CFTC Allows Initial Margin Calculations to Include Security-Based Swaps
The CFTC Division of Clearing and Risk, and the Division of Swap Dealer and Intermediary Oversight (collectively, the "Divisions") granted no-action relief in response to a request by ISDA. The relief permits a covered swap entity ("CSE") (i.e., a swap dealer or major swap participant that is regulated by the CFTC for uncleared swaps margin) to include security-based swaps ("SBS") in the product set for initial margin calculations ("IM") where the SBS are subject to the margin requirements that are applicable to the CSE's counterparty.
The relief is subject to the following conditions, among others:
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The swaps and SBS must be subject to the same eligible master netting agreement and netting portfolio thereunder.
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The swaps and SBS must be in the same broad-risk category pursuant to CFTC Rule 23.154(b)(2)(v).
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All SBS in the netting set must be included consistently in the margin calculation.
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The SBS must be treated as though they were swaps for purposes of the CFTC margin rules.
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Upon request by the CFTC and/or the NFA, the relying CSE must provide the information that is required by the CFTC margin rules.
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If the CSE has obtained approval from the NFA to use a model to compute its initial margin for uncleared swaps (an "Approved IM Model"), then the CFTC will allow the CSE to include SBS in the model, as long as the CSE notifies the NFA that it intends to (i) include SBS in the portfolio and (ii) provide any necessary documentation to NFA.
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If the CSE fails to obtain approval to include SBS in its Approved IM Model, it may post and collect margin on a portfolio basis for swaps and SBS, as long as it uses the standardized initial margin schedule under CFTC Rule 23.154(c).
Commentary
The CFTC's no-action relief addresses an odd consequence of Dodd-Frank's split regulation of swaps margin: prudentially regulated swap dealers are subject to margin regulation of their swaps and SBS, while all other swap dealers only are subject to the margin regulation of their swaps. When these two types of entities transact together, a technical reading of the requirements results in the CFTC-regulated entity posting margin on swaps and SBS, but collecting on swaps alone.
Things could become even more complicated if and when the SEC adopts margin requirements for non-prudentially regulated security-based swap dealers. In that case, an entity that is both a swap dealer and a security-based swap dealer, but is not prudentially regulated, would be required to follow CFTC rules on swaps, SEC rules on SBS, and, when posting margin to a bank counterparty, prudential regulator rules on swaps and SBS (never mind the additional complications that would occur if the dealer or its counterparties were regulated outside the United States).