Dodd-Frank Act
Sections 731 and 764 of the Dodd-Frank Act instruct regulators to establish
minimum margin requirements for initial and variation margin for uncleared swaps
and security-based swaps (collectively, swaps) entered into by certain
registered swap dealers and major swap participants. The Dodd-Frank Act requires
the registration of dealers and major swap participants with the Commodity
Futures Trading Commission (CFTC) and the Securities Exchange Commission (SEC);
therefore, the CFTC and SEC define what banking organizations will be included
as covered swap entities. The Act also requires the Office of the Comptroller of
the Currency, the Board of Governors of the Federal Reserve System, the Federal
Deposit Insurance Corporation, the Farm Credit Administration, and the Federal
Housing Finance Agency (collectively, the Agencies) to issue initial margin,
variation margin, and capital requirements for covered swap entities that fall
within their jurisdiction with respect to swaps that are not cleared through
central counterparties or derivative clearing organizations. Under the proposed
rule, the Agencies establish minimum margin collection requirements for covered
swap entities.
For a covered swap entity, the proposed rule would impose initial margin and
variation margin requirements for uncleared swaps held by the covered swap
entities. The Agencies' existing regulatory capital rules take into account and
address the unique risks arising from derivatives transactions. Therefore, the
proposed rule is based on a preliminary conclusion by the Agencies that these
existing rules are appropriate and sufficient to offset the greater risk to the
covered swap entity and the financial system arising from the use of uncleared
swaps.
The Dodd-Frank Act requires that initial margin and variation margin requirements
adopted by the Agencies must help ensure the safety and soundness of the covered
swap entity and be appropriate for the risk associated with the covered
derivatives. Consistent with that requirement, the proposed rule's initial
margin, variation margin, and capital standards are intended to offset the risk
to covered swap entities and the financial system arising from the use of
uncleared swaps.
The Proposed Rule
The proposed rule would require covered swap entities to calculate and collect
initial margin and variation margin from all counterparties. For covered swap
entities, this would require reciprocal collection from other covered swap
entities for all initial and variation margin requirements. However, the
proposed rule would provide a series of risk-based margin collection thresholds
for covered swap entities designed to limit the impact of margin collection
requirements on lower-risk financial end users. As such, the proposed initial
margin and variation margin collection requirements for covered swap entities
would change as the characteristics of the counterparties change. Specifically,
the collection requirements would change if the covered swap entity's
counterparty is a high- or low-risk financial end user or a commercial end user.
For a high-risk profile financial end user (for example, a hedge fund), covered
swap entities would be required to collect the entire initial margin amount and
variation margin amount required from such counterparty, as calculated under the
proposed rule. However, for a low-risk profile financial end user (for example,
an insured depository institution under certain circumstances), an initial
margin threshold and variation margin threshold may apply. For transactions with
a low-risk profile financial end user, the proposed rule would require a covered
swap entity to collect initial margin and variation margin to the extent that
such amount exceeds the applicable threshold. For low-risk financial end user
counterparties, the threshold would be the lesser of the range of $15-45 million
or 0.1-0.3 percent of the covered swap entity's tier 1 capital.
The proposed rule would require a covered swap entity to calculate a credit
exposure limit for a commercial end user and collect initial margin and
variation margin from a commercial end user when the credit exposure exceeds the
calculated limit. No explicit minimum supervisory threshold for margin
collection would apply to commercial end users.
Under the proposed rule, a covered swap entity to would be required to calculate
the initial margin requirement using either of two alternatives. Under the first
alternative, the covered swap entity may calculate minimum initial margin
requirements through the use of a standardized "lookup" table that specifies the
minimum initial margin that must be collected as a percentage of a swap's
notional amount. Under the second alternative, a covered swap entity may
calculate minimum initial margin requirements through the use of an internal
model approved by the primary regulator. Given the greater risk sensitivity of
models as well as the ability to recognize the benefits of netting, the Agencies
expect a covered swap entity to seek approval for the use of an internal model
to calculate the minimum initial margin requirements. In addition, the proposed
rule would require that the internal model used in the calculation of the margin
requirement be at least as conservative as those used by swap clearinghouses.
The proposed rule limits the types of collateral eligible to satisfy the initial
margin or variation margin requirements to immediately available cash funds;
obligations of, or fully guaranteed by, the United States; and senior debt
obligations of government-sponsored entities. Other than immediately available
cash funds, all types of eligible collateral are subject to haircuts for
determining the value for margin purposes. The proposed rule also would require
the covered swap entity to require the covered swap entity counterparty to
segregate and hold the collateral posted as initial margin at a third-party
custodian. The segregation requirement is based on a preliminary conclusion by
the Agencies that requiring a covered swap entity's initial margin to be
segregated is necessary to offset the greater risk to the covered swap entity
and the financial system arising from the use of uncleared swaps, and protect
the safety and soundness of the covered swap entity. Collateral collected from
end users may be segregated at the discretion of the end user.