as related proposed
amendments to existing capital rules for futures commission merchants
(``FCMs'') providing specific market risk and credit risk capital
deductions for swaps and security-based swaps (``SBS'') entered into by
FCMs.
DATES: Comments must be received on or before March 3, 2020.
ADDRESSES: You may submit comments, identified by RIN 3038-AD54 and
``Capital Requirements for Swap Dealers and Major Swap Participants'',
by any of the following methods:
CFTC website, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments
through the website.
Mail: Send to Chris Kirkpatrick, Secretary, Commodity
Futures Trading Commission, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Same as Mail above.
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 is exempt from disclosure under the Freedom of
Information Act, a petition for confidential treatment of the exempt
information may be submitted according to the procedures set forth in
Regulation 145.9 of the Commission's regulations.\1\
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\1\ Commission regulations referred to herein are found at 17
CFR Chapter 1. Commission regulations are accessible on the
Commission's website, http://www.cftc.gov.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from http://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: Joshua Sterling, Director, 202-418-
6056, [email protected]; Thomas Smith, Deputy Director, 202-418-5495,
[email protected]; Joshua Beale, Associate Director, 202-418-5446,
[email protected]; Jennifer C.P. Bauer, Special Counsel, 202-418-5472,
[email protected]; Rafael Martinez, Senior Financial Risk Analyst, 202-
418-5462, [email protected], Division of Swap Dealer and Intermediary
Oversight; or Lihong McPhail, Research Economist, 202-418-5722,
[email protected], Office of the Chief Economist; Commodity Futures
Trading Commission, Three Lafayette Centre,
[[Page 69665]]
1155 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
Section 731 of the Dodd-Frank Act \2\ amended the CEA \3\ by adding
section 4s(e), which requires the Commission to adopt rules
establishing capital requirements for SDs and MSPs to help ensure their
safety and soundness.\4\ Section 4s(e) applies a bifurcated approach
requiring each SD and MSP subject to the capital requirements of a
prudential regulator to meet the capital requirements adopted by the
applicable prudential regulator, and requiring each SD and MSP that is
not subject to the capital requirements of a prudential regulator to
meet the capital requirements adopted by the Commission.\5\
Accordingly, SDs and MSPs that are not banking entities, including
nonbank subsidiaries of bank holding companies regulated by the Federal
Reserve Board, are subject to the Commission's capital requirements.\6\
Further, Section 764 of the Dodd-Frank Act provides that the Securities
and Exchange Commission (``SEC'') shall prescribe capital and margin
requirements for security-based swap dealers (``SBSDs'') and major
security-based swap participants (``MSBSPs''), and Section 4s(e)(3)(D)
of the CEA provides that the CFTC, SEC, and prudential regulators
shall, to the maximum extent practicable, establish and maintain
comparable minimum capital requirements for SDs and MSPs.
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\2\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the
Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
\3\ 7 U.S.C. 1 et seq.
\4\ See 7 U.S.C. 6s(e)(3)(A). Section 4s(e) also directs the
Commission to adopt regulations for SDs and MSPs imposing initial
and variation margin requirements on all swaps that are not cleared
by a registered clearing organization. The Commission adopted final
SD and MSP margin requirements for uncleared swap transactions on
December 18, 2015. See, Margin Requirements for Uncleared Swaps for
Swap Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016).
\5\ The term ``prudential regulator'' is defined in section
1a(39) of the CEA for purposes of the section 4s(e) capital
requirements. Specifically, the term ``prudential regulator'' is
defined to mean the Board of Governors of the Federal Reserve System
(``Federal Reserve Board''); the Office of the Comptroller of the
Currency (``OCC''); the Federal Deposit Insurance Corporation; the
Farm Credit Administration; and the Federal Housing Finance Agency.
All references to an ``SD'' or an ``MSP'' in this proposal will mean
an SD or MSP that is subject to the Commission's capital rules,
unless otherwise specified.
\6\ The prudential regulators, including the Federal Reserve
Board and OCC, that have capital responsibilities for SDs
provisionally-registered with the Commission have adopted capital
rules that incorporate capital requirements for swap and SBS
transactions. In this regard, the Federal Reserve Board and OCC have
adopted revised capital rules to incorporate Basel III capital
adequacy requirements. See, Regulatory Capital Rules: Regulatory
Capital, Implementation of Basel III, Capital Adequacy, Transition
Provisions, Prompt Corrective Action, Standardized Approach for
Risk-weighted Assets, Market Discipline and Disclosure Requirements,
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital
Rule, 78 FR 62018 (Oct. 11, 2013).
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In 2011, the Commission proposed capital and financial reporting
requirements for SDs and MSPs, and proposed amendments to the capital
requirements for FCMs to explicitly address swap and SBS
transactions.\7\ The Commission, however, elected to defer
consideration of final capital and financial reporting rules until
after the Commission adopted final margin rules for uncleared swaps,
which were adopted in 2015.\8\
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\7\ See Capital Requirements of Swap Dealers and Major Swap
Participants, 76 FR 27802 (May 12, 2011).
\8\ See 81 FR 636.
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In 2016, the Commission re-proposed the capital and financial
reporting requirements for SDs and MSPs, and re-proposed amendments to
the existing capital requirements for FCMs.\9\ The Commission drew on
existing CFTC, prudential regulator, and SEC capital rules in
developing the 2016 Capital Proposal. Specifically, the 2016 Capital
Proposal, depending on the characteristics of the registered entity,
would permit: (i) SDs to elect a capital requirement that is based on
existing bank holding company capital rules adopted by the Federal
Reserve Board (the ``Bank-Based Capital Approach''); (ii) SDs to elect
a capital requirement that is based on the existing CFTC FCM capital
rule, the existing SEC broker-dealer (``BD'') capital rule, and the
SEC's proposed capital requirements for SBSDs, (the ``Net Liquid Assets
Capital Approach''); or (iii) SDs that meet defined conditions designed
to ensure that they are predominantly engaged in non-financial
activities to compute their minimum regulatory capital based upon the
firms' tangible net worth (the ``Tangible Net Worth Capital
Approach'').
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\9\ See Capital Requirements of Swap Dealers and Major Swap
Participants, 81 FR 91252 (Dec. 16, 2016) (the ``2016 Capital
Proposal'' or the ``Proposal'').
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The Commission received comments from a broad spectrum of market
participants, industry representatives, and other interested parties in
response to the 2016 Capital Proposal. The commenters raised several
topics in the 2016 Capital Proposal including the use of models by SDs
and MSPs for computing market risk and credit risk capital charges, the
need for the harmonization of the Commission's rules and requirements
with the rules and the requirements of the prudential regulators and
the SEC, and a desire for an additional opportunity to comment on the
2016 Capital Proposal once the SEC finalized its SBSD and MSBSP capital
and financial reporting requirements.
Since the 2016 Capital Proposal was published in the Federal
Register, the SEC in 2018 reopened its comment period and solicited
further comment on its proposed capital, margin, and segregation
requirements for BDs, SBSDs, and MSBSPs.\10\ The SEC finalized these
capital, margin, and segregation requirements in 2019.\11\ The SEC also
finalized its financial reporting requirements for SBSDs and MSBSPs in
2019.\12\
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\10\ See Capital, Margin and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital Requirements for Broker-Dealers, 83 FR
53007 (Oct. 19, 2018) (``SEC Comment Reopening'').
\11\ See Capital, Margin and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital and Segregation Requirements for Broker-
Dealers, 84 FR 43872 (Aug. 22, 2019) (``SEC Final Capital Rule'').
\12\ See Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and
Broker-Dealers, publication in the Federal Register forthcoming. A
prepublication version of the document can be found at https://www.sec.gov/rules/final/2019/34-87005.pdf.
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The Commission has carefully considered the comment letters to the
2016 Capital Proposal and believes it is in the public interest to
provide an additional opportunity for comment on the proposed capital
and financial reporting rules. The Commission believes that it is
particularly appropriate to reopen the comment period in light of the
SEC Comment Reopening and the SEC Final Capital Rule, and in
recognition that the 2016 Capital Proposal includes significant
components of the SEC's SBSD capital rules that were recently adopted
as final in the SEC's Final Capital Rule. In addition, the Commission
believes the public should have the opportunity to provide comment on
the potential economic effects of the 2016 Capital Proposal in light of
regulatory and market developments since the Proposal was published.
Accordingly, the Commission is reopening the comment period for 75 days
and is seeking comment on all aspects of the 2016 Capital Proposal. The
Commission also is seeking specific comment on certain aspects of the
2016 Capital Proposal where further information would be particularly
helpful to the Commission. In particular, the Commission is seeking
[[Page 69666]]
comment on potential modifications contemplated in light of previously
received comments as discussed herein and the SEC Final Capital Rule,
and potential rule language that would modify rule text that was
included in the 2016 Capital Proposal. The modified rule language would
be included in: Regulation 1.17(c)(5)(iii)(A), (B) and (C)(2);
Regulation 23.102(c), (d) and (e); and, Regulation 23.105(d)(3) and
(p)(2). Comment letters received by the Commission in response to the
2016 Capital Proposal previously need not be re-submitted as they will
continue to be a part of the public comment file for this rulemaking
and considered by the Commission.
II. Request for Comment
The Commission renews its request for comment on all aspects of the
2016 Capital Proposal and on the specific topics identified below.
Commenters are requested to provide empirical data in support of any
arguments and analyses. The Commission notes that comments are of the
greatest assistance to rulemaking initiatives when accompanied by
supporting data and analysis, and, if appropriate, accompanied by
alternative approaches and suggested rule text language.
The Commission also requests comments and data on how the baseline
of the economic analyses has changed since the publication of the 2016
Capital Proposal. The swap market activity has experienced significant
changes, in part due to the fact that participants in this market are
now subject to various new rules. For example, the 2015 uncleared
margin rules adopted by the prudential regulators and the Commission,
which requires SDs to exchange variation margin, and in many cases
initial margin, with financial end users and other SDs against
uncleared swap positions, has been phased in for a significant number
but not all participants. To comply with these margin rules, these
entities in the uncleared swap markets have been exchanging margin.
Additionally, as noted above the SEC has finalized capital, margin and
segregation requirements for the SBSDs. Moreover, swap market
participants also may be subject to other regulatory regimes, including
foreign regulatory authorities. The Commission requests comments on how
those changes in the baseline would impact the potential benefits and
costs of capital requirements.
A. Capital
The 2016 Capital Proposal included proposed minimum capital
requirements for SDs and MSPs, and proposed amendments to the minimum
capital requirements for FCMs. Proposed Regulation 23.101(a)(1)(i)
would require an SD electing the Bank-Based Capital Approach \13\ to
maintain regulatory capital equal to or in excess of the highest of the
following:
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\13\ Proposed Regulation 23.101(a)(1)(i) permits an SD that
elects the Bank-Based Capital Approach to use market risk and credit
models approved by the Commission or a registered futures
association, or to use the standardized market risk charges in
Regulation 1.17 and the standardized credit risk charges in subpart
D of 12 CFR part 217.
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(1) Common equity tier 1 capital (``CET1 Capital'') of $20 million;
\14\
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\14\ For purposes of the 2016 Capital Proposal, CET1 Capital is
defined in the rules of the Federal Reserve Board, and generally
represents the sum of a bank holding company's common stock
instruments and any related surpluses, retained earnings, and
accumulated other comprehensive income. See 12 CFR 217.20.
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(2) CET1 Capital equal to or greater than 8% of the SD's risk
weighted assets; \15\
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\15\ See 2016 Capital Proposal, 81 FR at 91310; Proposed
Regulation 23.101(a)(1)(i)(B). Risk-weighted assets would be defined
and computed in accordance with rules of the Federal Reserve Board,
12 CFR part 217.
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(3) CET1 Capital equal to or greater than 8% of the sum of:
(a) The amount of uncleared swap margin \16\ for each uncleared
swap position open on the books of the SD, computed on a counterparty
by counterparty basis pursuant to the Commission's margin rules for
uncleared swap transactions (CFTC Regulation 23.154);
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\16\ See 2016 Capital Proposal, 81 FR at 91309-10. Proposed
Regulation 23.100 would define the term ``uncleared swap margin'' to
mean the amount of initial margin, computed in accordance with the
CFTC's uncleared swap margin rules (Regulation 23.154), that an SD
would be required to collect from each counterparty for each
outstanding swap position of the SD. An SD would have to include all
swap positions in the calculation of the uncleared swap margin
amount, including swaps that are exempt from the scope of the
Commission's uncleared swap margin rules. Furthermore, in computing
the uncleared swap margin amount, an SD would not be able to exclude
the ``Initial Margin Threshold Amount'' or the ``Minimum Transfer
Amount'' as such terms are defined in Regulation 23.151.
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(b) The amount of initial margin that would be required for each
uncleared SBS position open on the books of the SD, computed on a
counterparty by counterparty basis pursuant to SEC Rule 18a-
3(c)(1)(i)(B) (17 CFR 240.18a-3(c)(1)(i)(B)) without regard to any
initial margin exemptions or exclusions that the SEC rules may provide
to such SBS positions; and
(c) The amount of initial margin required by clearing organizations
for cleared proprietary futures, foreign futures, swaps, and SBS
positions open on the books of the swap dealer; or,
(4) The amount of capital required by a registered futures
association of which the SD is a member.\17\
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\17\ Currently, the National Futures Association (``NFA'') is
the only registered futures association registered with the
Commission under section 17 of the CEA.
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Proposed Regulation 23.101(a)(1)(ii) would require an SD electing
the Net Liquid Asset Capital Approach to maintain regulatory net
capital equal to or in excess of the highest of the following:
(1) $20 million (and for SDs approved to use internal capital
models, $100 million of tentative net capital and $20 million of net
capital);
(2) Eight percent of the sum of:
(a) The amount of uncleared swap margin for each uncleared swap
position open on the books of the SD, computed on a counterparty by
counterparty basis pursuant to CFTC Regulation 23.154;
(b) The amount of initial margin that would be required for each
uncleared SBS position open on the books of the SD, computed on a
counterparty by counterparty basis pursuant to SEC Rule 18a-
3(c)(1)(i)(B) (17 CFR 240.18a-3(c)(1)(i)(B)) without regard to any
initial margin exemptions or exclusions that the rules of the SEC may
provide to such SBS positions;
(c) The amount of ``risk margin'', as defined in Regulation
1.17(b)(8), required by a clearing organization for proprietary
futures, swaps, and foreign futures positions open on the books of the
SD; and
(d) The amount of initial margin required by a clearing
organization for proprietary SBS open on the books of the SD; or
(3) The amount of capital required by a registered futures
association of which the SD is a member.
The 2016 Capital Proposal also included proposed amendments to the
existing capital requirements applicable to FCMs that engage in swap
and SBS transactions, and also would be applicable to entities dually-
registered with the Commission as SDs and FCMs. The minimum capital
requirements for FCMs and entities dually-registered as SDs and FCMs
were proposed to be amended to require each entity to maintain adjusted
net capital equal to or greater than the highest of the following;
(1) $20 million (and for FCMs, including entities dually-registered
as FCM/SDs, approved to use internal capital models, $100 million of
net capital and $20 million of adjusted net capital);
(2) The FCMs risk-based capital requirement, computed as 8% of the
sum of:
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(a) The FCM's or FCM/SD's total ``risk margin'' \18\ requirement
for cleared swap, futures and foreign futures positions carried by the
FCM or FCM/SD in customer and noncustomer accounts;
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\18\ The term ``risk margin'' is defined in Regulation 1.17(b)
and generally means the level of maintenance margin or performance
bond required for the customer or noncustomer positions by the
applicable exchanges or clearing organizations.
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(b) The total initial margin that the FCM or FCM/SD is required to
post with a clearing agency or broker for cleared SBS positions carried
in customer and noncustomer accounts;
(c) The total ``uncleared swaps margin'', as defined in Commission
Regulation 23.100;
(d) The total initial margin that the FCM or FCM/SD is required to
post with a broker or clearing organization for all proprietary cleared
swaps positions carried by the FCM or FCM/SD;
(e) The total initial margin computed pursuant to SEC Rule 18a-
3(c)(1)(i)(B) (17 CFR 240.18a-3(c)(1)(i)(B)) for all uncleared
security-based swap positions carried by the FCM or FCM/SD without
regard to any initial margin exemptions or exclusions that the SEC
rules may provide to such SBS positions; and,
(f) The total initial margin that the FCM or FCM/SD is required to
post with a broker or clearing agency for proprietary cleared SBS;
(3) The amount of adjusted net capital required by a registered
futures association of which the FCM is a member; or
(4) For FCMs, including FCMs registered as SDs, that are registered
with the SEC as securities brokers and dealers, the amount of net
capital required by Rule 15c3-1(a) of the Securities and Exchange
Commission (17 CFR 240.15c3-1(a)).
