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CFTC Issues Proposed Margins Rule for Uncleared Swaps in Cross-Border Transactions

The U.S. Commodity Futures Trading Commission voted unanimously Monday to propose a rule that would apply the Commission’s margin requirements for uncleared swaps in the context of cross-border transactions.

The proposed rule would apply to Commission-registered swap dealers and major swap participants that are not subject to the margin requirements of other prudential regulators, such as the Federal Reserve Board, Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (collectively, covered swap entities).

Because swaps that are not centrally cleared are an important part of the swaps market, “margin requirements for uncleared swaps are critical to ensuring the safety and soundness of swap dealers and major swap participants and the stability of the U.S. financial system,” the CFTC said.

Monday’s action is part of the Commission’s overall proposed rule covering over-the-counter swaps that are not centrally cleared issued in October 2014. CFTC Chairman Timothy G. Massad, responding to reporter’s questions, said he expected a final version of the basic rule would be issued “in a few months.” He called it “one of the most important rules for regulation of the over-the-counter swaps market under Dodd-Frank Wall Street Reform and Consumer Protection Act.

“Margin can be an effective tool for addressing counterparty credit risk arising from uncleared swaps. Our rule will make sure that registered swap dealers post and collect margin in their transactions with other registered swap dealers and financial institutions that are above certain thresholds. That helps lower the risk to the financial system and the overall economy. I also note that the requirements do not apply to commercial end users,” Massad said.

“The proposal we are issuing today addresses the possibility that risk created offshore can flow back into the U.S. And so it applies to activities of non-U.S. swap dealers that are registered with us. At the same time, our proposal recognizes the importance of harmonizing rules with other jurisdictions.”

 Under the proposed rule issued Monday, covered swap entities would be required to comply with the Commission’s margin rules for all uncleared swaps in cross-border transactions, with a limited exclusion. In addition, it would allow covered swap entities to comply with comparable margin requirements in a foreign jurisdiction as an alternative means of complying with the Commission’s margin rules for uncleared swaps (substituted compliance).

The proposed rule would work as follows:

  • U.S. covered swap entities would be required to comply with the Commission’s margin rules for all uncleared swaps but would be eligible for substituted compliance with respect to margin that they post (but not that they collect) for swaps with certain non-U.S. counterparties.
  • Uncleared swaps of non-U.S. covered swap entities whose obligations under the relevant swap are guaranteed by a U.S. person would be treated the same as uncleared swaps of U.S. covered swap entities.
  • Uncleared swaps of non-U.S. covered swap entities whose obligations under the relevant swap are not guaranteed by a U.S. person would be eligible for substituted compliance unless the counterparty to the swap is a U.S. covered swap entity or a non-U.S. covered swap entity whose obligations under the swap are guaranteed by a U.S. person.
  • Uncleared swaps between a non-U.S. covered swap entity and a non-U.S. counterparty would be excluded from the margin rules, if neither party’s obligations under the relevant swap are guaranteed by a U.S. person and neither party is a U.S. branch of a non-U.S. covered swap entity nor consolidated in the financial statements of a U.S. person.

With regard to substituted compliance, the Proposed Rule sets forth proposed procedures for requests for comparability determinations, including eligibility and submission requirements, as well as the standard of review that would apply to Commission determinations.

Massad said the CFTC’s proposal on margins on cross-border swaps is “very similar to the approach proposed last fall by the prudential regulators,” which is essential because many of the swap dealers are subject to rules of the other regulators or have affiliates which are subject to them.

The provisions for “substituted compliance” helps to harmonize the CFTC rules with those of other jurisdictions.

The comment period ends 60 days after the publication in the Federal Register.

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