June 25, 2020

Prudential Regulators Adopt Swap Margin Amendments

Nihal Patel Commentary by Nihal Patel

The FDIC adopted a series of amendments to its swap margin rules, including for LIBOR transition, inter-affiliate initial margin, and to extend compliance dates.

In an accompanying memorandum, the FDIC states that the rules are being adopted jointly with other "prudential regulators" (i.e., the OCC, the Fed, the Financial Conduct Authority and the Federal Housing Financial Authority). The other regulators have yet to vote.

The rulemaking consists of two formal actions: (1) a final rule adopting a series of amendments to swap margin rules and (2) an interim final rule adopting a delay in the compliance dates for initial margin requirements.

Final Rules. The final rule includes a number of substantive amendments to the margin rules. (A summary of the proposal is available here.)

  • IBOR Transition. The rule provides relief in order to permit amendments to IBOR-related provisions (and "necessary follow-on amendments") without a swap losing its "legacy" status and becoming subject to margin requirements.

  • Inter-Affiliate Margin. The final rule adopts an exclusion from initial margin requirements for inter-affiliate transactions, subject to (1) a limitation on the aggregate amount that can be recognized as exempted at 15% of the swap dealer's tier 1 capital; and (2) the swap dealer taking into account the risk posed by the affiliate the swaps entered into with such affiliate.

  • Compliance Dates. Subject to further relief in the interim final rule that was also adopted, the final rule adds a sixth category of compliance phase in for entities between $8 and $50 billion under the notional counting requirements.

  • Pre-Threshold Documentation. The final rule adopts a provision that expressly states that initial margin documentation is not required to be put into place prior to the time that the collection and/or posting of collateral is required.

  • Non-Material Amendments. The final rules adopt an exclusion in order to permit "legacy" transactions to retain that status, notwithstanding amendments made for "logistical or risk management purposes arising from routine industry practices over the life-cycle of the swap."

Interim Final Rule. The interim final rule follows on a recommendation from the Basel Committee on Banking Supervision and IOSCO ("BCBS-IOSCO") (as well as a recent action by the CFTC). As amended by the final rule, initial margin requirements that were scheduled to be phased in on September 1, 2020 (for entities between $50 billion and $750 billion under the notional counting requirements) and September 1, 2021 (for entities between $8 billion and $50 billion), respectively, will be delayed by a year until 2021 and 2022, respectively. The interim final rule is scheduled to be effective 61 days following its publication in the Federal Register, with comments due 60 days following its publication in the Federal Register.

Commentary

The final rule appears to stick to what the prudential regulators proposed last year. (Discussed in much further detail here.) Here are a few points from the adopting release worth highlighting:

  • IBOR Reform:

    • The discussion in the adopting release (p. 10-20) contains some useful examples, but generally the regulators adopted the proposal "as is" with a handful of sensible clarifications.

    • The regulators specifically declined to include basis swaps entered into as part of IBOR transition in the IBOR reform. (p. 12-13)

    • The regulators declined a request by some commenters to change the limitation on extensions of maturity or effective notional, but added language to permit extensions and increases as necessary to accommodate market conventions that may differ between the proposed and replacement rate. (p. 18)

    • The regulators agreed to incorporate certain CFTC relief for end-users (CFTC Letters 19-28 and 19-26 by reference, but reiterated that CFTC letters are not otherwise automatically incorporated by reference into the prudential regulator rules. (p. 20)

  • Inter-Affiliate IM.

    • The discussion suggests commenters were divided between market participants and public interest advocates. The prudential regulators approach appears to contain some lip service to the latter group in the form of the numerical limitation based on tier-1 capital. ("Lip service" in the sense that the agencies note that they have observed that no one is at this level of IM.)

    • However, the new limitation does not apply to non-US entities that do not have a US ultimate parent.

More generally, the adopting release is fairly light on comparing the approach of the prudential regulators to that of the CFTC. In numerous places the prudential regulators' approach differs from the CFTC, with varying degrees of materiality (e.g., IBOR amendments, inter-affiliate IM, non-material amendments, compliance dates). This isn't an ideal way for parallel regulatory schemes to work. If there are to be non-identical terms, the regulators should specifically state the reasons for the distinctions.

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