1. Swap Dealer Capital--8% Risk Margin Amount
The proposed SD capital requirement would require an SD to maintain
regulatory capital equal to or greater than 8% of the initial margin
associated with the SD's proprietary cleared and uncleared futures,
foreign futures, swap, and SBS positions (i.e., the ``risk margin
amount''). The proposed minimum capital requirement was drawn from the
Commission's experience with the ``risk-based'' capital requirements
currently imposed on FCMs.\19\ Under the existing FCM ``risk-based''
capital model, an FCM is required to maintain adjusted net capital
equal to or greater than 8% of the aggregate of each customer's and
non-customer's initial margin requirements associated with their
respective portfolio of futures, foreign futures and cleared swaps
positions.\20\ Accordingly, an FCM's minimum capital requirement
increases/decreases as the total initial margin for its customers' and
noncustomers' portfolios increases/decreases.\21\
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\19\ See Regulation 1.17(a)(1)(i)(B).
\20\ The 2016 Capital Proposal includes a proposal to revise the
FCM ``risk-based'' capital requirement to further include 8% of
customer and non-customer cleared SBS positions, proprietary cleared
SBS positions, and proprietary uncleared swap and SBS initial
margin. See, 2016 Capital Proposal, 81 FR at 91306.
\21\ See CFTC Regulation 1.17(a)(1)(i)(B).
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The SD 8% capital component of the 2016 Capital Proposal also is
consistent with the approach adopted by the SEC for BDs and SBSDs. The
SEC Final Capital Rule established a minimum net capital requirement
for BDs and SBSDs that incorporates a component based upon a percentage
of the margin associated with a BD's or SBSD's customer cleared and
uncleared SBS positions.\22\ The SEC Final Capital Rule implemented
this financial ratio as a lower percentage, with the possibility of a
scalable requirement to be implemented and increased over a number of
years, beginning with a 2% requirement, and possibly under SEC orders
increasing to a 4% requirement and ultimately to a 8% percent
requirement.\23\
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\22\ See SEC Final Capital Rule, Rule 15c3-1(a)(7) (17 CFR
240.15c3-1(a)(7)) for BDs (including BDs dually-registered as SBSDs)
approved to use internal capital models and Rule 15c3-1(a)(10) (17
CFR 240.15c3-1(a)(10)) for BDs dually-registered as SBSDs (84 FR at
44042), and Rule 18a-1(a)(2) (17 CFR 240.18a-1(a)(2)) for standalone
SBSDs approved to use internal models (84 FR at 44052).
\23\ Id.
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One commenter strongly supported the 2016 Capital Proposal's 8%
risk margin amount threshold on a comprehensive basis, noting concern
that basing capital requirements on models could be manipulated, and
that the 8% floor based on all calculated initial margin was therefore
appropriate as a counterbalance to ensure internal modelling does not
reduce loss absorbency.\24\
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\24\ See Letter from Marcus Stanley, Americans for Financial
Reform (May 15, 2017) (AFR 5/15/17 Letter). The comment letters for
the 2016 Capital Proposal are available at: https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1769 (the
public comment file).
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Several commenters, however, raised concerns with the 8% risk
margin amount contained in the Bank-Based Capital Approach and the Net
Liquid Asset Capital Approach.\25\ These commenters generally stated
that the 8% risk margin amount was both too high of a percentage and
over-inclusive of the various types of business activities engaged in
by SDs.\26\ Several of the commenters also stated that the proposed
risk margin amount has a limited relationship to the actual risk of the
SD's risk from swaps, SBS, futures, and foreign futures
transactions.\27\ Commenters also generally noted that under the 2016
Capital Proposal the risk margin amount is computed on a counterparty-
by-counterparty basis and not on the aggregate of all of the SD's
positions across all counterparties, which may overstate the SD's risk
by not taking into account offsetting positions across multiple
counterparties, including hedging positions.\28\
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\25\ See, e.g., Letter from Mary Kay Scucci, Securities Industry
and Financial Markets Association (May 15, 2017) (SIFMA 5/15/17
Letter); Letter from Walt Lukken, Futures Industry Association (May
15, 2017) (FIA 5/15/17 Letter); Letter from Stephen John Berger,
Citadel Securities (May 15, 2017) (Citadel 5/15/17 Letter); Letter
from William Dunaway, INTL FCStone Markets, LLC (May 15, 2017) (IFM
5/15/17 Letter); Letter from Sebastien Crapanzano and Soo-Mi Lee,
Morgan Stanley (May 15, 2017) (MS 5/15/17 Letter); Letter from
Christine Stevenson, BP Energy Company (May 15, 2017) (BPE 5/15/17
Letter); Letter from Steven Kennedy, International Swaps and
Derivatives Association (May 15, 2017) (ISDA 5/15/17 Letter); Letter
from the Japanese Bankers Association (May 14, 2017) (JBA 5/14/17
Letter); and, Letter from Joanna Mallers, FIA Principal Traders
Group (May 24, 2017) (FIA-PTG 5/24/17 Letter).
\26\ Id.
\27\ Id.
\28\ See, e.g., ISDA 5/15/17 Letter; JBA 5/14/17 Letter; SIFMA
5/15/17 Letter.
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A commenter also noted that the risk margin amount did not reflect
the actual risk of a SD's proprietary cleared swap, SBS, futures and
foreign futures positions as the risk margin amount is required to be
computed on a clearing organization-by-clearing organization basis and,
therefore, does not recognize hedging and risk-reducing portfolio
margin across multiple clearing organizations.\29\ Commenters further
noted that under the Net Liquid Assets Capital Approach requiring net
capital to exceed 8% of margin double counts the risks of various
positions as these risks are counted once in the market and credit risk
charges used to compute net capital and then again in computing the
risk margin amount.\30\
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\29\ See FIA-PTG 5/24/17 Letter.
\30\ See SIFMA 5/15/17 Letter; ISDA 5/15/17 Letter; FIA 5/15/17
Letter; FIA PTG 5/24/17 Letter; JBA 5/14/17 Letter; Letter from
Sunhil Cutinho, CME Group, Inc. (May 15, 2017) (CME 5/15/17 Letter);
and Citadel 5/15/17 Letter.
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Other commenters took exception to the inclusion of the 8% risk
margin amount computation for SDs electing the Bank-Based Capital
Approach in proposed Regulation 23.101(a)(1)(i). Commenters noted that
the current bank holding company capital rules adopted
[[Page 69668]]
by the Federal Reserve Board, and incorporated as one of the components
of the Commission's proposed minimum capital requirements for SDs
electing the Bank-Based Capital Approach, does not include the 8% risk
margin amount requirement. One of the commenters stated that the
inclusion of the 8% risk margin amount would exaggerate the actual risk
of the SD's transactions, and would place the SD at a competitive
disadvantage to a SD subject to the capital rules of a prudential
regulator, which are not subject to the 8% risk margin amount.\31\
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\31\ See SIFMA 5/15/17 Letter; ISDA 5/15/17 Letter; and JBA 5/
14/17 Letter.
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One commenter suggested that the Commission consider limiting the
8% risk margin amount solely to uncleared swaps subject to the
uncleared margin rules \32\ and another asked the Commission to
reconsider the application of the 8% risk margin threshold to cleared
swaps.\33\
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\32\ See IFM 5/15/17 Letter.
\33\ See ISDA 5/15/17 Letter.
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Several commenters also requested that if the Commission were to
retain a minimum capital requirement for SDs based upon a percentage of
the risk margin amount as defined in the 2016 Capital Proposal, that
the Commission adjust the 8% to a lower multiplier, such as 2%, for a
period of time to allow the Commission to gather empirical data in
order to determine an appropriate level.\34\
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\34\ See SIFMA 5/15/17 Letter and MS 5/15/17 Letter.
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As noted in the 2016 Capital Proposal, capital serves as an overall
financial resource for the SD and is intended to cover potential risks
that are not adequately covered by other risk management programs
(i.e., ``residual risk'') including margin on uncleared swaps.\35\
Therefore, the Proposal expanded the types of financial instruments
included in the computation of the risk margin amount to include an
SD's futures, foreign futures, swaps, and SBS positions, which is a
more expansive list than the SEC imposed on SBSDs, as the Commission
believed that it was appropriate for SDs to maintain a minimum level of
capital that reflects the extent of the risks and activities posed by
the full, broad range of the SD's proprietary positions.\36\
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\35\ See 2016 Capital Proposal, 81 FR at 91259.
\36\ Id.
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Commenters, however, have identified significant issues and raised
important questions regarding the effect that the 8% risk margin amount
may have on driving the minimum requirement and consequentially the
funding and business activities of each SD. Therefore, the Commission
is seeking further comments on the following areas in an attempt to
ensure that the 8% risk margin amount is appropriately calibrated and
consistent with the statutory mandate of helping to ensure the safety
and soundness of the SDs subject to the Commission's capital
requirements, or if another percentage or approach is more
appropriate.\37\ In this regard, the Commission invites comments on all
aspects of the proposed risk margin amount, including comments
regarding the possible increase or decrease of the risk margin
percentage in coordination with the inclusion or exclusion of certain
products in order to establish the most optimal capital requirement.
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\37\ Id. at 91258.
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1-a. The Commission requests comment and supporting data on the
quantification of the potential minimum capital requirements that would
be required of SDs electing the Bank-Based Capital Approach, the Net
Liquid Assets Capital Approach, or the Tangible Net Worth Capital
Approach as a result of the proposed 8% risk margin amount threshold.
How would the amount of potential minimum capital based upon the 8%
risk margin requirement compare with the amount of capital currently
maintained by entities that are provisionally registered as SDs? How
would such amounts compare with the amounts of capital required of
SBSDs under the SEC Final Capital Rule? Please provide data in support
of comments provided.
1-b. The Commission requests comment on whether the proposed 8%
risk margin amount should be modified for SDs electing the Bank-Based
Capital Approach, the Net Liquid Assets Capital Approach, or the
Tangible Net Worth Capital Approach to a lower percentage requirement,
such as 4%. If so, is 4% risk margin properly calibrated to the
inherent risk of an SD and the activities that it engages in? If not
4%, what percentage of the risk margin should the Commission consider
including in the regulations, and why is the percentage an appropriate
percentage properly calibrated to the inherent risk of an SD and the
activities that it engages in? Please quantify the difference in the
amount of capital that would be required of an SD pursuant to the
proposed 8% risk margin amount and 4% or any other suggested lower
percentage of risk margin amount. To the extent it is possible to model
the impact of different percentages of risk margin on the minimum
capital requirements for an actual or hypothetical portfolio of
positions, please provide such information. How would the suggested
modified risk margin amount percentage be appropriate and consistent
with the statutory objective of establishing capital requirements
designed to help ensure the safety and soundness of the SD? Are there
differences in the products, size and activities between SDs subject to
the CFTC's proposed capital rule, SDs subject to the prudential
regulators' capital rules, and SBSDs subject to the SEC's capital rule,
(such as trading strategies or market share) that lead to practical
differences in the CFTC's capital rule? Please provide data and
analysis in support of any suggested modified percentage of the risk
margin amount.
1-c. The Commission requests comment on whether the proposed 8%
risk margin amount should be modified to be harmonized with the
approach adopted by the SEC for SBSDs in the SEC Final Capital Rule.
Specifically, should the Commission modify the regulation to lower the
risk margin amount percentage from 8% to 2%, and further modify the
regulation to authorize the Commission by order to increase the risk
margin amount percentage in stages from 2% to 4% or less, and from 4%
to 8% or less based upon the Commission's future experience with SD
capital levels after the implementation of the final regulations? In
responding to this question, please address the significant differences
in the size, complexity and scope of the swap products and markets as
compared to the SBS products and markets.
1-d. The Commission requests comment on whether the types of
derivatives positions included in the computation of the risk margin
amount threshold for SDs should be modified. Should the Commission
exclude any particular asset classes or positions from the computation
of the risk margin amount? For example, should the Commission exclude
cleared transactions from the risk margin amount? If so, explain why
such asset classes or positions should be excluded, how such exclusion
is consistent with the statutory objective of the safety and soundness
of the SD, and quantify the impact on the proposed minimum capital
requirement of excluding such asset classes or positions and the
overall risk to the financial system. Should the Commission consider
modifying a combination of the percentage of the risk margin amount and
the products that are included in the computation? If so, please
suggest how the Commission may determine an appropriate balance
[[Page 69669]]
between products and the risk margin percentage. Please provide data in
support of any modified list of asset classes or positions included in
the risk margin amount computation and the possible costs and benefits
that may result in such a change.
1-e. If the Commission modifies the capital requirements by, for
example, lowering the 8% risk margin amount to a lower level or by
removing certain transactions from the risk margin amount computation,
the Commission believes that this may result in a lower amount of
required capital for SDs, which may increase the level of risk at some
SDs. The Commission requests comment as to whether lowering the
percentage of risk margin to a 4% level, the SEC's 2% level or a
different level, or removing transactions from the risk margin amount
computation would result in an SD not holding a sufficient level of
capital to help ensure its safety and soundness. Specifically, given
the size, breadth and complexity of the swaps market, does a 2% or 4%
capital level serve the intended goals as established in the CEA?
Alternatively, what percentage of risk margin would result in capital
levels that were so high that certain current swaps and futures
activities of the SD would become uneconomic? How does the capital
requirement impact that ability of an SD to service certain types of
clients, to provide liquidity to the marketplace, or otherwise impact
the efficiency and competitiveness of the swaps market? The Commission
further invites comments on the general costs and benefits of modifying
the risk margin amount as discussed above. Please provide data with any
comment or analysis.
1-f. The Commission requests comment on whether Regulation 23.101
should be modified by removing the minimum capital requirement based
upon the 8% of risk margin amount calculation from the Bank-Based
Capital Approach and the Net Liquid Assets Capital Approach. If the
Commission were to modify Regulation 23.101 to remove the 8% risk
margin amount from the Net Liquid Assets Capital Approach, SDs electing
that capital approach would be required to maintain net capital equal
to or in excess of $20 million and, if approved to use capital models,
$100 million of tentative net capital and $20 million of net capital.
Does this level of minimum regulatory capital provide adequate
assurance that an SD can meet its obligations and is it consistent with
the objective of helping to ensure that safety and soundness of the SD?
1-g. The 2016 Capital Proposal did not include a leverage ratio
requirement. The Commission requests comment on whether it would be
appropriate, at a future date after notice and comment, to revise the
capital requirements by adopting a leverage ratio for SDs in lieu of
the proposed percentage of the risk margin amount if adopted as final.
To assist the Commission in its assessment of this possible future
action, the Commission requests comment on the cost, if any, in terms
of additional required capital under each of the proposed capital
methods and how the adoption of a leverage ratio requirement would
affect the efficiency, competitiveness, integrity, safety and
soundness, and price discovery of swap markets. Please provide any
supporting data with your comment.
2. FCM Minimum Capital Requirement
The 2016 Capital Proposal included a proposed revision to the FCM
net capital requirement to require an FCM (or dually-registered FCM/SD)
to include in its minimum capital requirement eight percent of the
uncleared swaps margin for uncleared swaps and eight percent of the
initial margin for uncleared SBS for which the FCM or FCM/SD was a
counterparty, as well as eight percent of the total initial margin that
the FCM or FCM/SD was required to post with a broker or clearing
organization for all proprietary cleared swaps and proprietary cleared
SBS. These proposals were contained at a proposed revised Regulation
1.17(a)(1)(i)(B). The Commission's general rationale for proposing such
revisions was that an FCM's or FCM/SD's capital should reflect
exposures to all swap counterparties, in order to promote safety and
soundness.\38\
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\38\ See 2016 Capital Proposal, 81 FR at 91266.
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Several commenters focused their comments on the impact on FCMs.
Several commenters stated that the proposed inclusion of an FCM's or
FCM/SD's proprietary cleared swaps and SBS positions in the 8% risk
margin amount would place an unnecessary financial burden on FCMs and
would not properly recognize that the same proprietary positions are
subject to an existing net capital charge based upon exchange or
clearinghouse margin requirements under Regulation 1.17(c)(5)(x).\39\
One commenter referred specifically to this as duplicative, and argued
it would unnecessarily increase the amount of adjusted net capital an
FCM would hold for swaps and SBS exposures which could burden smaller
SD FCMs which are not BDs and threaten their ability to provide
clearing services for swaps.\40\ This commenter noted that the
Commission had noted that such types of FCMs were often ones that may
be willing to provide swaps markets in commodities to agricultural
firms and smaller commercial end-users, and this commenter suggested
that overburdening smaller SD FCMs in this manner could further
exacerbate the concentration of clearing among larger FCMs. Considering
these comments, specifically that existing net capital charges already
apply to proprietary cleared swaps and SBS in Regulation 1.17, and that
the Commission also proposed additional net capital market risk charges
applicable to swaps and SBS in other parts of Regulation 1.17, the
Commission is reconsidering the proposed FCM amendments to Regulation
1.17(a)(1)(i)(B) contained within the 2016 Capital Proposal.
