The CFTC adopted a final rule establishing capital requirements for swap dealers ("SDs"). (Whle major swap participants ("MSPs") are also subject to the rule, we do not expect there to be any such entities.) The vote was 3-2, along party lines, with dissenting Democratic CFTC Commissioners Rostin Behnam and Dan Berkovitz asserting that certain of the capital measures were not sufficiently strict.
As previously covered, in December 2019, the CFTC voted to reopen the comment period for a proposed rule on capital and financial reporting requirements for SDs. The proposal was first published in December 2016.
Highlights of the Final Rule
The final rule imposes capital requirements, and financial reporting and recordkeeping requirements, on non-prudentially regulated ("nonbank") SDs. The rule provides three alternative methods for nonbank SDs to calculate their capital requirements:
1. the bank-based method, which incorporates by reference capital adequacy rules of the bank regulators (an alternative that is most likely to be attractive to nonbank SDs that are part of a banking group);
2. the net liquid assets method, which is based on the capital requirements applicable to futures commission merchants ("FCMs"), securities broker-dealers and security-based swap dealers ("SBSDs"); and
3. the tangible net worth method, which is tailored specifically to nonbank SDs that are "part of a larger commercial enterprise" (i.e., predominantly engaged in non-financial activities).
The final rule also provides for a substituted compliance process so that foreign-domiciled SDs subject to the capital requirements of a foreign regulator can satisfy U.S. requirements by complying with the capital and financial reporting regime of its foreign regulator.
Other principal aspects of the final rule are that it:
- amends existing FCM capital requirements to more appropriately reflect swap and security-based swap activities;
- includes a "comprehensive model approval process" for SDs, permitting the use of internal capital models approved by the CFTC or NFA; and
- requires financial reporting, recordkeeping and notifications that are comparable to the requirements for FCMs. These requirements have been largely harmonized with the SEC's requirements for SBSDs.
The final rule indicates that market participants must be compliant with its requirements by October 6, 2021.
Commissioner Statements
CFTC Chair Heath Tarbert supported the final rule, emphasizing that the rule is "designed to enhance customer protection and reduce systemic risk in the financial system." Chair Tarbert highlighted that the CFTC's development of three alternative capital calculation approaches was an example of the "regulatory flexibility" of the requirements, in contrast to a "one-size-fits-all" approach that would be "incompatible" with the diverse financial character of derivatives markets participants.
CFTC Commissioner Brian Quintenz supported the final rule, stating that the capital requirements "are appropriately calibrated to the true risks posed by an SD's or FCM's business and ensure that these firms have the capital necessary to support their active participation in the markets." Mr. Quintenz noted three areas that, in his view, require further exploration: (i) recalibrating and reducing the standardized market risk capital charges for FCMs in CFTC Regulation 1.17; (ii) consideration of alternative forms of collateral (e.g., letters of credit and liens); and (iii) a requirement for firms electing the net liquid assets approach to maintain "tentative net capital in excess of the risk margin amount" (in lieu of the current net capital requirement).
CFTC Commissioner Dawn Stump supported the final rule. She said that additional regulatory action may be needed on model approval and implementation. Ms. Stump noted that the final rule establishes a CFTC review process to determine the consistency between the CFTC's and NFA's model approval processes. She emphasized that the CFTC and NFA should continue to be in "constant communication" if the CFTC's review is to be completed "expeditiously." Ms. Stump also drew attention to the October 2021 compliance deadline in connection with substitute compliance determinations, stating that the date is "already fast approaching."
Commissioner Behnam and Commissioner Berkovitz voted against the final capital rule. Commissioner Behnam argued that the rule suffers from a lack of information gathering, as shown in the adoption of a 2% multiplier for uncleared swaps. Commissioner Berkovitz went further, stating, that there is "no rational basis to conclude that the minimum capital requirements in the [final rule] meet [the Dodd-Frank Act's standards for the SD capital requirement] and serve their intended purpose." He remarked that the final rule seemed to be constructed so that "most dealers will not need to raise more capital."
The final rule becomes effective 60 days after the date of its publication in the Federal Register.
Primary Sources
- CFTC Press Release: CFTC to Hold Open Commission Meetings on July 22 and 23
- Federal Register: Sunshine Act Meetings
- CFTC Press Release: CFTC Approves Final Swap Dealer Capital Rule at July 22 Open Meeting
- Statement of CFTC Chair Heath Tarbert in Support of Final Swap Dealer Capital Rule
- Supporting Statement of CFTC Commissioner Brian Quintenz regarding Final Swap Dealer Capital Rule
- Supporting Statement of CFTC Commissioner Dawn Stump regarding Swap Dealer Final Swap Dealer Capital Rule
- Dissenting Statement of CFTC Commissioner Dan Berkovitz regarding Final Swap Dealer Capital Rule
- Dissenting Statement of CFTC Commissioner Rostin Benham regarding Final Swap Dealer Capital Rule
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