Banking Agencies Re-Propose Margin and Capital Requirements for Covered Swap Entities
The Board of Governors of the Federal Reserve System, the FDIC, the Office of the Comptroller of the Currency, the Farm Credit Administration and the Federal Housing Finance Authority, (the "Prudential Regulators") voted to establish minimum margin and capital requirements for registered swap dealers, major swap participants, security-based swap dealers and major security-based swap participants for which one of the Prudential Regulators has primary margin authority.
The proposed rules implement Dodd-Frank Sections 731 and 764, which requires the Prudential Regulators to adopt rules jointly to establish capital requirements and initial and variation margin requirements for such entities and their counterparties on all non-cleared swaps and non-cleared security-based swaps. The rules are also intended to be consistent with the margin framework published by G-20 countries under the joint auspices of the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO). The proposal provides for a 60-day comment period and compliance dates that are in line with the BCBS-IOSCO framework.
The Cadwalader memorandum linked below provides a further summary and analysis of the proposal.
Click here for a Cadwalader summary and analysis of the proposal.
See: Text of Proposed Rules; Board Memo Regarding Proposed Rules; FRB Press Release; FDIC Press Release; OCC Press Release. See also: Chair Yellen's Statement; Governor Tarullo's Statement; SIFMA Statement.
Commentary
As anticipated, the re-proposal varies substantially from the earlier 2011 proposal and largely tracks the BCBS-IOSCO recommendations. Although the recommendations, in general, (and the recommendation for two-way initial and variation margin, in particular) are complicated and burdensome for the industry, they reflect a welcome effort at regulatory harmonization. In this regard, it is notable that while the re-proposal and proposed European rules both generally follow BCBS-IOSCO, there are material differences between the proposals. In many cases, the U.S. proposal appears to improve on the European counterpart by eliminating complications (e.g., various conditions on collateral eligibility) that would prove difficult and burdensome to implement. However, the divergence of rules itself imposes significant complexity and the possibility of conflicts that may be difficult to reconcile in cross-border situations. Market participants will need to review these areas of divergence closely.
The re-proposal provides some good news to non-financial end users, who are afforded greater clarity that they will be carved out from margin requirements. Conversely, for financial entities, it lowers the expected threshold for swap notional amounts that will trigger initial margin requirements. Significantly, it also appears to require retroactive application of the new requirements to historical trades if they are maintained under the same default netting agreement as new trades. The regulatory justification for this is unclear at best, and it would appear to have a number of significant negative consequences (not the least of which being that it would reduce the ability to achieve bankruptcy netting).