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\39\ See CME 5/15/17 Letter; FIA 5/15/17 Letter; Citadel 5/15/17
Letter; and the SIFMA 5/15/17 Letter.
\40\ See CME 5/15/17 Letter.
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2-a. The Commission requests additional comment on the advisability
of deleting the proposed changes to Regulation 1.17(a)(1)(i)(B) to the
net capital requirement for all FCMs and dually-registered FCM/SDs,
which would leave such section as currently in effect, instead of
adopting the changes proposed within the 2016 Capital Proposal.\41\ The
Commission would rely on net capital charges proposed and applicable to
proprietary cleared and uncleared swaps and SBS to reflect the risks to
FCMs (and dually-registered FCM/SDs) from swaps and SBS business,
without any add-on minimum capital requirement for swap dealing, other
than the higher minimum dollar threshold of $20 million, which the
Commission still would retain from the 2016 Capital Proposal. If the
Commission adopts this change, the Commission believes that this would
lower the amount of required capital under this Proposal; however, FCMs
would still be required to deduct market risk charges for cleared and
uncleared proprietary positions in computing their net capital and
adjusted net capital, which is intended to provide a capital cushion to
protect against future adverse price movements in the positions. Please
provide comment on how this change would affect the overall costs and
benefits of the Proposal and the efficiency, competitiveness, financial
[[Page 69670]]
integrity, and price discovery of the swaps market?
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\41\ The modification to Regulation 1.17(a)(1)(i)(B) would
result in the customer and noncustomer cleared swaps, futures, and
foreign futures being included in the computation of the risk margin
amount.
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3. Composition of Common Equity Tier 1 Capital
The 2016 Capital Proposal would require SDs electing the Bank-Based
Capital Approach to maintain a minimum level of regulatory capital of
CET1 Capital equal to or in excess of the highest of: (1) $20 Million;
(2) 8% of the SD's risk-weighted assets; or (3) 8% of the SD's risk
margin amount.\42\ For purposes of the Proposal, CET1 Capital is
defined by rules of the Federal Reserve Board, and generally represents
the sum of a bank holding company's common stock instruments and any
related surpluses, retained earnings, and accumulated other
comprehensive income.\43\ The 2016 Capital Proposal also would require
an SD to file a notice with the Commission if its net capital was below
120% of the SD's minimum capital requirement (``Early Warning
Notice'').\44\
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\42\ See 2016 Capital Proposal, 81 FR at 91310; Proposed
Regulation 23.101(a)(1)(i). Risk-weighted assets would be defined
and computed in accordance with rules of the Federal Reserve Board,
12 CFR part 217.
\43\ See 12 CFR 217.20.
\44\ See 2016 Capital Proposal, 81 FR at 91318; Proposed
Regulation 23.105(c)(2).
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As noted in the 2016 Capital Proposal, the Commission proposed to
limit the forms of capital that a SD electing the Bank-Based Capital
Approach could recognize to CET1 capital as such capital is a more
conservative form of capital than Additional Tier 1 capital or Tier 2
capital, particularly as it relates to the permanence of the capital
and its availability to absorb unexpected losses.\45\ Moreover, the
Commission believed that limiting the capital to CET1 Capital was
appropriate as the Commission did not propose to include several
capital add-ons maintained in the rules of the Federal Reserve Board,
including, for instance, the capital conservation buffer and the
countercyclical capital buffer.\46\
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\45\ Id. at 91259-91260. Under the rules of the Federal Reserve
Board, Additional Tier 1 capital includes certain types of non-
cumulative preferred stock instruments and Tier 2 capital includes
qualifying subordinated debt. (See 12 CFR 217.20).
\46\ Id. at 91260, footnote 45.
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The Commission received comments regarding the proposed requirement
to limit regulatory capital to only CET1 Capital. One commenter
supported the proposed requirement that an SD electing the Bank-Based
Capital Approach must satisfy its capital requirement with only CET1
Capital.\47\ This commenter stated that the more conservative CET1
Capital requirement is appropriate given that the 2016 Capital Proposal
does not contain all of the add-ons and supervisory safeguards that are
set forth in the prudential regulators' capital framework.\48\
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\47\ See AFR 5/15/17 Letter.
\48\ Id.
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Other commenters stated that the proposed minimum capital
requirement of CET1 Capital equal to or greater than 8% of risk-
weighted assets would impose a capital requirement on SDs that is
materially higher and more restrictive than the prudential regulators'
capital requirement for banks and bank holding companies.\49\ These
commenters noted that the prudential regulators' minimum capital
requirements provide that an entity is ``adequately capitalized'' if
its CET1 Capital is equal to or greater than 4.5% of the SD's risk-
weighted assets, and is ``well capitalized'' if its CET1 Capital is at
least 6.5% of its risk-weighted assets.\50\ These commenters further
stated that the proposed Early Warning Notice requirement would
effectively require SDs to maintain CET1 Capital equal to at least 9.6%
(120% x 8%) of risk-weighted assets as entities subject to the Early
Warning Notice requirements generally ensure that regulatory capital
exceeds such requirements.\51\ Another commenter stated that the
Proposal may make it difficult for SDs subject to the CFTC capital rule
to compete with SDs subject to the capital rules of a prudential
regulator, and more generally would deviate from the more tailored
risk-based approach taken by the prudential regulators.\52\
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\49\ See ISDA 5/15/17 Letter; MS 5/15/17 Letter; SIFMA 5/15/17
Letter.
\50\ Id.
\51\ Id.
\52\ JBA 5/15/17 Letter.
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In addition, a commenter requested that the Commission revise its
Bank-Based Capital Approach to recognize subordinated debt as capital
in meeting the 8% of risk-weighted assets capital ratio.\53\ This
commenter noted that prudential regulators' capital requirements permit
a bank or bank holding company to recognize certain subordinated debt
as capital in meeting the 8% of risk-weighted assets capital ratio
requirement.\54\
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\53\ SIFMA 5/15/17 Letter.
\54\ Id.
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The Commission continues to support the concept of aligning, as
appropriate, the requirements of the proposed Bank-Based Capital
Approach with the capital requirements imposed on SDs subject to the
prudential regulators' jurisdiction. Consistency between the Bank-Based
Capital Approach requirements and the prudential regulators'
requirements satisfies the Commission's objective of providing capital
alternatives that are based upon existing bank requirements, while also
providing market participants with greater certainty as to the
operation of the capital requirements and regulations, and should
assist in addressing potential competitive disadvantages that SDs
subject to the CFTC Bank-Based Capital Approach may be subject to
relative to prudentially regulated SDs. Accordingly, the Commission is
considering adjusting the CET1 Capital approach based on comments
received, particularly those which identified a possible competitive
disadvantage to a SD under the CFTC's jurisdiction relative to a SD
subject to the capital requirements of a prudential regulator.
3-a. The Commission requests comment on whether Regulation
23.101(a)(1)(i)(B) should be modified to permit SDs electing the Bank-
Based Capital Approach to recognize capital other than CET1 Capital in
meeting the 8% of risk-weighted assets ratio requirement. Should the
proposed Regulation be modified to permit an SD to recognize Additional
Tier 1 capital and/or Tier 2 capital (as such terms are defined in 12
CFR 217.20) in meeting its 8% of risk-weighted assets capital ratio
requirement? If so, are there particular elements of Additional Tier 1
capital or Tier 2 capital that the Commission should prohibit or
otherwise limit an SD from recognizing in meeting the 8% of risk-
weighted assets capital ratio?
3-b. The Commission requests comment on whether Regulation
23.101(a)(1)(i)(B) should be modified such that an SD is required to
maintain a CET1 Capital ratio of at least 6.5% of risk-weighted assets,
with an additional 1.5% of risk-weighted assets permitted to be held in
the form of Additional Tier 1 capital or Tier 2 capital? Should the
Commission place any restrictions or conditions on the type of
instruments that would qualify as Additional Tier 1 capital or Tier 2
capital in meeting the capital ratio?
3-c. The Commission requests comment on whether Regulation
23.101(a)(1)(i)(B) should be modified such that an SD is required to
maintain a CET1 Capital ratio of 4.5% of risk-weighted assets, with the
remaining 3.5% of risk-weighted assets permitted to be held in the form
of Additional Tier 1 capital or Tier 2 capital? Should the Commission
place any restrictions or conditions on the type of instruments that
would qualify as Additional Tier 1 capital or Tier 2 capital?
3-d. The Commission recognizes that an FCM is permitted to exclude
[[Page 69671]]
subordinated debt that complies with the conditions set forth in
Regulation 1.17 from its liabilities in computing its adjusted net
capital.\55\ In addition, an SD that elects the Net Liquid Assets
Capital Approach also would be permitted to exclude subordinated debt
that satisfies the conditions specified in SEC Rule 18a-1d (17 CFR
240.18a-1d) from its liabilities in computing its net capital.\56\ The
Commission requests comment on whether an SD that elects the Bank-Based
Capital Approach should be permitted to include subordinated debt in
computing the amount of capital available to meet the 8% of risk-
weighted assets ratio requirement? If so, should the subordinated debt
be subject to the same conditions as set forth in Regulation 1.17(h)
and/or SEC Rule 18a-1d (17 CFR 240.18a-1d) for Satisfactory
Subordination Agreements? Should the subordinated debt be classified as
Tier 2 capital in the modified rule? Please suggest rule language to
effect any modification to the Regulation.
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\55\ See Commission Regulation 1.17(h).
\56\ See SEC Rule 18a-1(c)(1)(ii)(17 CFR 240.18a-1(c)(1)(ii)).
---------------------------------------------------------------------------
3-e. The Commission requests comments and supporting data on how
the various modifications to the CET1 discussed in questions 3-a
through 3-d above would affect the capital adequacy of an SD. Would
such modifications encourage regulatory arbitrage between SDs subject
to the capital rules of a prudential regulator and SDS subject to the
capital rules of the CFTC? What impact would the proposed modifications
have on an SD's cost of capital. How would the various modifications
affect efficiency, competitiveness, financial integrity, and price
discovery of swaps market?
4. Standardized Market Risk Charges--Netting of Uncleared Currency and
Commodity Swaps
The 2016 Capital Proposal contained standardized market risk
capital charges for uncleared swaps and uncleared SBS for FCMs and SDs
not approved to use internal models.\57\ The standardized market risk
capital charges for swaps and SBS for FCMs and dually-registered FCM/
SDs were proposed in revised Regulation 1.17(c)(5)(iii) and (iv),
respectively.\58\ The standardized capital charges for SDs that are not
dually-registered as FCMs (i.e., ``Standalone SDs'') are set forth in
proposed Regulation 23.101(a)(1). Proposed Regulation
23.101(a)(1)(i)(B) sets forth the standardized capital charges for
Standalone SDs that elect the Bank-Based Capital Approach and
effectively imposes the same standardized capital charges as set forth
in Regulation 1.17(c)(5)(iii) for FCMs and dually-registered FCM/SDs.
Proposed Regulation 23.101(a)(1)(ii)(A) sets forth the standardized
capital charges for Standalone SDs electing the Net Liquid Assets
Capital Approach, and effectively imposes the same standardized capital
charges as set forth in the SEC's Final Capital Rule for SBSDs.\59\
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\57\ FCMs or SDs may seek Commission approval to use internal
models to compute market risk charges for proprietary positions. The
internal models would have to meet certain qualitative and
quantitative requirements set forth in proposed Regulation 23.102
and Appendix A to Regulation 23.102.
\58\ See 2016 Capital Proposal, 81 FR at 91307.
\59\ Proposed Regulation 23.101(a)(ii)(A), which applies to
Standalone SDs electing the Net Liquid Assets Capital Approach,
would incorporate the SEC's standardized market risk and credit risk
capital charges as it provides that the Standalone SDs must compute
regulatory capital in accordance with the SEC's capital rules as if
the Standalone SDs were SBSD subject to the SEC's capital rules.
---------------------------------------------------------------------------
FCMs and SDs must maintain capital to cover the market risk of
their swap portfolios. Standardized capital charges provide an option
for FCMs and SDs to calculate the amount of capital necessary to cover
the risk of their portfolios. Using standardized charges to measure
risk capital is relatively easy and cheap to implement, compared to
using internal models. Therefore, standardized charges reduce the
operational cost of being an SD and potentially encourage more firms to
enter the swap dealing business. However, simple standardized haircuts
are less risk-sensitive than model-based charges and less likely to
recognize appropriate netting for different portfolios. Netting is
critical in managing risk of derivative portfolios and needs to account
appropriately for different portfolios. Without a netting provision,
standardized charges can be too high, particularly for uncleared swap
portfolios made of long and short positions simultaneously, therefore
netting/offsetting provisions are critical when standardized charges
are used to measure risk capital for the swap dealing book. Due to
these reasons, sometimes standardized charges may not be tailored
appropriately to the risk of the relevant positions. To be a viable
alternative to models for calculating risk capital for FCMs and SDs,
the Commission recognizes that standardized charges need to recognize
netting benefits and must be subject to recalibration and refinement.
Proposed Regulation 1.17(c)(5)(iii) sets forth the standardized
market risk charges for uncleared credit default swaps (``CDS'')
referencing broad-based securities indices, interest rate swaps,
currency swaps, commodity swaps, and SBS. The standardized market risk
charges for uncleared CDS referencing broad-based securities indices
generally would be determined by multiplying the notional amount of the
swap by a fixed percentage based upon the remaining length of the time
to maturity of the swap and the current basis point spread of the swap.
The proposed regulation would further provide for certain netting or
offsetting of long and short uncleared CDS positions.\60\
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\60\ Id.
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The proposed standardized market risk charge for uncleared interest
rate swap positions would be determined by multiplying the notional
amount of the swap by a fixed percentage based upon the remaining term
of the swap. The FCM or dually-registered FCM/SD also would be
permitted to net or offset long and short uncleared interest rate swap
positions that are in the same time to maturity groupings or
categories, provided that the market risk capital charge deduction may
not be less than 0.5% of the amount of the long positions netted
against the short positions in each individual categories with a
maturity of three months or more.\61\
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\61\ Id. Proposed Regulation 1.17(c)(5)(iii)(B) would provide
that the capital charge for uncleared interest rate swaps would be
determined by reference to SEC Regulation 15c3-1(c)(2)(vi)(A) (17
CFR 240.15c3-1(c)(2)(vi)(A)). The Commission had proposed a minimum
standardized market risk capital charge on matched long and short
interest rate swap positions equal to 0.5% of net notional amount in
each grouping or category of swaps. The SEC proposed a minimum
standardized market risk capital charge on matched long and short
interest rate swaps equal to 1% of the net notional amount in each
grouping or category of swaps. See SEC Comment Reopening.
---------------------------------------------------------------------------
Proposed Regulation 1.17(c)(5)(iii) would further require an FCM or
dually-registered FCM/SD to incur standardized market risk charges for
uncleared currency swaps and commodity swaps. The standardized market
risk capital charges for uncleared currency swaps would be based upon a
fixed percentage of the notional amount of the currency swaps.\62\ The
standardized market risk capital charge for uncleared commodity swaps
would be based upon a fixed 20% of the market value of the commodity
underlying the commodity swaps. Proposed Regulation 1.17(c)(5)(iii),
however, did not include a provision that would provide for any netting
or
[[Page 69672]]
offsetting of the uncleared currency or uncleared commodity swaps
positions in computing the standardized market risk charges. Proposed
Regulation 1.17(c)(5)(iii) would require a standardized market risk
charge equal to the sum of the standardized charge applicable to each
long and short uncleared currency swap and each long and short
uncleared commodity swap position.
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\62\ Proposed Regulation 1.17(c)(5)(iii)(C)(1)(ii) would provide
that the standardized market risk capital charge for currency swap
is 6% of the notional amount of currency swaps referencing euros,
British pounds, Canadian dollars, Japanese yen, or Swiss francs, and
20% of the notional amount in the case of currency swaps referencing
any other foreign currencies.
