Senator Warren and Representative Cummings Urge SEC and CFTC to Require Two-Way Initial Margin between Affiliates

Setting aside the question of whether the amendments to Section 716 of Dodd-Frank were good policy, it is not clear that imposing strong margin requirements on transactions between non-bank swap entities and their affiliates is a good response to the loss of protection for depository institutions created by those amendments.

(1) Section 716 applies to the swaps activities of insured depository institutions. Insured depository institutions are the one group of swap entities over which the SEC and CFTC do not have the jurisdiction to impose margin requirements. If the SEC and CFTC adopted stronger margin requirements than the prudential regulators did, then such requirements would have a limited impact on the risk to the depository institution and a significant impact on a wide variety of other affiliate transactions entered into by such SEC or CFTC-regulated swap entities.

(2) If the SEC and CFTC margin requirements are stronger than the prudential regulators', then the result could be that more transactions are booked to depository institutions, since there would be an incentive to book transactions to such entities instead of affiliated SEC or CFTC-regulated entities.

(3) Senator Warren and Representative Cummings seem to have relied on a fairly small sample of the discussions about the prudential regulators' margin requirements in order to arrive at the view that it was a "lucrative concession" to banks (a search reveals only one Bloomberg article). As the prudential regulators noted, "Commenters including members of Congress were generally critical of the [inter-affiliate margin requirement in the proposed rules]." Just a few months ago, a letter was submitted to six U.S. regulators from two members of the House Committee on Agriculture (one from each party) urging the CFTC not to impose initial margin requirements on inter-affiliate transactions.

(4) Transactions between depository institutions and their affiliates are subject already to significant requirements under Sections 23A and 23B of the Federal Reserve Act. (See the Cadwalader memorandum that discusses how Dodd-Frank changed these requirements here.)

(5) Under the prudential regulators' final rules, depository institutions that are swap entities are required to (i) collect and post variation margin with affiliates, and (ii) collect initial margin from affiliates that are swap entities (including those that are regulated by the SEC or the CFTC) or "financial end users." Such transactions largely are subject to the margin requirements. The key requirement that is excused is for a depository institution to post initial margin to an affiliate. It seems odd to argue that depository institutions would be better protected if they had to post collateral to their affiliates.

There was never any academic support for Section 716's inclusion within Dodd-Frank, and the section was opposed generally by the banking regulators prior to its adoption. According to contemporaneous press reports - see, e.g., this report from the Bloomberg press of May 6, 2010 - Section 716 was added to Dodd-Frank in order to win the support of then-Senator Blanche Lincoln, whose vote was needed to pass Dodd-Frank.

Regarding Senator Warren's implicit suggestion that swaps should be cleared, we refer to the remarks of FDIC Vice Chair Thomas Hoenig in which he argues that mandated central clearing did little or nothing to address systemic risk. FDIC Vice Chair Hoenig Considers Risk Associated Regulatory Capital (with Lofchie Comment) (Nov. 10, 2015). Hoenig himself is an advocate of central clearing.