On July 22, 2020, by a 3-2 vote, the Commodity Futures Trading Commission (CFTC) adopted final rules establishing capital and financial reporting requirements for swap dealers (SDs) and major swap participants (MSPs) (the Final Rules). Under the Final Rules, SDs will be subject to capital requirements as follows:

  • FCM-SDs: An SD dually registered as a futures commission merchant (FCM) will be subject to a modified version of the CFTC's existing FCM net capital rule;
  • Standalone SDs: An SD that is neither dually registered as an FCM nor subject to the capital requirements of a Prudential Regulator1 may elect one of the following three approaches:
    1. Net Liquid Assets Approach: A standalone SD could elect to follow a modified version of the net capital requirements adopted by the Securities and Exchange Commission (SEC) for a securitybased swap dealer (SBSD) that does not have a Prudential Regulator;
    2. Bank-Based Approach: A standalone SD could elect to follow a modified version of the capital requirements adopted by the Federal Reserve Board for bank holding companies; or
    3. Tangible Net Worth Approach: If it or its parent company is predominantly engaged in nonfinancial activities, a standalone SD could elect a capital requirement based on its tangible net worth;
  • Foreign SDs: A standalone SD organized and domiciled in a non-U.S. jurisdiction for which the CFTC has issued a comparability determination may substitute compliance with its home country capital rules.
  • Bank SDs: An SD subject to the capital requirements of a Prudential Regulator will follow that regulator's capital requirements instead of the CFTC's, but it will remain subject to certain CFTC financial reporting requirements.

The Final Rules are the culmination of a process that began with a proposal in May 2011, a reproposal in December 2016, and a re-opened comment period in December 2019. As one might expect from a rulemaking that took over nine years to complete, the Final Rules reflect a number of significant changes from prior proposals. The most notable changes are the following:

  • Margin-Based Minimum Capital Requirements: The CFTC's 2016 proposal would have required FCM-SDs and standalone SDs to maintain capital equal to at least 8% of the SD's initial margin (IM) for its positions in futures, cleared swaps, uncleared swaps, cleared security-based swaps (SBS) and uncleared SBS. The Final Rule modified this requirement substantially by (a) lowering the multiplier from 8% down to 2% for FCM-SDs and standalone SDs that follow the Net Liquid Assets Approach; and (b) eliminating futures, cleared swaps, cleared SBS and uncleared SBS from the calculation.
  • Bank-Based Approach: Under the 2016 proposal, the Bank-Based Approach would have required an SD to maintain common equity tier 1 (CET1) capital equal to the greater of 8% of its risk-weighted assets or 8% of the IM amount noted above. The Final Rules instead permit an SD to meet these requirements through a combination of CET1, additional tier 1 (AT1), and tier 2 capital, subject to a CET1 minimum set at 6.5% of risk-weighted assets. The Final Rule also clarified how SDs can compute their risk-weighted assets and deferred to the Federal Reserve Board's requirements for market and credit risk models.
  • Tangible Net Worth Approach: The Final Rules expanded the availability of the Tangible Net Worth Approach to standalone SDs that themselves do not satisfy the "predominantly engaged in non-financial activities" test but which are wholly-owned subsidiaries of a parent company that satisfies that test.
  • Provisional Model Approval: In recognition of the importance of using models to compute market and credit risk capital requirements and the supervisory resources needed to approve such models, the Final Rules permit SDs provisionally to use models approved by certain other regulators, although such SDs must still submit model approval applications and a certification regarding compliance with the CFTC's model requirements.
  • Liquidity Requirements: Unlike the 2016 proposal, the Final Rules do not include any quantitative liquidity requirements for FCM-SDs or standalone SDs. Instead the CFTC will continue to rely on the qualitative liquidity requirements in its SD risk management rule.
  • Financial Reporting: The Final Rules somewhat streamlined SD financial reporting requirements by eliminating weekly position and margin reporting rules, expanding the circumstances where SDs can rely on International Financial Reporting Standards (IFRS), and permitting SDs dually registered with the SEC instead to rely on certain SEC financial reports.

The Final Rules' compliance date will be October 6, 2021. In advance of that date, non-U.S. SDs, or their trade association or regulators, will need to apply to the CFTC for comparability determinations. In addition, standalone SDs will need to submit applications to use internal models, even if they intend to rely on the provisional model approval provisions noted above.

Footnotes

1 The Prudential Regulators include the Board of Governors of the Federal Reserve System (Federal Reserve Board), the Federal Deposit Insurance Corporation (FDIC), the Federal Housing Finance Agency, the Farm Credit Administration, and the Office of the Comptroller of the Currency (OCC).

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Originally published 05 August, 2020

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