---------------------------------------------------------------------------
The SEC Final Capital Rule included similar standardized market
risk charges for uncleared swaps for BDs and SBSDs, however the SEC
adopted a netting proviso applicable to both BDs and SBSDs, permitting
a reduction of the resulting capital charge by an amount equal to any
reduction recognized for a comparable long or short position in the
reference asset or interest rate under Regulation 1.17 or SEC Rule
15c3-1 (17 CFR 240.15c3-1). This netting proviso is adopted in the SEC
Final Capital Rule at Rule 15c3-1b(b)(2)(ii)(B) (17 CFR 240.15c3-
1b(b)(2)(ii)(B) and Rule 18a-1b(b)(2)(ii)(B) (17 CFR 240.18a-
1b(b)(2)(ii)(B)). The Commission intends to maintain consistency with
the SEC Final Capital Rule with respect to the applicability of the
standardized market risk charges for uncleared currency and commodity
swaps, and therefore requests comment on including the same netting
proviso appended to the proposed Regulation 1.17(c)(5)(iii)(C), which
would provide that the deduction under Regulation 1.17(c)(5)(iii)(C)(1)
may be reduced by an amount equal to any reduction recognized for a
comparable long or short position in the reference asset under Sec.
1.17 or 17 CFR 240.15c3-1.
4-a. The Commission requests comment and supporting data on the
potential modification to the standardized market risk charges as
proposed, through new rule text that would be appended to the proposed
Regulation 1.17(c)(5)(iii)(C), that would provide for the netting or
offsetting of currency swaps and commodity swaps as discussed above.
How would various changes regarding netting or offsetting provisions
affect an FCM's or SD's risk management, liquidity provision, and
capacity to serve end users in commodity swap and currency swap
markets? How would various changes affect efficiency, competitiveness,
integrity, and price discovery in commodity swap and currency swap
markets?
4-b. Would rule language as described above affect this potential
modification to the rule text in the 2016 Capital Proposal? If not,
please explain why and suggest alternative rule language.
4-c. The Commission notes that the Federal Reserve Board's current
capital framework does not include a standardized calculation for
market risk which recognizes offsets across commodity positions. The
Basel III framework, however, does include provisions for such
offsets.\63\ While it is anticipated that the prudential regulators
will adopt a standardized market risk calculation based on Basel III,
they have not done so to date.
---------------------------------------------------------------------------
\63\ BCBS Minimum Capital Requirements for Market Risk, January
2019 (revised February 2019), BIS, https://www.bis.org/bcbs/publ/d457.htm.
---------------------------------------------------------------------------
The Commission requests comments on whether Regulation
1.17(c)(5)(iii) should be modified to include the Basel III simplified
standardized approach of market risk for commodity swaps.\64\ If the
Commission were to modify Regulation 1.17(c)(5)(iii) consistent with
the current Basel III framework for the simplified standardized
approach for computing market risk, should the Commission consider
amending Regulation 1.17(c)(5)(iii) with the objective of maintaining a
harmonized approach with the prudential regulators if and when they
adopt the corresponding aspect of the Basel III framework? How would
such revisions impact FCMs or SDs that are dually-regulated as BDs or
SBSDs? While the intent of the Commission would be to limit the
incorporation of the Basel III approach only to those sections that
describe allowable netting within the commodities class, it may be that
the fusion of these sections or concepts into the rest of the
Commission's proposed rule present additional challenges. Accordingly,
the Commission requests comments identifying and addressing these
challenges and suggestions on how the Commission may modify the
regulations to overcome them. This may include for example, differences
in definitions between the Basel III framework and definitions
contained in the Proposal.
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\64\ Id. See MAR 40.2 for commodities which references MAR40.63
to MAR40.73 (commodities risk), plus additional requirements for
option risks from commodities instruments (non-delta risks) under
MAR40.74 to MAR40.86 (treatment of options).
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5. Revision of Minimum Market Risk Capital Charge for Uncleared
Interest Rate Swaps
The 2016 Capital Proposal included a standardized market risk
capital charge for uncleared interest rate swaps.\65\ The proposed
standardized market risk capital charges for uncleared interest rate
swaps was consistent with the SEC's proposed standardized market risk
capital charges for uncleared interest rate swaps in an effort to
harmonize the two rules to minimize operational costs on entities
dually registered with the CFTC and SEC, and therefore subject to both
CFTC and SEC capital rules.\66\
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\65\ See 2016 Capital Proposal, 81 FR at 91307; Proposed
Regulation 1.17(c)(5)(iii)(B). Regulation 1.17(c)(5)(iii)(B) would
apply to FCMs, SDs that elect to follow the Bank-Based Capital
Approach and are not approved to use internal capital models, and
dually-registered FCM/SDs (collectively referred to as ``Covered
Firms'').
\66\ See Capital, Margin, and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital Requirements for Broker-Dealers, 77 FR
70213 (Nov. 23, 2012) (the ``SEC Proposed Capital Rule'').
---------------------------------------------------------------------------
Pursuant to the Proposal, a Covered Firm that was not approved to
use internal market risk models would be required to take a
standardized market risk capital charge equal to a percentage of the
notional amount of the uncleared interest rate swap. The percentage
that would be applied to the notional amount would be based upon the
remaining time to maturity of the interest rate swap, and would range
from 0% (for interest rate swaps with a remaining time to maturity of
less than 3 months) to 6% (for interest rate swaps with a remaining
time to maturity of 25 years or more). The 2016 Capital Proposal
further provided that a Covered Firm may net certain of the long and
short uncleared interest rate swaps to reduce the net notional amount,
provided that the net notional amount is subject to a minimum floor
standardized capital charge equal to 0.5%.\67\
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\67\ The SEC proposed minimum standardized market risk charge of
1% of the net notional value of the interest rate swaps for SBSDs
and 0.5% for BDs. See SEC Proposed Capital Rule, 77 FR at 70345;
Proposed Rule 18a-1b(b)(2)(i)(C) (17 CFR 240.18a-1b(b)(2)(i)(C)) for
SBSDs and Proposed Rule 15c3-1b(2)(i)(C) (17 CFR 240.15c3-
1b(2)(i)(C)).
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Commenters objected to the proposed standardized market risk
charges as being too punitive and not tailored to the risk posed by the
relevant portfolios of positions.\68\ Specifically, commenters noted
that the proposed standardized market risk charges would be
substantially higher than the capital charges based on clearing house
maintenance margin requirements for cleared interest rate futures
contracts.\69\ These commenters indicated that the excessive capital
requirements derived from the proposed standardized capital charges
would particularly impact small to mid-sized Covered Firms that are not
[[Page 69673]]
approved or otherwise do not use internal market risk models.
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\68\ SIFMA 5/15/17 Letter; Jefferies 5/12/17 Letter.
\69\ SIFMA and Jefferies each estimated that the proposed
standardized market risk charges for uncleared interest rate swaps
would be approximately 144 times higher than the clearing house
margin requirements. See, Id.
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The Commission continues to believe that it is appropriate for the
capital rule to include standardized market risk charges for uncleared
interest rate swap positions to help ensure that a Covered Firm
maintains capital to address potential decreases in the value of such
positions, and as a general cushion to cover other types of risks. The
Commission also believes that standardized market risk charges are
necessary as not all Covered Firms will have internal models to compute
market risk charges.
The Commission, however, recognizes that the Proposal would impose
substantial capital charges that are not properly calibrated to the
risks of the interest rate swap positions. In addition, the Commission
acknowledges that the standardized market risk charges would impact
Covered Firms that do not use internal models, which is expected to be
smaller to mid-sized Covered Firms that are not part of a financial
group that has obtained the approval of the SEC, prudential regulators,
or a foreign regulator to use internal capital models. The Commission
believes that establishing an appropriate level for the standardized
capital charge for uncleared interest rate swaps would benefit market
participants by encouraging smaller to mid-sized SDs to remain or to
enter the market. Accordingly, the Commission request further comment
on the proposed standardized market risk charge for uncleared interest
rate swaps.
5-a. The Commission requests comment on modifying the proposed
capital charges for interest rate swap positions for Covered Firms.
Should the Commission modify the proposed regulation to include the
0.125% capital charge adopted by the SEC? Is the 0.125% capital charge
appropriately calibrated to the risk of the interest rate swap
positions? What would be the financial impact on Covered Firms' capital
by modifying the regulation to provide for a 0.125% capital charge? How
would the modified capital charge at a 0.125% level satisfy the
statutory requirement of helping to ensure the safety and soundness of
a SD? What would be the potential impact of having a capital charge
that was not appropriately calibrated to the risk of the swap
positions? Please provide empirical data and analysis in support for
your responses.
5-b. The Commission requests comment on whether additional guidance
concerning the method of applicable netting of uncleared interest rate
swaps positions is necessary.
6. Revision of the Length of Time to Maturity Categories for Credit
Default Swaps
The 2016 Capital Proposal would require an FCM or SD to incur a
standardized market risk capital charge for uncleared CDS. As noted
above in section 4, the standardized market risk capital charge for
uncleared CDS would be determined by multiplying the notional amount of
the swap by a fixed percentage based upon the remaining length of time
to maturity of the swap and the current basis point spread of the swap.
The SEC Final Capital Rule includes the same standardized market
risk capital charges for uncleared CDS referencing broad-based security
index.\70\ However, the SEC Final Capital Rule contains slightly
different categories of remaining length of maturity of the swap than
the Commission's 2016 Capital Proposal.\71\ This difference was not
intentional and is not deemed material.
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\70\ See SEC Final Rule; Rule 15c3-1b(b)(2)(i)(A) (17 CFR
240.15c3-1b(b)(2)(i)(A)) for BDs and Rule 18a-1b(b)(2)(i)(A) (17 CFR
240.18a-1b(b)(2)(i)(A)) for SBSDs.
\71\ The length of time to maturity component of the respective
CFTC and SEC standardized grids were different by one month.
---------------------------------------------------------------------------
The Commission and SEC have a long history of harmonizing CFTC and
SEC capital requirements in order to reduce costs that would otherwise
be imposed on dually-regulated entities, including dually-registered
FCM/BDs, from having to comply with two different regulatory
requirements. This approach to a uniform capital rule reduces costs to
registrants and encourages entities to engage in activities that
require registration with both the CFTC and SEC, while also providing
appropriate regulatory requirements. To maintain this established
system of uniform capital requirements, the Commission proposes to
modify the grid of the final length of time to maturity of the CDS
contact referencing broad-based security index in proposed Regulation
1.17(c)(5)(iii)(A)(1) to harmonize the standardized uncleared CDS
contract market risk capital charges with the final SEC standardized
capital charges.
6-a. The Commission requests comment on the potential modification
of the standardized market risk charges for uncleared CDS referencing
broad-based security index.
6-b. The potential modification to paragraph (c)(5)(iii)(A)(1) of
Regulation 1.17 would revise the language of each row heading one month
less, for example the first row would be titled less than 12 months as
opposed to 12 months or less.
Would the potential modification described above appropriately
address the harmonization of the CFTC and SEC standardized market risk
capital charge for uncleared CDS referencing broad-based security
index? If not, are there additional modifications that would need to be
addressed, or different rule language necessary to appropriately
harmonize the CFTC and SEC CDS standardized market risk charges? The
Commission is of the view that the changes to the table above would
have a de minimis effect on the required amount of capital; however,
the Commission requests comments and supporting data on how the changes
to the table would, if at all, affect efficiency, competitiveness,
financial integrity, and price discovery of swaps market?
7. Tangible Net Worth Capital Approach
The 2016 Capital Proposal included a provision permitting SDs that
are ``predominantly engaged in non-financial activities'' to compute
their minimum regulatory capital based upon the firms' ``tangible net
worth'' (the ``Tangible Net Worth Capital Approach'') in lieu of the
Bank-Based Capital Approach or the Net Liquid Assets Capital
Approach.\72\ Proposed Regulation 23.101(a)(2) defined the term
``predominantly engaged in non-financial activities'' by referencing
the definition of the term ``financial activities'' under the Federal
Reserve Board's regulations establishing criteria for determining if a
nonbank financial company is predominantly engaged in financial
activities.\73\ For purposes of the Proposal, an entity would be
considered ``predominantly engaged in non-financial activities'' if:
(1) The consolidated annual gross financial revenues of the entity in
either of its two most recently completed fiscal years represents less
than 15 percent of the entity's consolidated gross revenue in that
fiscal year (``15% Revenue Test''), and (2) the consolidated total
financial assets of an entity at the end of its two most recently
completed fiscal years represents less than 15 percent of the entity's
consolidated total assets as of the end of the fiscal year (``15% Asset
[[Page 69674]]
Test''). For purposes of the 15% revenue test, consolidated annual
gross financial revenues would mean that portion of the consolidated
total revenue of the entity that are related to activities that are
financial in nature. For purposes of the 15% asset test, consolidated
total financial assets would mean that portion of the consolidated
total assets of the entity that are related to activities that are
financial in nature.
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\72\ See 2016 Proposed Capital Rule, 81 FR at 91310-11; Proposed
Regulation 23.101(a)(2). The term ``tangible net worth'' was
proposed to be defined in Regulation 23.100, in relevant part, as
the net worth of an SD as determined in accordance with generally
accepted accounting principles in the U.S., excluding goodwill and
other intangible assets.
\73\ See 12 CFR 242.3. The Financial Stability Oversight Council
uses the criteria when it considers the potential designation of a
nonbank financial company for consolidated supervision by the
Federal Reserve Board.
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The Commission proposed a Tangible Net Worth Capital Approach in
recognition that certain entities that engage primarily in non-
financial activities may meet the statutory and regulatory definitions
of the term ``swap dealer'' and, therefore, would be required to
register as such with the Commission.\74\ However, while these entities
may engage in swap dealing activities, they are primarily commercial
enterprises. The business activities and the composition of the balance
sheet of these commercial entities may differ materially from entities
predominantly engaged in financial activities, including the types of
transactions they enter into, and the types of market participants and
swap counterparties that they deal with. Because of these differences,
the Commission believed that application of the Bank-Based Capital
Approach or Net Liquid Assets Capital Approach to these SDs could
result in inappropriate capital requirements that would not be
proportionate to the risk associated with these entities.\75\ The
proposed Tangible Net Worth Capital Approach would provide that an SD
that was predominantly engaged in non-financial activities must
maintain tangible net worth equal to or greater than the highest of:
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\74\ The term ``swap dealer'' is defined by section 1a(49) of
the CEA and Regulation 1.3 of the Commission's regulations.
Regulation 1.3 provides that an entity may apply to limit its
designation as an SD to specified categories of swaps or specified
activities in connection with swaps.
\75\ Furthermore, as an SD, the entity is required to exchange
variation margin on swaps entered into with other SDs or financial
end users, and post and collect initial margin on swaps entered into
with SDs or financial end users with material swaps exposure. See
CFTC Regulations 23.152 and 23.153.
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(1) $20 Million plus the amount of the SD's market risk exposure
requirement and credit risk exposure requirement associated with the
SD's swaps and related hedge positions that are part of the SD's
dealing activities;
(2) 8% of the sum of the:
(a) The amount of uncleared swap margin \76\ for each uncleared
swap position open on the books of the SD, computed on a counterparty
by counterparty basis pursuant to the Commission's margin rules for
uncleared swap transactions (Regulation 23.154);
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\76\ See 2016 Capital Proposal, 81 FR at 91309-10.
---------------------------------------------------------------------------
(b) The amount of initial margin that would be required for each
uncleared SBS position open on the books of the SD, computed on a
counterparty by counterparty basis pursuant to SEC Rule 18a-
3(c)(1)(i)(B) (17 CFR 240.18a-3(c)(1)(i)(B)) without regard to any
initial margin exemptions or exclusions that the SEC rules may provide
to such SBS positions; and
(c) The amount of initial margin required by clearing organizations
for cleared proprietary futures, foreign futures, swaps, and SBS
positions open on the books of the swap dealer; or
(3) The amount of capital required by a registered futures
association of which the SD is a member.
Certain commenters generally supported the Tangible Net Worth
Capital Approach but questioned the criteria proposed to qualify for
the approach as overly narrow and entity specific. These commenters
generally noted that a parent entity that is predominantly engaged in
non-financial activities would not be permitted in any practical way to
establish an SD subsidiary that would be able to use the Tangible Net
Worth Capital Approach as the swaps activity of the SD would be
considered financial activities.\77\ Some commenters further noted that
the proposed Tangible Net Worth Capital Approach would discriminate
against corporate entities that are predominantly engaged in non-
financial activities but elect to maintain their swap dealing
activities in separate legal entities.\78\ Another commenter stated
that commercial enterprises may establish SD subsidiaries to perform
centralized risk management operations for the commercial enterprise,
and that such SD subsidiaries should have the option to elect a
Tangible Net Worth Capital Approach.\79\ These commenters generally
suggested that the assessment of whether the entity satisfies the
conditions for the use of the Tangible Net Worth Capital Approach
should be made at an SD's parent level and not at the level of the SD.
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\77\ See, e.g., Letter from Phillip Lookadoo, and Jeremy
Weinstein, International Energy Credit Association (May 15, 2017);
Letter from Scott Earnest, Shell Trading Risk Management LLC (May
15, 2017) (Shell 5/15/17 Letter); Letter from David McIndoe,
Commercial Energy Working Group (May 15, 2017); and Letter from
Michael P. LeSage, Cargill Risk Management, a unit of Cargill, Inc.
