Comments from Commissioner J. Christoper Giancarlo | Proposed Uncleared Margin Rules

Some pointed comments by the commissioner worth reading The CFTC have published the proposed uncleared margin rules in the Federal Register, the statement from Commissioner Giancarlo is worth reading, I've
October 7, 2014 - Editor
Category: CFTC

Some pointed comments by the commissioner worth reading

The CFTC have published the proposed uncleared margin rules in the Federal Register, the statement from Commissioner Giancarlo is worth reading, I've picked out the key passages below, but pasted his full statement for context, the extract below starts on page 38 of the PDF. The commissioner raises some key questions about how these rules might apply to smaller organisations, the ability of the CFTC to review and approve IM models "even though the Commission lacks adequate staff and expertise for evaluating models", and the lack of reasoning for the ten day Margin Period of Risk. This tip comes courtesy of Edward Ivey at Linklaters.

Appendix 3—Statement of Commissioner J. Christopher Giancarlo

I support the issuance of the proposed rules for uncleared margin. I look forward to reviewing well-considered, responsive and informative comments from the public. Seeking further public comment on this proposal is necessary given the passage of time and the further deliberations with our fellow regulators since the publishing of our 2011 proposal. For the same reasons, I urge the Commission to re-propose capital requirements for swap dealers and major swap participants, which are closely linked to the uncleared margin rules.

Uncleared over-the-counter swaps (OTC) and derivatives are vital to the U.S. economy. Used properly, they enable American companies and the banks they borrow from to manage changing commodity and energy prices, fluctuating currency and interest rates, and credit default exposure. They allow our state and local governments to manage their obligations and our pension funds to support healthy retirements. Uncleared swaps serve a key role in American business planning and risk management that cannot be filled by cleared derivatives. They do so by allowing businesses to avoid basis risk and obtain hedge accounting treatment for more complex, non-standardized exposures. While much of the swaps and OTC derivatives markets will eventually be cleared—a transition I have long supported—uncleared swaps will remain an important tool for customized risk management by businesses, governments, asset managers and other institutions whose operations are essential to American economic growth.

Advance Notice of Proposed Rulemaking: Cross-Border

I support the Commission’s decision to issue an advance notice of proposed rulemaking to determine how the uncleared margin rule should apply extraterritorially. I have long advocated that the Commission take a holistic, global approach to the cross- border application of its rules. This approach should prioritize the critical need for international harmony and certainty for American businesses and other market participants. It is undeniable that the lack of such certainty in the Commission’s cross- border framework is causing fragmentation of what were once global markets, increasing systemic risk rather than diminishing it. I therefore applaud the Commission’s decision to seek public comment on the most optimal cross-border framework with respect to uncleared margin.

In light of the recent decision from the U.S. District Court for the District of Columbia holding that the Commission’s cross-border guidance is non-binding and that the Commission will have to justify the cross- border application of its rules each time it brings an enforcement action, it is important that the Commission provide swaps market participants with certainty on how the uncleared margin rule will apply extraterritorially.

I believe that the advance notice of proposed rulemaking for the cross-border application of the uncleared margin rules demonstrates a pragmatism and flexibility that belies the oft repeated notion that CFTC rulemaking widely and woodenly overreaches in its assertion of extraterritorial jurisdiction. I commend it to our fellow regulators abroad as a portent of greater accord in global regulatory reform.

I look forward to reading and addressing well-considered comments on the cross-border issues. In particular, I join Commissioner Wetjen in welcoming thoughtful comment and analysis on the potential competitive impacts associated with each of the different approaches identified in the advance notice of proposed rulemaking. I encourage commentators to quantify, if practical, and be specific about particular provisions or concerns.

Furthermore, I think this rulemaking should be a template for things to come. I urge the Commission to follow the Securities and Exchange Commission’s (SEC) lead and replace its non-binding guidance with a comprehensive set of rules, supported by a rigorous cost-benefit analysis, delineating when activities outside the United States will have a direct and significant connection with activities in, or effect on, commerce in the United States. Good regulation requires nothing less.

Notwithstanding my support for the issuance of these proposed rules and the advance notice of proposed rulemaking on cross-border issues in order to solicit comment, I have a number of substantive concerns which I will now address.

Ten-Day Margin Requirement

Today’s proposal requires collateral coverage on uncleared swaps equal to a ten- day liquidation period. This ten-day calculation comports with rules adopted recently by the U.S. prudential bank regulators. Yet, it still must be asked: Is ten days the right calculation? Why not nine days; why not eleven? Should it be the same ten days for uncleared credit default swaps as it is for uncleared interest rate swaps and for all other swaps products? Surely, all non- cleared swap products do not have the same liquidity characteristics or risk profiles. I encourage commenters to provide their input on these questions.

