Economic Consulting Group Conducts Cost-Benefit Analysis of CFTC-Proposed Rule on Margin Requirements for Uncleared Swaps
Commentary by Bob Zwirb
Experts at NERA Economic Consulting issued a quantitative impact study to analyze the potential costs and benefits of the CFTC's proposed rule on initial and variation margin requirements of uncleared swaps for swap dealers and major swap participants.
According to the NERA study:
- the aggregate incremental opportunity costs of the proposed margin requirements in normal markets are substantial, estimated at $411 million per year;
- several aspects of the proposed rule are pro-cyclical and thus will likely increase systemic risks rather than mitigate them, including monthly recalibration of initial margin models with immediate margin requirement increases, limits on the forms of eligible collateral available for margin purposes, and mandatory full, daily posting of variation margin;
- several aspects of the proposed rule place U.S. firms at a disadvantage to foreign competitors, and threaten more than 4,000 derivatives industry job listings in the United States. Such provisions include a Material Swaps Exposure threshold of $3 billion rather than the international standard of $11 billion and limits on variation margin eligible collateral.
The study concludes that the proposed rule may not reduce systemic risks associated with uncleared swaps due to its pro-cyclical provisions. Additionally, the rule imposes substantial costs. According to the study, the rule should be modified in order to eliminate the pro-cyclical aspects that place U.S. firms at a competitive disadvantage. Other provisions should be modified to reduce the total incremental cost of compliance.
See: "Cost-Benefit Analysis of the CFTC"s Proposed Margin Requirements for Uncleared Swaps" by NERA expert Dr. Sharon Brown-Hruska and analyst Trevor Wagener.
Commentary
The CFTC, like the SEC, operates under a statute that requires it, inter alia, to consider the costs and benefits of a proposed rule. The question is, what does that mean? At one end of the spectrum is the interpretation advanced by the CFTC, i.e., that the cost/benefit requirement requires the Commission only to "consider" costs and benefits, not to conduct "a rigorous, quantitative analysis." The agency recently obtained support for this minimalist view from Federal District Court Judge Paul Friedman, who in remanding its cross-border guidance for failing to conduct any cost-benefit analysis did so with a wink and a nod, noting that that the requirement "is not particularly demanding." SIFMA v. CFTC, Civil Action No. 13-1916 (D.D.C., 2014). At the other end of the spectrum is the D.C. Circuit Court of Appeals, which has required the SEC to "determine as best it can the economic implications" of a proposed rule. Chamber of Commerce v. SEC, 412 F.3d 133, 143 (D.C. Cir. 2005).
The analysis of the CFTC's proposed margin rule for uncleared swaps by Dr. Brown-Hruska (a former Commissioner and Acting Chair of the CFTC) and Mr. Wagener is the kind of rigorous economic analysis that the CFTC should not only take seriously, but should strive to conduct on its own. That is especially important here, because the proposed rule, which establishes criteria for determining margin levels and when such margin should be imposed and with whom, does so in a highly prescriptive and complex manner that will make compliance a challenge at best.
Unfortunately, what often passes for cost-benefit analysis at a regulatory agency is a simplistic totaling up of the nominal costs entailed in complying with a rule and a shallow assertion of purported benefits. Meaningful cost-benefit analysis, however, requires much more. At a minimum, it should comprise not only the likely quantitative costs and benefits of a rule, but also the qualitative effects of the rule on the market - both good and bad. That is, it should "determine the likely economic consequences" and "assess the economic effects of a new rule." Business Roundtable v. SEC, 647 F.3d 1144, 1148 (D.C. Cir. 2011). The Supreme Court once said that "no legislation pursues its purposes at all costs." Rodriguez v. United States, 480 U.S. 522, 525-26 (1987). The same principle should also apply to legislative rules. The value of the NERA Brown-Hruska/Wagener study is the light it shines on such costs in the context of an important CFTC rule proposal and the rigorous empirical way it goes about it.