(May 15, 2017) (Cargill 5/15/17 Letter).
\78\ See e.g., Shell 5/15/17 Letter.
\79\ See Letter from National Corn Growers Association and
National Gas Supply Association, (May 15, 2017).
---------------------------------------------------------------------------
The Commission continues to believe as it stated in the 2016
Capital Proposal that certain SD entities which may engage in dealing
activities but be associated with primarily commercial entities will
need a more flexible capital requirement than either the Bank-Based
Capital Approach or the Net Liquid Assets Capital Approach. In
consideration of the comments that the Tangible Net Worth Capital
Approach may not be available to the full universe of SDs that it may
best fit, based on the type of transactions and market functions
fulfilled by such SDs, the Commission believes ensuring the continued
viability of the current range of SD businesses merits seeking
additional comment on possibly broadening the applicability of the
Tangible Net Worth Capital Approach, while considering the need for
associated additional risk mitigants if a broader application is
adopted. Expanding the availability of the Tangible Net Worth Capital
Approach to SDs that are subsidiaries of a corporate group that is
predominantly engaged in non-financial activities would provide
flexibility to allow such corporate groups to determine the most
efficient and effective corporate structure to meet their business and
operational needs without forcing such entities to elect either the Net
Liquid Assets Capital Approach or Bank-Based Capital Approach, which
are designed primarily for financial entities, for their SD
subsidiaries. Providing SDs that are subsidiaries of corporate groups
that are predominantly engaged in non-financial activities with a
choice of using the Tangible Net Worth Capital Approach may also
encourage non-financial firms to register as SDs, which may benefit
commercial end users and other market participants that use such SDs to
hedge their commercial risk. Accordingly, the Commission is requesting
further information with respect to the consideration of the Tangible
Net Worth Capital Approach as follows.
7-a. The Commission requests comment on whether the rules should
permit an SD that is not ``predominantly engaged in non-financial
activities'' as defined in proposed Regulation 23.100 to nevertheless
to use the Tangible Net Worth Capital Approach if its parent entity or
the ultimate parent of its consolidated ownership group otherwise
satisfies the criteria? This approach would effectively permit SDs that
are subsidiaries of commercial enterprises that are ``predominantly
engaged in non-financial activities'' as defined by the proposed rules
to elect to use the Tangible Net Worth Capital
[[Page 69675]]
Approach in computing their capital requirements. What conditions
should the Commission consider if it were to adopt such an approach?
Under various conditions, how would cost of capital requirement change?
7-b. Should the Commission require an SD that relies on a parent
entity to satisfy the ``predominantly engaged in non-financial
activities'' criteria to elect the Tangible Net Worth Capital Approach
to obtain parent guarantees, or some other form of financial support,
for its swaps obligations? In addition to parent guarantees, what other
forms of financial support should the Commission consider? How and to
what extent might such requirements help protect market participants
and the public? If no guarantees or other forms of financial support
are provided, how would the SD be ensured of meeting its financial
obligations?
7-c. Should the Commission require a higher minimum capital
requirement for SDs that rely on its parent to meet the criteria to be
eligible to use the Tangible Net Worth Capital Approach? If so, what
should the minimum capital requirement be for such SDs? How should the
Commission determine such SD's minimum capital requirements?
7-d. Should the Commission consider any revisions to the 15% Asset
Test and/or the 15% Revenue Test? If so, what revisions should the
Commission consider? Why are such revisions necessary to achieve the
purpose of the Tangible Net Worth Capital Approach?
7-e. Should the Commission further expand the use of the Tangible
Net Worth Capital Approach to SDs that are subsidiaries of parent
entities that are predominantly engaged in financial activities if such
SDs are primarily engaged in commodity swap transactions? How would the
minimum capital requirement for such SDs under the proposed Tangible
Net Worth Capital Approach compare to the minimum capital requirement
under the Bank-Based Capital Approach or Net Liquid Assets Capital
Approach.
7-f. The Commission request comments and supporting data on how
various choices regarding changes under Tangible Net Worth Capital
Approach would affect SD's risk management, liquidity provision, and
capacity of serving end users? How would these choices affect
efficiency, competitiveness, integrity and price discovery of swaps
markets?
7-g. Should the Commission include in the rules a procedure that
would allow an SD to petition the Commission on a case-by-case basis to
use the Tangible Net Worth Capital Approach?
8. Quantitative and Qualitative Requirements for Internal Models
The 2016 Capital Proposal included proposed Appendix A to
Regulation 23.102 which described the requirements for the calculation
of market risk exposure using internal models.
8-a. Commenters noted that while proposed Regulation
23.101(a)(1)(i)(B) provided that an SD that elects the Bank-Based
Capital Approach must compute its risk-weighted assets in accordance
with the requirements of the Federal Reserve Board for bank holding
companies and set forth in 12 CFR part 217, the internal capital model
requirements in proposed Regulation 23.102 did not explicitly
incorporate the market risk and credit provisions of 12 CFR part
217.\80\ To address this omission, a commenter suggested that the
Commission modify paragraph (c) of proposed Regulation 23.102 to
provide that a swap dealer's application must include: (1) In the case
of a swap dealer subject to the minimum capital requirements in Sec.
23.101(a)(1)(i) applying to use internal models to compute market risk
exposure, the information required under 12 CFR 217 subpart F, as if
the swap dealer were a bank holding company subject to 12 CFR part 217;
(2) in the case of a swap dealer subject to the minimum capital
requirements in Sec. 23.101(a)(1)(i) applying to use internal models
to compute credit risk exposure, the information required under 12 CFR
217 subpart E, sections 131-155, as if the swap dealer were a bank
holding company subject to 12 CFR part 217; or (3) in the case of a
swap dealer subject to the minimum capital requirements in Sec.
23.101(a)(1)(ii), the information set forth in Appendix A of the
section.
---------------------------------------------------------------------------
\80\ See SIFMA 5/15/17 Letter; MS 5/15/17 Letter.
---------------------------------------------------------------------------
In addition, the commenter suggested the Commission modify
paragraph (d) of proposed Regulation 23.102 to provide that the
Commission or the registered futures association may approve or deny
the application, or approve an amendment to the application, in whole
or in part, subject to any conditions or limitations the Commission or
registered futures association may require, if the Commission or
registered futures association finds the approval to be appropriate in
the public interest, after determining, among other things, whether the
applicant has met the requirements of this section, and the appendices
to this section. A swap dealer that has received Commission or
registered futures association approval to compute market risk exposure
requirements and credit risk exposure requirements pursuant to internal
models must compute such charges in accordance with 12 CFR 217 subpart
F, Sec. 217 subpart E, sections 131-155 or Appendix A of the section,
as applicable per paragraph (c).
The Commission requests comment on the suggested modifications to
paragraphs (c) and (d) of proposed Appendix A to Regulation 23.102,
which are intended to explicitly provide that SDs that elect to use the
Bank-Based Capital Approach are subject to the Federal Reserve Board's
market risk and credit risk model requirements. This modification would
revise the text of Appendix A to be consistent with the Commission's
stated objective and intent in the 2016 Capital Proposal that SDs that
elect the Bank-Based Capital Approach would be subject to the Federal
Reserve Bank's capital requirements, including the market risk and
credit risk model requirements contained in 12 CFR part 217. Would the
rule language accurately reflect the potential modification and
properly address the issue? If not, please provide alternative rule
language to affect the modification.
8-b. Commenters to the 2016 Capital Proposal requested
clarification whether an SD applying for approval to use internal
models would need to apply for models for market risk and credit risk
or if they could request approval to use models for only one of the
exposure types, market or credit, while opting for the standardized
calculation method for the other.\81\ The Commission invites comments
and supporting data on this issue. How different would capital
requirements be under various choices? Some commenters also inquired
whether an SD's application for internal model approval had to
encompass asset classes or asset types in which it is not actively
dealing. The Commission would like to clarify that the suitability of
internal models is to be evaluated for the specific activities of the
SD and not for activities that the SD does not engage in.
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\81\ See e.g., SIFMA 5/15/17 Letter.
---------------------------------------------------------------------------
9. Model Approval Process
The 2016 Capital Proposal would require SDs and FCMs, in computing
their respective capital, to take market risk capital charges to
protect against potential losses in the value of their proprietary
trading positions, and to take counterparty credit risk charges to
protect against potential counterparty credit risk. Proposed Regulation
23.102 would permit an SD (and an FCM that is registered as an SD),
subject to the
[[Page 69676]]
prior approval of the Commission or a registered futures association
(i.e., NFA), to compute market risk and credit risk capital charges
using internal models in lieu of standardized market risk and credit
risk capital charges.\82\ The Commission proposed to permit market risk
and credit risk modeling as it recognized that properly designed and
monitored internal models, including value-at-risk models, are a more
effective means of measuring economic risk from complex trading
strategies involving swaps, SBS, and other investment instruments than
the standardized capital charges, which are primarily computed based
upon a fixed percentage of the notional or fair values of the
instruments.
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\82\ See 2016 Capital Proposal, 81 FR at 91311-17; Proposed
Regulation 23.102 and proposed Appendix A to Regulation 23.102.
---------------------------------------------------------------------------
The SD's application to use internal models would have to be in
writing and filed with the Commission and with the NFA in accordance
with the applicable instructions. The model application would have to
include specified information, which is contained in proposed Appendix
A to Regulation 23.102. For example, proposed Appendix A would require
an SD to submit: (1) A list of categories of positions the SD holds in
its proprietary accounts and a brief description of the methods the SD
would use to calculate deductions for market risk and credit risk on
those categories of positions; (2) A description of the mathematical
models to be used to price positions and to compute deductions for
market risk and credit risk; (3) A description of how the SD will
calculate current exposure and potential future exposure for its credit
risk charges; and, (4) A description of how the SD would determine
internal credit risk weights of counterparties, if applicable.\83\
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\83\ Id.
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The 2016 Capital Proposal would further provide that as part of the
approval process, and on an ongoing basis, an SD would be required to
demonstrate to the Commission or NFA that the models reliably account
for the risks that are specific to the types of positions the SD
intends to include in the model computations.\84\ Finally, the 2016
Capital Proposal provided that the Commission or NFA may approve, in
whole or in part, an application or an amendment to the application,
subject to any conditions or limitations the Commission or NFA may
require.\85\
---------------------------------------------------------------------------
\84\ Id.
\85\ See 2016 Capital Proposal, 81 FR at 91312; Proposed
Regulation 23.102(d).
---------------------------------------------------------------------------
The Commission received several comments concerning the use of
internal capital models. One commenter expressed a strong concern
regarding the 2016 Capital Proposal's potential heavy reliance on the
use of internal models.\86\ The commenter stated that a reliance on
internal models can permit regulated entities to manipulate risk
controls to increase their own profits at the cost of increasing risks
to the public. The commenter pointed out that analysis of the crisis
experience evidenced manipulation of models to reduce capital charges.
While the commenter acknowledged post-crisis refinements to internal
model requirements, both in technique and governance, it argued that
resource limitations at regulators, as well as continuing pressure from
industry, may limit regulators' ability to prevent weakening standards
and model misuse. The commenter thus advocated for strong limitations
and floors on the use of internal models.\87\
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\86\ See AFR 5/15/17 Letter.
\87\ Id.
---------------------------------------------------------------------------
Other commenters generally supported the Commission's proposal to
permit internal capital models in lieu of standardized capital
charges.\88\ Another commenter stated that it strongly supports
permitting SDs the flexibility to use internal models, when
appropriate.\89\
---------------------------------------------------------------------------
\88\ See, e.g., ISDA 5/15/17 Letter; SIFMA 5/15/17 Letter; and
MS 5/15/17 Letter.
\89\ See IFM 5/15/17 Letter.
---------------------------------------------------------------------------
Several commenters stated that it was necessary for the Commission
to develop an efficient approach to the review and approval of internal
models. In this regard, one commenter stated that it believed that the
Commission's final rule should provide for the recognition of internal
capital models used throughout corporate families if such models have
been approved by a prudential regulator, the SEC, or a foreign
regulator in a jurisdiction that has adopted the Basel capital
requirements, provided that the relevant regulatory authority has
ongoing periodic assessment power with regard to the model and provides
the CFTC and the NFA with appropriate information.\90\ Another comment
stated that the Commission should modify the Proposal to permit SDs
that are U.S. non-bank entities to use internal capital models approved
and periodically assessed by a prudential regulator, the SEC, or the
SDs' home country supervisor (if applicable), without requiring
additional pre-approval of those models by the Commission or NFA.\91\
Several commenters stated that the Commission should automatically
approve market risk models and credit risk models of SDs that have
already been approved by a prudential regulator, the SEC, or certain
foreign regulators.\92\ Another commenter stated that all models should
be deemed ``provisionally approved'' while under review by the
Commission or NFA, and that in no event should an SD be required to use
the proposed standardized capital charges while awaiting model
approval.\93\ One commenter requested that the Commission clarify that
no SD would be required to use the proposed standardized capital
charges while awaiting model approval.\94\
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\90\ See ISDA 5/15/17 Letter.
\91\ Letter from ABN, ING, Mizuho and Nomura (May 15, 2017).
\92\ See, e.g., FIA 5/15/17 Letter; SIFMA 5/15/17 Letter.
\93\ See ISDA 5/15/17 Letter.
\94\ See IFM 5/15/17 Letter.
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The Commission continues to believe the regulations should provide
for the appropriate use of internal market risk and credit risk models
in lieu of the standardized capital charges. As the Commission noted in
the 2016 Capital Proposal, the Commission considered the degree to
which its Proposal would be consistent with existing regulatory
frameworks. Currently, prudential regulators permit SDs subject to
their capital requirements to use internal capital models. In addition,
the SEC Final Rule will permit SBSDs to seek approval from the SEC to
use internal capital models. Accordingly, the Commission continues to
support a capital requirement that would permit SDs to use internal
capital models, which will allow such firms to compete with
prudentially regulated or SEC regulated entities.
The use of models by firms that demonstrate compliance with both
the quantitative and qualitative requirements also will potentially
benefit market participants. As noted above, the Commission believes
that properly designed and monitored internal models are a more
effective means of measuring economic risk from complex trading
strategies than the standardized capital charges, which are primarily
computed based upon a fixed percentage of the notional or fair values
of the instruments. SDs authorized to use models will generally have
lower capital costs as compared to SDs that use standardized capital
charges. The lower costs may result in the SDs engaging in mores swaps
with counterparties or lower transaction costs for the SDs and
counterparties.
The Commission requests comment on the following with respect to
the model approval process.
[[Page 69677]]
9-a. The Commission requests comment on whether the proposed
process for an SD to obtain regulatory approval to use internal models
should be modified. If so, how should the Commission modify the model
approval process? Should the Commission have different processes for
SDs and for FCMs (including FCMs that are dually-registered as SDs)?
9-b. The Commission requests comment on permitting the Commission
or NFA to accept market risk and/or credit risk models of an SD, or SD
affiliate, that have been approved by a prudential regulator, the SEC,
or a foreign regulator to be used by the SD to comply with the
Commission's model requirements? What conditions should the Commission
or NFA consider in permitting SDs to use models of affiliates that have
been approved by other regulators? How would the Commission or NFA
address possible situations where the SD's positions are materially
different, such as a heavy concentration in a particular asset class or
a particularly illiquid asset, from the positions of the affiliate that
obtained model approval?
9-c. One commenter provided suggested rule language to modify
Regulation 23.102 to permit SDs to use internal market risk and/or
credit risk models without obtaining the prior written approval of the
Commission or the NFA.\95\ The ability for an SD to use a model without
obtaining the prior written approval would be subject to the following
conditions: (1) The model had been approved by the SEC, a prudential
regulator, or a foreign regulatory authority whose capital adequacy
requirements are consistent with the Basel-based capital requirements
for banks; (2) the SD makes available to the Commission copies of
underlying documentation; and, (3) for models approved by foreign
regulators, a description of how the relevant foreign jurisdiction
capital adequacy framework addresses the elements of the Commission's
capital requirements.\96\ The potential modification would establish a
new paragraph (e) to Regulation 23.102 which would provide a swap
dealer subject to the minimum capital requirements in Section
23.101(a)(1) may use an internal credit risk or an internal market risk
capital model without the prior written approval of the Commission or a
registered futures association if: (1) The relevant model has been
approved and currently is in use, either by the relevant swap dealer or
by an affiliated entity, under the supervision of the Securities and
Exchange Commission, a prudential regulator or a foreign regulatory
authority whose capital adequacy requirements are consistent with the
Basel-based capital requirements for banking institutions; and (2) the
swap dealer has made available to the Commission any copies of
underlying documentation, including regulatory approvals, evidencing
review, approval and supervision of the internal capital models, to the
extent permitted by applicable law.