SEC Chair Mary Jo White recently stated: ‘‘Our regulatory changes must be informed by clear-eyed, unbiased, and fact-based assessments of the likely impacts—positive and negative—on market quality for investors and issuers.’’ Chair White’s standard of assessment must surely apply to the proposed margin rule on uncleared swaps. Where is the clear-eyed assessment of the ten-day margin requirement? Where is the cost benefit analysis? What are the intended consequences? What will be the unintended ones? Will American swaps end users wind up paying for the added margin costs even though they are meant to be exempt? I would be interested to hear from commentators on this issue.

I am troubled by recent press reports of remarks by unnamed Fed officials that the coverage period may be intentionally ‘‘punitive’’ in order to move the majority of trades into a cleared environment. I would be interested to review any considered analysis of the likely impact of the ten-day liquidation period and whether or not it may have a punitive effect on markets for uncleared swaps products.

Any punitive or arbitrary squeeze on non- cleared swaps will surely have consequences—likely unintended—for American businesses and their ability to manage risk. With tens of millions of Americans falling back on part-time work, it is not in our national interest to deter U.S. employers from safely hedging commercial risk to free capital for new ventures that create full-time jobs. It is time we move away from punishing U.S. capital markets toward rules designed to revive American prosperity. I look forward to reviewing well-considered comments as to the appropriateness of a ten- day liquidation period, as well as its estimated costs and benefits, particularly the impact on American economic growth.

End Users

As noted in the preamble, the Dodd-Frank Act requires the CFTC, the SEC, and the prudential regulators to establish comparable initial and variation margin requirements for uncleared swaps. In 2011, however, the Commission and the prudential regulators issued proposals that varied significantly in several respects. In particular, the rules proposed by the prudential regulators in 2011 would have required non-financial end users to pay initial and variation margin to banks, while the Commission’s rules exempted these entities in accordance with Congressional intent.

I am pleased that the prudential regulators have moved in the CFTC’s direction and will not require that non-financial end users pay margin unless necessary to address the credit risk posed by the counterparty and the risks of the swap. It is widely recognized that non-financial end users, that generally use swaps to hedge their commercial risk, pose less risk as counterparties than financial entities. It is my hope that upon finalization of these rules, swap dealers and major swap participants will treat non-financial end users consistently when it comes to margin, no matter which set of rules apply.

The prudential regulator’s proposal contains the following provision: ‘‘A covered swap entity is not required to collect initial margin with respect to any non-cleared swap or non-cleared security-based swap with a counterparty that is neither a financial end user with material swaps exposure nor a swap entity but shall collect initial margin at such times and in such forms (if any) that the covered swap entity determines appropriately address the credit risk posed by the counterparty and the risks of such non-cleared swaps and non-cleared security-based swaps.’’ Margin and Capital Requirements for Covered Swap Entities, slip copy at 167, available at This is somewhat different, but not inconsistent with the Commission’s proposal, which will allow the parties to exchange margin by agreement, or to arrange other types of collateral agreements consistent with their needs.

Threshold for Swaps Exposure

I am also pleased that our collaboration with the BCBS/IOSCO international working group has resulted in proposed rules that are largely harmonious with the 2013 international framework. There is a particular and significant difference that troubles me, however. The CFTC and the prudential regulators have set the threshold for material swaps exposure by financial end users at $3 billion, while the 2013 international framework sets the threshold at €8 billion (approximately $11 billion). This means that a whole middle-tier of American financial end users could be subject to margin requirements that will not be borne by similar firms overseas. It may well limit the number of counterparties willing to enter into swaps with these important lenders to American business. I am concerned that this could potentially reduce the utility of risk reducing strategies for a class of middle-tier, U.S. financial institutions that have already been hit hard by new capital constraints, among other rules.

In this time of dismal economic growth, it is hard to justify placing higher burdens on America’s medium-sized financial firms than those their overseas competitors face. We have not, in my opinion, sufficiently addressed in our cost benefit analysis the impact of this threshold difference on American firms and their customers. Where is the clear-eyed analysis of the impact of this rule on the American economy? I hope that the Commission will not perpetuate this divergence in the final rules without carefully weighing the costs and benefits. I encourage commenters to address this point and to supply any data and analysis that may be illuminating. It is time our rules were designed less to punish and more to promote U.S. capital markets. Punishment as a singular regulatory policy is getting old and counterproductive. It is time our rules focused on returning America to work and prosperity.

Increase Reliance on International Collaboration

Similarly, I want to echo Commissioner Wetjen’s call for comments on two areas where the Commission can harness international collaboration. First, I welcome comments on whether the Commission should exclude from the scope of this rulemaking any derivative cleared by a central counterparty (CCP) that is subject to regulation and supervision consistent with the CPSS–IOSCO Principles for Financial Market Infrastructures (PFMIs), an alternative on which the Commission seeks comment in the preamble. It is reported that at least one U.S. financial firm is a member at 70 different CCPs around the globe. The present proposal, if finalized, could result in trades cleared on many of these CCPs being treated as if they are uncleared.8 This would seem to be a needlessly costly and burdensome imposition on American commerce. Global regulators have already agreed on international standards in the PFMIs to determine how CCPs should be regulated and supervised. It makes sense to leverage these standards where we can. I encourage comment on this issue.

