United States: U.S. Prudential Regulators To Propose Amendments To Swap Margin Rules

The FDIC proposed amending its rules governing margin requirements for uncleared swaps and security-based swaps.

The proposal would make five substantive changes to the derivatives margin rules:

  • Inter-Affiliate Margin. The proposal would remove the requirement that dealers collect initial margin from their affiliates. (Variation margin would continue to be required.)
  • Benchmark Amendments. The proposal would not subject "legacy" transactions to margin requirements as a result of amendments to replace terms based on interbank offered rates (e.g., LIBOR) and other interest rates determined to have lost relevance as reliable benchmarks.
  • Compliance Period. The proposal would amend the compliance schedule for initial margin to conform to a recent BCBS-IOSCO statement providing that the September 2020 "phase-in" would apply to entities whose "daily aggregate notional amount" of swaps exceeds $50 billion over a measuring period, and that full compliance for all in-scope entities (i.e., those over $8 billion) would apply as of September 2021.
  • Non-Material Amendments. The proposal would permit "legacy" swaps to be amended for certain "life-cycle activities" without losing their legacy status.
  • Pre-Threshold Documentation. The proposal would clarify that documentation is required only at the time a dealer is required to collect or post margin (i.e., when the relevant amount exceeds the $50 million threshold permitted under the rules).

To date, only the FDIC has approved the proposal. It is expected that the OCC, the Federal Reserve Board, the Federal Housing Finance Agency and the Farm Credit Administration will also approve the proposal. Comments on the proposal must be submitted within 30 days of its publication in the Federal Register.

Commentary

The proposal covers a grab bag of issues that have been discussed in relation to derivatives margin requirements over time. Only inter-affiliate margin is likely to be controversial (at least in concept).

Benchmark Amendments. The proposal follows on a BCBS-IOSCO recommendation that changes related to benchmark reform should not impose margin requirements on transactions that are otherwise out of scope. The proposed operative language covers (i) changes "to accommodate" replacement of various IBORs and any other interest rate a dealer reasonably expects "to be discontinued or reasonably determines has lost its relevance as a reliable benchmark due to a significant impairment"; (ii) changes for any rate succeeding one of the foregoing rates; and (iii) changes incorporating spreads or other adjustments and technical changes relating to benchmark changes, so long as the effective notional is not increased and the maturity is not extended.

As previously noted, market participants should remember that margin requirements are just one of a number of derivatives regulatory issues likely to arise from benchmark reform . (The others, at least in the United States, would need to be addressed by the CFTC and SEC.)

Compliance Period. The extension of compliance periods is essentially consistent with the recent BCBS-IOSCO recommendation. Perhaps most notable is that the prudential regulators have kept the somewhat quirky counting period in U.S. rules for 2021 and beyond. The counting period for the September 2020 compliance date is March-May of 2020. However, for the final phase-in date (September 1, 2021), the relevant counting period is June-August of 2020.

Non-Material Amendments. The proposal carves out the following types of amendments as not subjecting "legacy" transactions to margin requirements: (i) amendments or replacements as a result of risk reduction or risk-neutral portfolio compression exercises, so long as the exercise does not extend the maturity or increase the effective notional amount of the relevant swap(s); and (ii) "technical changes," with examples given of addresses, notice delivery, and "other administrative or operational provisions," so long as they do not alter the underlying asset or indicator, maturity, or effective notional amount (subject to limited exceptions as to notional). In a statement in the accompanying discussion, the prudential regulators also indicated that swaps resulting from the exercise of a swaption that was itself a "legacy" swap is also considered a legacy swap.

In these changes, it is notable that the prudential regulators are not exactly following the lead of the CFTC. A CFTC staff no-action letter earlier this year provided similar relief, but there is basis between the proposed rules and that relief. Among other things, the CFTC referenced its own definition of "material terms" in indicating what types of amendments would be considered out of scope. The prudential regulators' view of "technical changes," at least based on the examples given, seems to be fairly narrow.

Thresholds. These changes are also consistent with a BCBS-IOSCO recommendation, but once again not entirely consistent with a CFTC staff action addressing the same issue. While the prudential regulators simply state that documentation is required only when posting/collection is required, the CFTC staff statement went on to provide more detailed interpretations as to dealers' duties in getting documentation in place. While that staff advisory purported to rely on certain rules applicable even to dealers that are subject to prudential regulator margin rules (e.g., CFTC Rule 23.600), by its terms, the letter applies only to dealers subject to the CFTC margin requirements.

Inter-Affiliate Initial Margin. Industry groups have long pushed for this requirement to go away and the issue caused a split among Democrats in Congress. FDIC Director Martin Gruenberg dissented on the proposal, saying that the change would create incentives to concentrate derivatives in an insured bank "because of the subsidy provided by the public safety net."

Primary Sources

  1. OCC, FRB, FDIC, Farm Credit Administration and FHFA: Proposal regarding Margin and Capital Requirements for Covered Swap Entities
  2. FDIC Memorandum: Notice of Proposed Rulemaking regarding Swap Margin Requirements

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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