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\95\ See SIFMA 5/15/17 Letter, Appendix A. SIFMA also
recommended corollary changes to their proposed subparagraph (f) (as
proposed by the Commission in subparagraph (e)) which would refer to
their proposed additional subparagraph (e) and retains the
Commission or NFA's ability to determine if the models are no longer
sufficient.
\96\ Id.
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Further, this modificiation would provide, in the case of a model
approved by a foreign regulatory authority, the swap dealer has
submitted to the Commission: (i) A description of the objectives of the
relevant foreign jurisdiction's capital adequacy requirements; (ii) a
description (including specific legal and regulatory provisions) of how
the relevant foreign jurisdiction's capital adequacy requirements
address the elements of the Commission's capital adequacy requirements
for swap dealers, including, at a minimum, the methodologies for
establishing and calculating capital adequacy requirements; and (iii) a
description of the ability of the relevant foreign regulatory authority
or authorities to supervise and enforce compliance with the relevant
foreign jurisdiction's capital adequacy requirements. Such description
should discuss the powers of the foreign regulatory authority or
authorities to supervise, investigate, and discipline entities for
compliance with capital adequacy requirements, and the ongoing efforts
of the regulatory authority or authorities to detect and deter
violations, and ensure compliance with capital adequacy requirements.
The description should address how foreign authorities and foreign laws
and regulations address situations where an entity is unable to comply
with the foreign jurisdiction's capital adequacy requirements.
The Commission requests comments on the suggested new paragraph (e)
to Regulation 23.102. Please suggest any modifications that are
necessary to the new paragraph (e). In addition, what types of
information do registrants feel they may be restricted under law from
providing to the Commission? Please be specific and identify the legal
requirements and/or privileges that may impact the registrant's
provision of information to the Commission or NFA. How can the
Commission and NFA ensure they receive the information they need to
supervise the use of the model on a going forward basis?
9-d. The Commission requests comments and supporting data on how
various changes to the model approval process would affect the
efficiency, competitiveness, financial integrity, and price discovery
of the swaps market? Would the various changes affect the ability of
the Commission to effectively meet the safety and soundness mandate
established for capital requirements in the CEA?
B. Liquidity
10. Liquidity Requirements
The 2016 Capital Proposal included liquidity requirements for SDs,
which would include SDs that also are registered as FCMs.\97\ Proposed
Regulation 23.104(a) would require each SD electing the Bank-Based
Capital Approach to meet the liquidity coverage ratio established by
the Federal Reserve for bank holding companies under 12 CFR part 249.
The proposed liquidity coverage ratio would require an SD to maintain
each day an amount of high quality liquid assets (``HQLAs'') \98\ that
is no less than 100 percent of the SDs total net cash outflows over a
prospective 30 calendar-day period (the ``HQLA Test'').\99\
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\97\ See 2016 Capital Proposal, 81 FR at 91317-38; Proposed
Regulation 23.104.
\98\ HQLAs are assets that are unencumbered by liens and other
restrictions on the ability of the SD to transfer the assets (see 12
CFR 249.22(b)).
\99\ See 12 CFR 249.10. Federal Reserve Board rules require a
regulated institution to maintain a liquidity coverage ratio of
HQLAs to net cash outflows that is equal to or greater than 1.0 on
each business day.
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For SDs that elect the Net Liquid Assets Capital Approach, and for
FCMs dually-registered as SDs, proposed Regulation 23.104(b) would
require each SD/FCM to perform stress testing on at least a monthly
basis that takes into account certain assumed conditions lasting for 30
consecutive days (the ``Liquidity Stress Test''). The assumed
conditions for the Liquidity Stress Test would include a decline in
creditworthiness of the SD/FCM severe enough to trigger contractual
credit related commitment provisions of counterparty agreements; the
loss of all existing unsecured funding at the earlier of its maturity
or put date and an inability to acquire a material amount of new
unsecured funding; and, the potential for a material net loss of
secured funding. The Commission's proposed Liquidity Stress Test was
consistent with the liquidity stress testing requirements proposed by
the
[[Page 69678]]
SEC for BDs and SBSDs.\100\ The SEC, however, elected not to adopt
final liquidity requirements for BDs and SBSDs.\101\
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\100\ See SEC Proposed Capital Rule; Proposed Rule 18a-1(f) (17
CFR 240.18a-1(f)).
\101\ See SEC Final Capital Rule, 84 FR 43872, 43874.
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Commenters raised issues with the proposed HQLA Test and the
Liquidity Stress Test. One commenter suggested that SD entities should
be able to elect either the HQLA Test or the Liquidity Stress Test
requirement unrelated to the SD's chosen capital approach.\102\ Another
commenter stated that the requirements of the HQLA Test and the
Liquidity Stress Test should be revised to be more similar to each
other given that both approaches have the comparable regulatory
objective of helping to ensure that an SD has sufficient access to
liquidity to meet its obligations during periods of expected and
unexpected market activity.\103\ The commenter specifically noted that
the Liquidity Stress Test's definition of liquidity reserves is
materially narrower than the HQLA Test's definition of high quality
liquid assets, and that the Commission should expand the definition
under the Liquidity Stress Test to match the definition under the HQLA
Test so as to recognize the full range of assets that are actually
available to a firm to support its liquidity needs.\104\
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\102\ See, e.g., MS 5/15/17 Letter.
\103\ See, SIFMA 5/15/17 Letter.
\104\ Id.
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Commenters also raised the concept of a third alternative, which
would be the application of a more qualitative than quantitative
requirement applicable to SDs that are subsidiaries of bank holding
companies and already subject to comprehensive overall liquidity risk
management program requirements at a parent level.\105\
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\105\ See, SIFMA 5/15/17 Letter; MS 5/15/17 Letter.
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The Commission proposed liquidity requirements to address the
potential risk that an SD may not be able to efficiently meet both
expected and unexpected current and future cash flow and collateral
needs as a result of adverse events impacting the SD's daily operations
or financial condition.\106\ The proposed liquidity requirements would
apply to SDs electing the Bank-Based Capital Approach and the Net
Liquid Assets Capital Approach, but were not proposed for entities
electing the Tangible Net Worth Capital Approach, as such SDs must be
predominantly engaged in non-financial activities, which would limit
their activities as counterparties or financial intermediaries to other
parties.
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\106\ See, 2016 Capital Proposal, 81 FR at 91273.
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The Commission recognizes that SDs are subject to existing CFTC
requirements to maintain a general risk management program that
addresses liquidity risk. Regulation 23.600(b)(1) provides that an SD
must establish, document, maintain, and enforce a system of risk
management policies and procedures designed to monitor and manage the
risks associated with the swaps activities of the SD. Regulation
23.600(c)(4)(iii) provides that the risk management program must
include liquidity risk policies and procedures that take into account,
among other things, a daily measurement of liquidity needs; the
assessment of procedures to liquidate all non-cash collateral in a
timely manner and without significant effect on price; and the
application of appropriate collateral haircuts that accurately reflect
market and credit risk. The Commission, however, proposed the Liquidity
Stress Test and the HQLA Test to provide specific quantitative and
qualitative criteria that an SD must use in measuring its liquidity
under defined scenarios. The Commission continues to believe that
liquidity requirements are a necessary complement to the SD capital
requirements, particularly for SDs that elect the Bank-Based Capital
Approach. As previously discussed, the Bank-Based Capital Approach is
not a liquidity-based capital requirement in the manner similar to the
Net Liquid Assets Capital Approach.
The Commission requests further comments on the proposed liquidity
requirements as set forth below.
10-a. The Commission requests comment on all aspects of the
liquidity proposals contained in the 2016 Capital Proposal. Please
provide modified regulatory text in support of any comments provided,
if applicable.
10-b. Should the Commission modify the Proposal to permit an SD to
elect the HQLA Test or the Liquidity Stress Test, irrespective of the
capital approach followed by the SD?
10-c. Should the Commission modify the definition of liquidity
reserves to make the definition in the Liquidity Stress Test similar to
the HQLA Test? If so, how should the definition be modified? Please
suggest rule language to modify the regulation.
10-d. Should the Commission modify the Proposal to permit an SD to
consider relying on the existing application of qualitative liquidity
controls applicable at bank holding companies for SDs which are
subsidiaries of bank holding companies in lieu of requiring the
quantitative HQLA Test requirement proposed in Rule 23.104(a) as
suggested by commenters as a third alternative? How would such approach
apply to SDs electing the Bank-Based Capital Approach?
10-e. Should the Commission, similar to the SEC, not adopt the
Liquidity Stress Test requirement as proposed in Rule 23.104(b)? If so,
should the Commission impose an alternative liquidity requirement on
SDs that elect the Net Liquid Assets Capital Approach beyond the
general risk management requirements of Regulation 23.600? If the
Commission does not adopt the Liquidity Stress Test or an alternative
liquidity requirement, would this raise any competitive impact on SDs
electing the Bank-Based Capital Approach? If so, how should the
Commission address the competitive issues?
10-f. Should the Commission consider eliminating specific
quantitative liquidity requirements for SDs electing either the Bank-
Based Capital Approach or the Net Liquid Assets Capital Approach, in
consideration of the requirement of all SDs to have comprehensive risk
management programs including liquidity risk as in effect under Rule
23.600?
10-g. Should the Commission include any additional quantitative or
more specific qualitative liquidity risk requirements in connection
with any consideration of additional expansion of the Tangible Net
Worth Capital Approach to a broader subset of SDs?
10-h. The Commission requests comments and supporting data on how
various choices regarding changes to liquidity requirements would
affect the cost of SD's participation in the swap markets? How would
various choices affect the efficiency, competitiveness, integrity, and
price discovery of swap markets?
C. Financial Reporting
The 2016 Capital Proposal included proposed financial reporting
requirements for SDs and MSPs. SDs and MSPs that are subject to the
Commission's capital requirements would be required to, among other
things: (1) Maintain current ledgers and other similar records
summarizing transactions affecting their assets, liabilities, income,
and expenses; (2) file notices of certain events with the Commission,
including notices of failing to comply with the minimum capital
requirements; (3) file monthly unaudited and annual audited financial
statements with the Commission; and (4) respond to requests from the
[[Page 69679]]
Commission for additional information as requested.\107\
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\107\ See 2016 Capital Proposal, 81 FR at 91318-22; Proposed
Regulation 23.105.
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The 2016 Capital Proposal would also require SDs and MSPs that are
subject to the capital rules of a prudential regulator to file certain
information with the Commission. Such information includes: (1)
Quarterly balance sheet, regulatory capital computations, and aggregate
swaps position information; (2) notice filings, including notice of a
failure to maintain the minimum applicable capital requirement; and (3)
additional information as requested by the Commission.\108\
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\108\ Id.
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11. Use of International Financial Reporting Standards
The 2016 Capital Proposal would permit certain SDs and MSPs to
submit unaudited and audited financial statements in accordance with
International Financial Reporting Standards issued by the International
Accounting Standards Board (``IFRS'') in lieu of generally accepted
accounting principles established in the United States (``U.S.
GAAP'').\109\ To be eligible to use IFRS, the SD or MSP may not be
organized under the laws of a state or other jurisdiction of the United
States, and may not be otherwise required to prepare financial
statements in accordance with U.S. GAAP.\110\
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\109\ Id.; Proposed Regulation 23.105(d)(2) and (e)(3).
\110\ Id.
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Commenters generally supported the Commission approach of
permitting non-U.S. SDs and MSPs to use IFRS in lieu of U.S. GAAP in
the preparation of required financial statements. Commenters, however,
requested that the Proposal be modified to permit U.S.-based SDs that
are subsidiaries of non-U.S. parent entities to prepare required
financial statements in accordance with IFRS.\111\ These commenters
stated that U.S. SDs that are subsidiaries of foreign-based holding
companies may prepare their financial statements in accordance with
IFRS as the subsidiary is consolidated with the parent in producing the
parent's consolidated financial statements, and further stated that
requiring U.S. GAAP financial statements in such situations would
impose unnecessary costs on SDs without providing substantial
enhancements to the regulatory objectives.\112\
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\111\ See e.g., Shell 5/15/17 Letter; BPE 5/15/17 Letter.
\112\ Id.
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As stated in the 2016 Capital Proposal, the Commission recognized
that several SDs or MSPs domiciled outside the U.S. may not use U.S.
GAAP as their native accounting principles and that requiring these
registrants to maintain two separate accounting records and systems to
satisfy two separate financial reporting requirements would involve
substantial expense and burden.\113\ The Commission also does not want
to burden or create an unfair advantage to U.S. domiciled SDs or MSPs
that do not otherwise prepare financial statements in accordance with
U.S. generally accepted accounting principles.
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\113\ See 2016 Capital Proposal, 81 FR at 91275.
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11-a. The Commission requests comment as to whether the 2016
Capital Proposal should be modified to permit U.S. domiciled SDs or
MSPs that are subsidiaries of foreign parent entities or holding
companies to submit required unaudited or audited financial statements
prepared in accordance with IFRS in lieu of U.S. GAAP. If so, should
the modification be limited to U.S. SDs that are consolidated into
foreign entities that are predominantly engaged in non-financial
activities?
11-b. The Commission further requests comment regarding material
differences between IFRS and U.S. GAAP, and how such differences may
impact the financial condition of the SDs or MSPs?
12. Certified Financial Statements of Certain Non-Bank SDs
The 2016 Capital Proposal would require in proposed Regulation
23.105(e)(5) that an SD or an MSP subject to the Commission's capital
rules file an annual audited financial report as of the close of its
fiscal year no later than sixty days after the close of the SDs or MSPs
fiscal year-end. Several commenters expressed concern that the sixty
day timeline was not practical for many large non-financial companies
as they are typically permitted to provide audited financial statements
within ninety days of the end of the year.\114\ In 2016 Capital
Proposal the Commission noted that the sixty day financial reporting
timeline is consistent with the timeline required by both the SEC and
that currently required of FCMs. Further, timely financial reporting
ensures that the Commission and its oversight functions can assess
equally across all firms compliance with its capital rule, as well as,
promote a culture of compliance at the firm and with its auditor that
is at least as stringent as other similarly situated registrants.
However, the Commission recognizes that not all SDs may be subjected to
the same operational burdens and is cognizant that imposing an
accelerated reporting cycle on certain SDs may unnecessarily increase
costs of compliance without much added benefit.
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\114\ See e.g., Shell 5/15/17 Letter; Cargill 5/15/17 Letter.
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12-a. The Commission requests comment as to whether the 2016
Capital Proposal should be modified to recognize an exception to the
proposed requirement for SDs to file annual audited financial report
with the Commission within sixty-days of the SD's year-end date.
12-b. Should the Commission modify the requirement to permit a
ninety-day period for SDs or MSPs that are not predominantly engaged in
financial activities or that consolidate into parent entities that are
not predominantly engaged in financial activities?
12-c. Are there other alternatives of how the Commission should
define SDs that would be eligible to file annual audited financial
statements within ninety days of the SDs' year-end dates?
12-d. How much additional cost will a SD save if they are permitted
to file their audited financial statements within a ninety day period
as opposed to a sixty day period?
13. Public Disclosures
Proposed Regulation 23.105(i)(3) and 23.105(p)(7)(ii) would require
that certain financial information be publically posted to the SD's or
MSP's website within ten business days after the SD or MSP is required
to file the financial information with the Commission. Several non-bank
SDs that are subsidiaries of public companies requested that the
posting period on firm's website be extended from ten days to twenty
days for the quarterly information, noting that additional timeframe
would be necessary to allow for internal and external auditors to
review the information.\115\ One commenter stated that public
disclosure of financial reports will be onerous for commercial SDs,
while others requested elimination of public disclosures by
prudentially regulated SDs.\116\
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\115\ See Shell 5/15/17 Letter; Letter from National Corn
Growers Association and National Gas Supply Association, (May 15,
2017); and Letter from David McIndoe, Commercial Energy Working
Group (May 15, 2017).
\116\ See Shell 5/15/17 Letter; SIFMA 5/15/17 Letter; MS 5/15/17
Letter.
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The Commission noted in the 2016 Capital Proposal that its approach
was consistent with the financial reporting information the Commission
had previously determined should not qualify as exempt from the Freedom
of Information Act for FCMs. For the bank
[[Page 69680]]
SDs, the Commission noted the Proposal was consistent with publicly
available information provided by bank entities in call reports.\117\
The Commission also noted that the SEC requires similar public posting
of financial information pursuant to Regulation 17 CFR 240.18a-7(b)(1)
and (2).\118\ The Commission continues to agree that public disclosure
of basic financial information is in the public's best interest, but
wishes to ensure that manner in which disclosure is accomplished does
not create an unnecessary burden on similarly situated or dual-
registered registrants.