I would also be interested in commenters’ views on how the Commission should conduct its comparability analysis under this rulemaking. In the advance notice of proposed rulemaking, the Commission proposes to permit market participants to comply with foreign rules, if such rules are comparable to the Commission’s margin requirements. Yet, a better approach may be to compare a foreign regime to the international standards put forward by the BCBS/IOSCO international working group that included participation from over 20 regulatory authorities. Doing so would give the Commission some comfort that foreign rules meet a necessary baseline, but could avoid unnecessary and potentially destabilizing disputes over comparability in the future. I hope the insights of interested parties will guide not only the Commission, but also the prudential regulators. I further hope all concerned parties can use this rulemaking as an opportunity to promote international comity at a time when it is sorely needed.

Treatment of Small Financial Entities

Another aspect of the proposed rules that concerns me is the treatment of financial entities that qualify for the small bank exemption from clearing and financial cooperatives. Section 2(h)(7)(C)(ii) of the CEA directed the Commission to consider whether to exempt from the definition of ‘‘financial entity’’ small banks, savings associations, farm credit system institutions and credit unions with total assets of $10 billion or less. In response, the Commission exempted these small financial institutions from the definition of financial entity for purposes of clearing. It recognized that these institutions serve a crucial function in the markets for hedging the commercial risk of non-financial end users. Moreover, the Commission acknowledged that the costs associated with clearing, including margin and other fees and expenses, may be prohibitive relative to the small number of swaps these firms execute over a given period of time.9 In addition, using its Section 4(c) exemptive authority, the Commission permits cooperative financial entities, including those with total assets exceeding $10 billion, to elect an exemption from mandatory clearing for swaps executed in connection with originating loans for their members, or that hedge or mitigate commercial risk related to loans or swaps with their members.10

Despite the CFTC’s otherwise appropriate treatment of these small banks and financial cooperatives, the proposed margin rules treat them as financial institutions required to post margin when their swaps exposure exceeds the $3 billion threshold. This means that small banks and cooperative financial institutions entitled to a clearing exemption will have to pay margin for their uncleared activity with swap dealers or major swap participants when they have material swaps exposure. It makes no sense to provide these entities with an exemption from clearing on the one hand, only to turn around and require them to bear the potentially even greater costs associated with uncleared swaps. They deserve the full benefit of their clearing exemption, which they may not get if they have to post margin. I encourage comment on this issue, which I will weigh carefully in the process of considering a final rule.

Inter-Affiliate Exemption

The proposed rules may also diminish the utility of the critically important, inter-affiliate clearing exemption the Commission adopted last year for certain eligible affiliate counterparties. The exemption was premised on recognition that transactions between affiliates do not present the same risks as market-facing swaps, and generally provide risk-mitigating, hedging, and netting benefits within a corporate group. I welcome comments addressing the impact the proposed rules may have on the ability of affiliated entities to efficiently manage their risk.

Use of Approved Models to Calculate Capital

Finally, I believe it is important to allow the use of models when calculating initial margin. The proposed rules require the Commission’s prior written approval before a model can be used, even though the Commission lacks adequate staff and expertise for evaluating models. We recognize in the preamble that many covered swap entities are affiliates of entities whose margin models are reviewed by one of the prudential regulators, the SEC, or a foreign regulator, and to avoid duplicative efforts we plan to coordinate with other regulators in an effort to expedite our review. Rather than go through a special approval process, however, I believe we should accept models approved by our fellow regulators, so long as they contain the required elements. Alternatively, as mentioned in the preamble and discussed at the open meeting, this may be an area in which the National Futures Association can provide assistance, and I am interested in hearing its views on the issue. I also join Commissioner Wetjen’s call for discussion on the circumstances in which the Commission may permit market participants to continue using models while Commission staff is reviewing them. Given the CFTC’s limited resources, I believe we should make every effort to leverage the expertise of other qualified regulators before asking for more tax dollars from Americans working two jobs just to stay afloat.


In spite of my stated concerns, I support the issuance of these proposed rules in order to solicit comment. They raise a number of important issues, particularly in their impact on the U.S. economy and job creation and the extent of their application across the globe. It is vital that we hear from interested parties on how to get them right. I commend the Chairman and my fellow Commissioners for their thoughtfulness and open-mindedness in arriving at the final proposals. I look forward to receiving and reviewing comments on the issues discussed above and all aspects of the rules.


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