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\117\ See 2016 Capital Proposal, 81 FR at 91277.
\118\ SEC Rule 18a-7(b)(1) (17 CFR 240.18a-7(b)(1)) requires
that every SBSD for which there is no prudential regulator to post
annual financial information 10 days after firm is required to file
with the SEC. SEC Rule 18a-7(b)(2) (17 CFR 240.18a-7(b)(2)) requires
bi-annual unaudited financial information to be posted 30 calendar
days within the date of the statements.
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13-a. The Commission requests comment on modifying the Proposal by
aligning the public disclosure requirements for SDs that are not
affiliated with banks with that required by SEC for stand-alone SBSDs
which would replace the quarterly public disclosure of financial
information requirement with a bi-annual requirement? This modification
would include change of the unaudited financial report posting
requirement on the firm's website from ten business days as proposed to
thirty calendar days following the date of the statements, while the
annual audited requirement would be required to be posted ten days
following the date they are filed. The Commission invites comment as to
whether these changes are practicable, especially for those swap
dealers which are not otherwise required to publicly disclose financial
information currently, and whether the modifications would continue to
provide the public with meaningful information on a timely basis?
13-b. The Commission requests comment on whether it would be
appropriate to remove the proposed requirement that bank SDs (SDs
subject to the capital requirements of a prudential regulator) be
publicly posted on their website under the rationale that this
information is already provided to the public on a timely basis as a
result of separate disclosure requirements imposed by the prudential
regulators? \119\
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\119\ See, generally 12 CFR 3.61-63.
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14. Technical Amendments Addressing Harmonization
Several commenters noted the importance with harmonizing the
Commission's financial reporting and notification requirements with
requirements of other regulators, namely the SEC and the prudential
regulators. The Commission agrees on this general principle. Since the
2016 Capital Proposal, the SEC has finalized its recordkeeping,
notification and reporting rule for SBSDs, which includes several
detailed forms and accompanying instructions.\120\ However, the
Commission in the 2016 Capital Proposal did not propose specific forms
for the monthly and annual financial reporting requirements, aside from
the specific schedules found in Appendices A and B to proposed
Regulation 23.105. Further, under proposed Regulation 23.105(d)(3) all
dual registered SD and SBSDs are permitted to file SEC forms in lieu of
the Commission's financial reporting requirements.
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\120\ See Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and
Broker-Dealers, publication in the Federal Register forthcoming. A
prepublication version of the document can be found at https://www.sec.gov/rules/final/2019/34-87005.pdf.
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The Commission continues to believe that proposing a detailed form
at this time is premature given the diversity of registrants under the
Commission's jurisdiction and the several ways in which capital
compliance can be achieved under the Commission's proposed approach.
Nonetheless, a commenter noted that the proposed appendices did not
contain accompanying form instructions, despite having defined terms in
both the column headings and rows.\121\ The 2016 Capital Proposal noted
that the Appendices are based on identical information found in SEC
forms now finalized in FOCUS Report Part II Schedules 1-4 of FORM X-
17A-5, and FOCUS Report Part IIC of FORM X-17A-5.\122\
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\121\ See SIFMA 5/15/17 Letter.
\122\ See Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and
Broker-Dealers, publication in the Federal Register forthcoming. A
prepublication version of the document can be found at https://www.sec.gov/rules/final/2019/34-87005.pdf.
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14-a. Accordingly, the Commission is considering including the
following explanatory footnote in the appendices to Regulation 23.105
which will incorporate by reference the form instructions published by
the SEC and invites comment as to whether this approach and language
will be sufficient. The footnote would state that the information
required to be reported within this form is intended to be identical to
that required to be reported by Security Based Swap Dealers and
Security Based Major Swap Participants under SEC FORM X-17A-5 FOCUS
Report Part II. Please refer to FOCUS REPORT PART II INSTRUCTIONS and
related interpretations published by the SEC in the preparation of this
form.
In addition, the Commission requests comment on the following
technical amendments to the financial statement forms and rules to
ensure that harmonization is better achieved in financial reporting:
14-b. References to FORM SBS in Rule 23.105(d)(3) would be replaced
with FORM X-17A-5 Focus Report Part II.
14-c. Regulation 23.105(p)(2) would be revised to require that SDs
or MSPs that are the subject to the capital requirements of a
prudential regulator would be required to file Appendix B to the
Commission within thirty calendar days after the end of each calendar
quarter.
14-d. Appendix A Schedule 1 column headings will be revised to
include the words LONG/BOUGHT and SHORT/SOLD.
14-e. Appendix A Schedule 1 rows will be reorganized and renamed to
require the identical information as found on FOCUS report Part II
Schedule 1 of SEC FORM X-17A-5.
14-f. Appendix A Schedule 2, 3, and 4 column heading Total Exposure
will be revised to state Current Net and Potential Exposure.
14-g. Appendix B column headings and rows will be revised to
include identical information in the SEC FORM X-17A-5 FOCUS Report Part
IIC and include the Cover Page included therein.
D. Additional Requests for Comment
15. SEC's Alternative Compliance Mechanism
SEC Rule 18a-10 (17 CFR 240.18a-10) provides an alternative
compliance mechanism pursuant to which a dual registered SD and SBSD
may elect to comply with the capital, margin, and segregation
requirements of the CEA and the Commission's rules in lieu of complying
with applicable SEC rules. In order to qualify for alternative CFTC
compliance, the SD/SBSD must be predominantly engaged in swaps business
and may not be registered as a BD or and OTC Derivatives Dealer with
the SEC.\123\
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\123\ In order to qualify, the aggregate gross notional amount
of the SD/SBSD's SBS positions must not exceed the lesser of a
maximum fixed dollar amount or 10% of the combined aggregate gross
notional amount of the firm's SBS and swap positions. The maximum
fixed-dollar amount is set at a transitional level of $250 billion
for the first 3 years after the compliance date of the rule and then
drops to $50 billion thereafter unless the SEC issues an order.
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[[Page 69681]]
15-a. What, if any, revisions need to be made to the Commission's
regulations or requirements in order to accommodate SD/SBSDs electing
to use the SEC's alternative compliance mechanism?
16. Commercial End Users--Margin Collateral To Offset Credit Risk
Charges
Should SDs recognize alternative forms of collateral (e.g., letters
of credit or liens) provided by commercial end users that are exempt
from clearing and from the uncleared margin requirements in computing
the SDs' counterparty credit risk charges for uncleared swap
transactions? \124\ Please provide comments with respect to SDs that
are approved to use internal credit risk models and SDs not approved to
use internal credit risk models. What would be the impact on the
liquidity, efficiency, and vibrancy of the swap markets, particularly
the commodity swaps markets, if alternative forms of collateral were
taken into account in computing credit risk charges?
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\124\ In the prudential regulators' recently adopted rule on the
standardized approach for calculating the exposure amount of
derivatives contracts (``SA-CCR''), the prudential regulators
removed the alpha factor for derivative transactions with commercial
end users.
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17. Compliance Date of the Regulations
In response to the 2016 Capital Proposal, commenters expressed a
general need for an appropriate period of time between the effective
date and the compliance date for any final rules to operationally and
legally prepare to implement capital and financial reporting regimes.
This included an appropriate amount of time for both the Commission and
NFA to review and approve the capital models of individual SDs, and for
the Commission to conduct and issue comparability determinations for
SDs domiciled in foreign jurisdictions. Commenters also raised concerns
regarding the implementation of final rules prior to the effective date
of the final phase-in of the uncleared margin requirements.
The Commission invites comments on an appropriate compliance
schedule for the final capital and financial reporting requirements.
Comments are particularly necessary now as the SEC issued its final
SBSD capital, margin, segregation and financial reporting rules since
the Commission's 2016 Capital Proposal.
18. Economic Implications
Regulatory capital is designed to ensure that a firm will have
enough capital, in times of financial stress, to cover the risk
inherent of the activities in the firm. Regulatory capital's framework
can be designed differently, but its primary purpose remains the same--
to meet this objective. Although a firm may mitigate its risks through
other methods, including risk management techniques (e.g., netting,
credit limits, margin), capital is viewed as the last line of defense
of an entity, ensuring its viability in times of financial stress. In
designing SD's capital requirement, the Commission is cognizant of the
purpose of capital and the potential trade-off between the costs of
requiring additional capital and the Commission's statutory mandate of
helping to ensure the safety and soundness of SDs thereby promoting the
stability of the U.S. financial system.
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its discretionary actions before promulgating a
regulation under the CEA or issuing certain orders. 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 swaps markets; (3) price discovery; (4)
sound risk management practices; and (5) other public interest
considerations.
The Commission requests comments and data on how the baseline of
the economic analyses has changed since the publication of the 2016
Capital Proposal. The swap market activity has experienced significant
changes, in part due to the fact that participants in this market are
now subject to various new rules. The Commission requests comments and
data on how the baseline of the economic analyses has changed since the
publication of the 2016 Capital Proposal. The swap market activity has
experienced significant changes in the past three years and the
Commission requests comments on how those changes in the baseline would
impact the potential benefits and costs of capital requirements
The Commission requests comments and data on how potential
alternatives set out above in response to questions would impact the
potential costs and benefits of capital and reporting requirements with
respect of the section 15(a) factors:
18-a. Protection of market participants and the public:
i. How much additional capital, if any, might be required for the
SD and/or the system relative to current levels? How much capital to
cover credit risk?
ii. How much capital would be required to cover market risk?
iii. How much capital would need to be required to safeguard
against model risk, operational risk, and etc.?
iv. How would SDs source funds for these capital charges?
v. What might be the cost of raising additional capital for an SD
and the combined cost for all the SDs?
vi. What sorts of costs do SDs expect to incur as a result of
capital requirements and how should the costs of SDs exiting certain
business lines as a result of holding more capital in reserve be
factored into the cost benefit consideration?
vii. What business lines would SDs not participate in, if any?
viii. What would happen to liquidity provision? Would smaller
clients and end users not be serviced in swaps market?
ix. What might be the cost of meeting reporting requirements for an
SD and the combined cost for all the SDs?
x. How and to what extent might such requirements help protect
market participants and the public?
18-b. Efficiency, competitiveness, and financial integrity of swaps
markets:
i. How might such requirements affect SD's competitiveness in swap
market?
ii. For each SD, how much capital might be required for the net
liquid asset approach, relative to the recently finalized SEC
requirements?
iii. How much capital might be required for the bank-based
approach, relative to the current banking capital requirement, as
Prudential Regulators continue to revise their capital requirements?
iv. How much capital might be required, relative to substituted
compliance from foreign jurisdictions?
v. How might such requirements affect SD's liquidity provision in
swap market?
vi. How might such requirements affect SD's ability to serve end
users in various segments of swaps markets?
18-c. Price discovery:
i. How might such requirements affect price discovery in the swaps
markets?
18-d. Sound risk management practices:
i. What are SD's current risk management practices for dealing with
losses stemming from the market risk, credit risk, and operational
risk?
ii. In the event that losses from trading activities exceed the
available resource, how are excess losses dealt with?
[[Page 69682]]
iii. How might such requirements affect these risk management
practices?
18-e. Other public interest considerations.
i. Are there other public interest considerations that the
Commission should consider? Please explain.
Issued in Washington, DC, on December 12, 2019, by the
Commission.
Robert Sidman,
Deputy Secretary of the Commission.
Note: The following appendicies will not appear in the Code of
Federal Regulations.
Appendicies to Capital Requirements of Swap Dealers and Major Swap
Participants--Commission Voting Summary and Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz and
Stump voted in the affirmative. Commissioners Behnam and Berkovitz
voted in the negative.
Appendix 2--Supporting Statement of Commissioner Brian Quintenz
I have long said that finalizing capital requirements for swap
dealers (SDs) and futures commission merchants (FCMs) is perhaps the
most consequential rulemaking of the post-crisis reforms to get
right.
The financial crisis exposed serious vulnerabilities in the
financial system--uncollateralized, opaque, bilateral exposures
which, under the right circumstances could have, and did, cause a
panic and liquidity freeze due to concerns around that counterparty
credit risk. This panic, in my opinion, transformed a significant
recessionary event into the crisis as we know it. Importantly, since
the financial crisis, global regulators and certainly those in the
U.S. have implemented many policy reforms, like central clearing
requirements and margin for uncleared swaps, designed to bring
transparency to those exposures.
I have long lamented prior regulators' implementation of the
important swaps market regulatory reforms by viewing them in
isolation of each other--calibrating each to try to think it alone
could have prevented the crisis. In fact, the elegance of the
reforms is that they work together and build upon each other.
Therefore, in my view, it is wrong to think of capital in terms
of what levels should have existed during the financial crisis that
could have prevented it. Very few capital regimes could have
provided the market with enough certainty, given the size, nature,
and opacity of these exposures, to remove the possibility of the
panic, and the capital levels which could have done so would have
rendered the entire swaps market obsolete and uneconomic. Therefore,
regulatory capital regimes implemented to respond to the last crisis
need to respect the increased transparency and certainty which other
reforms have already brought to the market. I believe we are asking
the right questions in this reopening to respect that progress in
calibrating our own capital regime appropriately.
The final pillar of our Dodd-Frank Act reforms, capital ensures
that firms are able to continue to operate during times of economic
and financial stress by providing an adequate cushion to protect
them from losses. Just as important as the safety and soundness of
individual firms, capital is designed to give the marketplace
confidence that any given firm has a high probability of surviving
the next crisis.
Capital requirements also create important incentives that drive
market behavior. The cost of capital may be the most determinative
factor in a firm's decision to remain, or become, a swap dealer, or
to continue to provide clearing services to clients, in the case of
an FCM. If capital costs are too expensive, firms will restrict
certain business activities, end unprofitable business lines, or, in
some cases, exit the swaps or futures markets altogether. As a
result, over time, the swaps and futures markets would become less
liquid, less accessible to end users, more heavily concentrated, and
less competitive. These are not the hallmarks of a healthy financial
system.
Therefore, appropriate capital levels are directly linked to
both the health and vibrancy of the derivatives markets and to the
sustainability of the entire financial system more broadly.
To promote a vibrant derivatives market, I believe it is
critically important that the CFTC finalize a capital rule that is
appropriately calibrated to the true risks posed by an SD's or FCM's
business. I am pleased to support the re-opening and request for
comment before us today. This document solicits comment on the key
issues the Commission must get right in the final rule to ensure
that capital requirements are appropriate and commensurate to a
firm's risk. I appreciate that market participants have commented on
two prior capital proposals and the Commission will continue to
consider all past comments in moving forward with a final rule.
Nevertheless, I hope commenters use this opportunity to provide the
Commission with much needed data and quantitative analysis
demonstrating the impact that various choices contemplated in this
proposal would have on a firm's minimum capital level--and, by
extension, on that firm's ability to participate in the market and
adequately service clients. Data will be vital to the Commission's
ability to evaluate various capital alternatives and identify those
alternatives that would render certain business lines or activities
uneconomic. It will also be vital to the Commission's assessment
that the capital requirements established ensure the safety and
soundness of the firm. I welcome comments on all aspects of the
reopening, but there are a few areas I am particularly interested in
hearing from commenters.
The eight percent risk margin amount. We heard from many
commenters that, of all the alternatives, the eight percent risk
margin amount would act not as a capital floor as intended, but
rather as the primary driver of firms' capital requirements and as a
potential binding constraint on their businesses. Whereas FCMs are
currently required to include in their minimum capital requirement
eight percent of the margin required for their futures and cleared
swaps customer positions, the 2016 proposal expanded the eight
percent risk margin amount to include proprietary futures, swaps and
security-based swap (SBS) positions for FCMs and for SDs electing
the net liquid asset capital approach. In addition to these
proprietary positions being included in the risk margin amount,
these FCMs and SDs would also be subject to capital charges on these
proprietary positions. I hope commenters can provide us with data
showing the capital costs of including proprietary positions, for
the first time, in an FCM's risk margin amount. To the extent
possible, it also would be helpful to see how different risk margin
percentages, or a different scope of products included in the margin
amount, impacts the minimum capital requirements for an actual or
hypothetical portfolio of positions. I would also be interested to
hear from commenters about whether it makes sense to remove the risk
margin amount altogether for standalone SDs electing the net liquid
asset approach or bank-based approach, given the other minimum
capital level requirements in the proposal.
Model approval process. The Commission must have a workable
model approval process. I am interested to hear commenters' views on
how the Commission or NFA should review or accept capital models
that have already been approved by another regulator. Should such
models be granted automatic or temporary approval, while the
Commission or NFA conducts its own review?
In closing, I have often worried that the accepted mantra on
regulatory capital requirements has become ``the higher, the
better.'' Respectfully, I disagree. There is a direct tradeoff
between the amount of capital regulators require firms to hold to
ensure firms' resilience and viability, and the amount of available
capital firms have to deploy in financial markets to support the
market's ongoing liquidity and health. There is a balance necessary
between capital levels that protect firms from losses on certain
products, and capital levels that allow firms an economic benefit in
servicing their customers' risk management needs through those
products. I hope the feedback we receive from commenters on this
reopening helps the Commission establish appropriate capital
requirements that are commensurate to a firm's risk and not
detrimental to its clients. I would also like to thank the staff of
the Division of Swap Dealer and Intermediary Oversight for answering
my questions and incorporating many of my comments into this
document.
Appendix 3--Dissenting Statement of Commissioner Rostin Behnam
I respectfully dissent from the Commodity Futures Trading
Commission's (the ``Commission'' or ``CFTC'') decision today to
reopen the comment period and request additional comment on proposed
regulations and amendments to implement section 731 of
[[Page 69683]]
the Wall Street Reform and Consumer Protection Act,\1\ which
requires the CFTC to establish capital rules for all registered swap
dealers (``SDs'') and major swap participants (``MSPs'') that are
not banks, including nonbank subsidiaries of bank holding companies,
as well as associated financial recordkeeping and reporting
requirements (the ``Reopening''). While I would have been
comfortable supporting the Reopening as a matter of moving this
critical Dodd-Frank Act rule forward to finalization, to the extent
it introduces supplementary avenues for future rulemaking such as a
leverage ratio requirement, it is a deception. Impulsively inviting
comment on matters tangential to the 2016 Capital Proposal,\2\ but
perhaps relevant to determining appropriate capital standards and
methodologies, as opposed to a thoughtful re-proposal sacrifices
discipline for expediency, and runs afoul of proper process for
notice and comment. I will not be complicit in supporting Commission
action that I believe could invite backdoor rationalization when
finalization is before us. The public deserves--and our integrity
demands--that we play by the rules.
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\1\ See The Dodd-Frank Wall Street Reform and Consumer
Protection Act, Public Law 111-203 section 731(e), 124 Stat. 1376,
1704-6 (2010) (the ``Dodd-Frank Act'').
\2\ Capital Requirements of Swap Dealers and Major Swap
Participants, 81 FR 91252 (proposed Dec. 16, 2016).
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Today's action is a reopening of the comment period and a
request for comment, rather than a true proposal, and thus the 2016
Capital Proposal remains the only concrete indicator to the public
of the Commission's intentions. If the 2016 Capital Proposal is an
extreme overshoot, the appropriate way to provide the public with an
opportunity to comment is to issue a reproposal. Asking further
questions, without a clear signal as to where the Commission is
going, at the minimum risks further slowing this nearly ten-year
effort to finalize a capital rule by adding an unnecessary step to
the process in the form of a reproposal at some time in the future;
and at the worst, incites the agency towards an exercise in creative
reasoning outside the bounds of process.
Too often over the last couple of years, I believe this agency
has slowed its own progress by snaking outside clear Administrative
Procedure Act (``APA'') trajectories and adding unnecessary steps to
the rulemaking process. In part, I fear that we are doing the same
thing today. The competing threads throughout the Reopening make it
harder for the public to discern what the Commission is proposing to
do, and will make it more difficult to effectively comment on the
existing proposal from 2016. This creates undue risk under the APA,
and arguably poisons the well in regard to the reachable goals of
this new request for comment.
To reiterate sentiments made in my first speech as a CFTC
Commissioner,\3\ capital is a cornerstone financial crisis reform
\4\ that is critical to protecting our financial institutions and
our financial system as a whole, specifically from systemic risk and
contagion, but also from unintended consequences if capital (and
margin) levels are applied and set without due regard to the
uniqueness of our financial markets and market participants. I
appreciate that in moving forward, we must heed our directive to
establish capital standards appropriately and in due consideration
of other activities engaged in by SDs and MSPs such that we ensure
that we do not penalize commercial end-users who need choices and
benefit from competition in our markets.
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\3\ See Rostin Behnam, The Dodd-Frank Inflection Point: Building
on Derivatives Reform, Remarks of CFTC Commissioner Rostin Behnam at
the Georgetown Center for Financial Markets and Policy (Nov. 14,
2017), https://www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam.
\4\ G20, Leaders' Statement, Framework for Strong, Sustainable
and Balanced Growth, The Pittsburgh Summit (September 24-25 2009),
http://www.g20.utoronto.ca/2009/2009communique0925.html (``We
committed to act together to raise capital standards . . .'').
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The Reopening's overarching premise is that the chosen response
to certain uncertainties at the time of the Commission's prior
proposals \5\ resulted in recommending standards that, in
application, could in no way be justified as appropriate to offset
the greater risk to SDs, MSPs, and the financial system,\6\ such
that the only solution for the potentially extreme overshoot is to
dial it back. With the passage of time comes a nagging amnesia to
the pain that the financial crisis brought on American households
and the global economy. We cannot forget that undercapitalization
was at the heart of the crisis.
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\5\ See Capital Requirements of Swap Dealers and Major Swap
Participants, 76 FR 27802 (proposed May 12, 2011); 2016 Capital
Proposal.
\6\ See Id. at section 731(e)(2)(C) and (e)(3)(A)(ii); 7 U.S.C.
6s(e)(2)(C) and (e)(3)(A)(ii).
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The overall changes to the derivatives market over the last
several years, the Commission's adoption and implementation of
margin rules for uncleared swaps and growing knowledge and
experience with SDs, and recent movement by the Securities and
Exchange Commission in finalizing capital, margin, and segregation
requirements as well as financial reporting requirements for
security-based swap dealers and major security-based swap
participants,\7\ provide a reasonable basis for affording the public
an opportunity to reevaluate the 2016 Capital Proposal. However, to
the extent the Reopening seeks additional comment on both broader
issues of harmonization and more targeted proposals regarding what
amount of capital is appropriate and what methodology is used, its
focus on solidifying a data-driven approach should send a strong
signal that the Commission must justify its final determinations
with respect to capital standards.
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\7\ See Capital, Margin, and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital and Segregation Requirements for Broker-
Dealers, 84 FR 43872 (Aug. 22, 2019); Recordkeeping and Reporting
Requirements for Security-Based Swap Dealers, Major Security-Based
Swap Participants, and Broker-Dealers, SEC Release No. 34-87005
(Sept. 19, 2019), available at https://www.sec.gov/rules/final/2019/34-87005.pdf.
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To reiterate, I would have liked to support today's Commission
action. To the extent it would move us toward a final rule on a
matter that is critical to the safety and resiliency of our markets,
the supplemental concepts for consideration and overarching premise
that we overshot the mark badly in the 2016 Capital Proposal raise
concerns. If the 2016 Capital Proposal is an extreme overshoot, and
if there are alternative methodologies and concepts to consider
because of new market data, the appropriate way to provide the
public with an opportunity to comment is to issue a reproposal.
While I would have liked to stand with my fellow Commissioners today
in supporting this first step towards a final capital rule, I cannot
justify it under these circumstances.
Appendix 4--Dissenting Statement of Commissioner Dan M. Berkovitz
I dissent from the document that is called a ``Proposed Rule''
on the Capital Requirements of Swap Dealers and Major Swap
Participants (the ``Document''). My objections are both procedural
and substantive. Procedurally, the Document asks many open ended
questions, is vague about what is being proposed, and lacks
sufficient supporting data to serve as the basis for a final rule
under the Administrative Procedure Act (``APA'').\1\ The Document as
structured is not a proposal that can lead to a final rule; rather
it appears to be more in the nature of an advance notice of proposed
rulemaking.
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\1\ It is ironic that on the very day this ``proposal'' is voted
on, the Commission is also adopting an amendment to Part 13 that
expressly confirms the APA as the procedures by which the Commission
will propose and adopt its regulations.
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Substantively, I dissent because the Document encourages mostly
changes that only weaken what the Commission had previously
proposed. The path forward suggested by the proposed changes would
undermine the statutory purpose of requiring swap dealers to retain
an appropriate minimum level of capital to serve as a buffer of last
resort after all other sources of credit support (e.g., initial and
variation margin) have been exhausted.
The Document Is Not a Proposal That Can Lead to a Final Rule
The Document asks over 140 questions regarding capital
requirements that the Commission proposed in 2011 and again in 2016.
We received numerous public comments on both prior proposals. The
Document briefly discusses these comments, most of which were
critical of the proposals, and then asks open-ended questions about
various alternatives to the initial proposals. The discussion of the
rationale behind the general alternatives posed in the questions is
often superficial.
For the most part, the Document does not propose any new rule
text or amendments to previously proposed rule text, but rather
summarizes comments and asks for further comments, data, and
analysis to support suggested alternatives to the previously
proposed regulations. In many cases, a wide range of alternatives
are suggested, such as capital levels ranging from 0 to 8% of risk
[[Page 69684]]
margin. In a number of places, the Document asks commenters to
propose new rule text for the Commission. The Document states
``[t]he Commission notes that comments are of the greatest
assistance to rulemaking initiatives when accompanied by supporting
data and analysis, and, if appropriate, accompanied by alternative
approaches and suggested rule text language.'' \2\ As an
illustrative example, the Document asks commenters to, ``Please
provide data and analysis in support of any suggested modified
percentage of the risk margin amount.'' \3\
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\2\ Document, introductory paragraph to section II.
\3\ Document, question 1-b.
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To the extent that some commenters provide significant new
information or data that the Commission intends to rely upon in
formulating or justifying a final rule, the public must be afforded
notice of and an opportunity to comment on the new information.
Under the APA it is not permissible for an agency to ask a wide
range of questions about potential approaches, and then proceed to
promulgate a final rule supported by new reasons and data sourced
from the comments received. Data that is relied on by an agency to
support its final rule and that is not merely supplemental or
confirming data must be subjected to the notice and comment
process.\4\
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\4\ See Idaho Farm Bureau Fed'n v. Babbitt, 58 F.3d 1392, 1402-
03 (9th Cir. 1995).
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Under the APA, an agency has a ``duty to identify and make
available technical studies and data that it has employed in
reaching the decisions to propose particular rules. . . . An agency
commits serious procedural error when it fails to reveal portions of
the technical basis for a proposed rule in time to allow meaningful
commentary.'' \5\
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\5\ Owner-Operator Indep. Drivers Assoc. v. Fed. Motor Carrier
Safety Admin., 494 F.3d 188, 199 (D.C. Cir. 2007) (quoting Solite
Corp. v. EPA, 952 F.2d 473, 484 (D.C. Cir 1991) and Conn. Light &
Power Co. v. NRC, 673 F.2d 525, 530-31 (D.C. Cir. 1982).
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I have stated many times that when practical, the Commission
should be guided by objective data in writing regulations. An
excellent example is our rule setting the minimum swap dealer
registration threshold at $8 billion. The CFTC staff undertook an
exhaustive, objective data analysis that, when completed, showed
that the $8 billion level captured the vast majority of swap dealing
activity. I voted for the rule based on that analysis. However, we
cannot rely on data submitted by commenters in the final rule
without first allowing the public to comment on that data.
A Weaker Capital Rule Is the Purpose
After reading the 140-plus questions in the Document, it is
clear that the Commission is headed in the wrong direction. The
Document does not pursue the goal stated by Congress for the capital
requirements to help assure the safety and soundness of the swap
dealers.\6\ In virtually every instance, the questions and
accompanying discussion seek alternatives that would reduce the
level of capital required or create greater flexibility for the swap
dealers to comply.\7\ The Document reads like an extensive diner
menu offering up every type of rule reduction that a hungry swap
dealer might desire.
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\6\ See 7 U.S.C. 6s(e)(3)(A).
\7\ In some instances, the questions are premised on the desire
to harmonize with the provisions of the SEC's securities-based swap
dealer capital rules. However, the SEC's final rules were often
premised on comments received on the CFTC's earlier capital rule
proposals and result in reduced requirements, as discussed later in
my statement.
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Let's consider two significant examples. Under one approach
proposed in the prior proposals, a swap dealer would be required to
hold capital equal to or exceeding 8% of uncleared swap margin and
initial margin for certain swaps and futures positions of the swap
dealer. As explained in the Document, the 8% level is drawn from the
Commission's experience with its risk-based capital requirements for
futures commission merchants.\8\
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\8\ See 17 CFR 1.17(a)(1)(i)(B).
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Based on comments received on the prior proposals, and in an
effort to harmonize with the SEC, the Document now proposes dropping
that level to 2% (or 4% or perhaps another level that a commenter
may propose) and allowing swap dealers to ``exclude any particular
asset classes or positions from the computation of risk margin
amount.'' No data is offered in the Document to explain why 2% would
be a sufficient level. Maybe 8% is not the right number, but how
does 2% in a formula that potentially excludes more asset classes or
swap positions from the calculation even enter the realm of
possibility when FCMs are held to much higher levels? The Document
provides no clear rationale related to the statutory purpose of the
rule. The rationale in the Document boils down to saying 2% would
harmonize our rule with the SEC's security-based swap dealer capital
rule. But the security-based swap market is very small and
relatively narrow in scope. The Document includes virtually no
analysis of whether a 2% level makes sense in the much larger,
complex, and varied swap market. An individual swap dealer may
maintain a portfolio of hundreds of different swap products with a
notional amount in excess of a trillion dollars with thousands of
counterparties. The dealer may make over a million trades a year.
Asking generic questions about the differences in these two markets
is helpful. However, it is apparent that any significant new data or
analysis provided by commenters in response to this Document that
the Commission uses to support the final rule will need to be
presented to the public for consideration and comment.
As a further example, the Document asks questions about
permitting expanded use of netting of offsetting positions when
calculating the exposures against which minimum capital must be
held. Netting of offsetting positions is an important function for
intermediaries like swap dealers for day-to-day cash flow,
liquidity, and risk management. In some respects, netting is the
basis on which certain types of intermediaries build their business
by dealing derivatives to different parties that want or need long
positions when other parties need or want corresponding short
positions.
However, when it comes to minimum capital requirements, which
are intended to serve as a source of funding of last resort at all
times, we must be very careful when proposing netting offsets.
Should a large swap dealer with a complex dealing book only be
required to hold some minimum amount of collateral simply because it
is able to net out its book? That would not appear to serve the
statutory purpose for a minimum capital requirement of helping to
assure the safety and soundness of the swap dealer.\9\ While I am
not suggesting that netting should play no role in the capital
requirement calculations, my concern is that the Document provides
little in the way of data, analysis, or rationale as to how the
netting provisions discussed, which could net significant portions
of the requirement down to nothing, would serve the intended
purpose. That is a concerning approach to take for a capital
requirement and it is difficult to see how a final rule could be
built on such questions in the Document.
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\9\ See 7 U.S.C. 6s(e)(3)(A).
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Harmonization and Cost Reduction Alone Are Not Valid Policy Goals
In the Document, the costs of compliance and harmonization with
the SEC's capital rule are repeatedly mentioned as reasons for
various possible changes. Compliance cost reduction and rule
harmonization, when feasible without undermining the policy goals of
the regulations, are certainly important considerations in writing
regulations. However, as I have stated in other contexts, these are
secondary considerations and should not supplant achieving the
policy goals stated by Congress in the Commodity Exchange Act. While
the Document acknowledges that safety and soundness of each swap
dealer is the stated purpose of the capital rule, and asks generic
questions about the impact on swap dealer safety and soundness, that
purpose is not mentioned as the reason for any of the proposed
changes to the capital requirements. This odd omission belies the
purported goals of the Document.
The Document also exposes the one-sided nature of the
``harmonization'' rationale. In several instances it relies almost
completely on harmonizing the CFTC regulation with the comparable
SEC regulation. In each of those instances, the result is always a
weaker regulatory requirement. And yet in a other instances,\10\ the
Document acknowledges that a change to the existing capital rule
proposals would conflict with the SEC's rules, but then goes on to
support implementing a different rule. It seems that harmonization
is used as a rationale for action only when it is convenient for
reducing regulation and therefore obfuscates the real reason for the
action.
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\10\ See, e.g., Document, sections II.A.5 and 10.
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Conclusion
For the reasons stated above, I dissent.
Notwithstanding my dissent, I want to acknowledge the hard work
of the staff in trying to address my many questions and comments in
the limited time we had to consider the Document. Capital
requirements
[[Page 69685]]
are one of the most complex and highly technical areas in our
regulations. We had a little less than a month to review the
Document, which was not enough time given the heavy schedule
currently set for the Commission and the complexity and history
behind the Document and the two prior capital rule proposals.
Notwithstanding this short time frame, I appreciate the staff's
efforts to incorporate a number of my requested changes and address
several complicated issues.
[FR Doc. 2019-27116 Filed 12-18-19; 8:45 am]
BILLING CODE 6351-01-P