Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 23732-23749 [2011-9598]

Agencies

• Commodity Futures Trading Commission

[Federal Register Volume 76, Number 82 (Thursday, April 28, 2011)]
[Proposed Rules]
[Pages 23732-23749]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-9598]


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Proposed Rules
                                                Federal Register
________________________________________________________________________

This section of the FEDERAL REGISTER contains notices to the public of 
the proposed issuance of rules and regulations. The purpose of these 
notices is to give interested persons an opportunity to participate in 
the rule making prior to the adoption of the final rules.

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Federal Register / Vol. 76, No. 82 / Thursday, April 28, 2011 / 
Proposed Rules

[[Page 23732]]



COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 23

RIN 3038--AC97


Margin Requirements for Uncleared Swaps for Swap Dealers and 
Major Swap Participants

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or 
``CFTC'') is proposing regulations to implement new statutory 
provisions enacted by Title VII of the Dodd-Frank Wall Street Reform 
and Consumer Protection Act (``Dodd-Frank Act''). The proposed 
regulations would implement the new statutory framework of Section 
4s(e) of the Commodity Exchange Act (``CEA''), added by Section 731 of 
the Dodd-Frank Act, which requires the Commission to adopt capital and 
initial and variation margin requirements for certain swap dealers 
(``SDs'') and major swap participants (``MSPs''). The proposed rules 
address initial and variation margin requirements for SDs and MSPs. The 
proposed rules will not impose margin requirements on non-financial end 
users. The Commission will propose rules regarding capital requirements 
for SDs and MSPs at a later date. The Commission will align the comment 
periods of these two proposals so that commenters will have an 
opportunity to review each before commenting on either.

DATES: Comments must be received on or before June 27, 2011.

ADDRESSES: You may submit comments, identified by RIN 3038-AC97, and 
Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap 
Participants by any of the following methods:
     Agency Web site, via its Comments Online process at https://comments.cftc.gov. Follow the instructions for submitting comments 
through the Web site.
     Mail: Send to David A. Stawick, Secretary, Commodity 
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, 
NW., Washington, DC 20581.
     Hand Delivery/Courier: Same as mail above.
     Federal eRulemaking Portal: https://www.regulations.gov. 
Follow the instructions for submitting comments.

Please submit your comments using only one method.

    All comments must be submitted in English, or if not, accompanied 
by an English translation. Comments will be posted as received to 
https://www.cftc.gov. You should submit only information that you wish 
to make available publicly. If you wish the Commission to consider 
information that may be exempt from disclosure under the Freedom of 
Information Act, a petition for confidential treatment of the exempt 
information may be submitted according to the established procedures in 
Sec.  145.9 of the Commission's regulation, 17 CFR 145.9.
    The Commission reserves the right, but shall have no obligation, to 
review, pre-screen, filter, redact, refuse or remove any or all of your 
submission from https://www.cftc.gov that it may deem to be 
inappropriate for publication, such as obscene language. All 
submissions that have been redacted or removed that contain comments on 
the merits of the rulemaking will be retained in the public comment 
file and will be considered as required under the Administrative 
Procedure Act and other applicable laws, and may be accessible under 
the Freedom of Information Act.

FOR FURTHER INFORMATION CONTACT: John C. Lawton, Deputy Director, 
Thomas Smith, Deputy Director, or Thelma Diaz, Associate Director, 
Division of Clearing and Intermediary Oversight, 1155 21st Street, NW., 
Washington, DC 20581. Telephone number: 202-418-5480 and electronic 
mail: jlawton@cftc.gov; tsmith@cftc.gov; or tdiaz@cftc.gov.

SUPPLEMENTARY INFORMATION:

I. Background

A. Legislation Requiring Rulemaking for Margin Requirements of SDs and 
MSPs

    On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\ 
Title VII of the Dodd-Frank Act amended the CEA \2\ to establish a 
comprehensive regulatory framework to reduce risk, increase 
transparency, and promote market integrity within the financial system 
by, among other things: (1) Providing for the registration and 
comprehensive regulation of SDs and MSPs; (2) imposing clearing and 
trade execution requirements on standardized derivative products; (3) 
creating rigorous recordkeeping and real-time reporting regimes; and 
(4) enhancing the Commission's rulemaking and enforcement authorities 
with respect to all registered entities and intermediaries subject to 
the Commission's oversight.
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    \1\  See Dodd-Frank Wall Street Reform and Consumer Protection 
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the 
Dodd-Frank Act may be accessed at https://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
    \2\ 7 U.S.C. 1 et seq.
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    The legislative mandate to establish registration and regulatory 
requirements for SDs and MSPs appears in Section 731 of the Dodd-Frank 
Act, which adds a new Section 4s to the CEA. Section 4s(e) explicitly 
requires the adoption of rules establishing margin requirements for SDs 
and MSPs, and applies a bifurcated approach that requires each SD and 
MSP for which there is a prudential regulator to meet margin 
requirements established by the applicable prudential regulator, and 
each SD and MSP for which there is no prudential regulator to comply 
with Commission's regulations governing margin.
    The term ``prudential regulator'' is defined in a new paragraph 39 
of the definitions set forth in Section 1a of the CEA, as amended by 
Section 721 of the Dodd-Frank Act. This definition includes the Federal 
Reserve Board; the Office of the Comptroller of the Currency (``OCC''); 
the Federal Deposit Insurance Corporation (``FDIC''); the Farm Credit 
Administration; and the Federal Housing Finance Agency. The definition 
also specifies the entities for which these agencies act as prudential 
regulators, and these consist generally of Federally insured deposit 
institutions, farm credit banks, Federal home loan banks, the Federal 
Home Loan Mortgage

[[Page 23733]]

Corporation, and the Federal National Mortgage Association. In the case 
of the Federal Reserve Board, it is the prudential regulator not only 
for certain banks, but also for bank holding companies and any foreign 
banks treated as bank holding companies. The Federal Reserve Board also 
is the prudential regulator for subsidiaries of these bank holding 
companies and foreign banks, but excluding their nonbank subsidiaries 
that are required to be registered with the Commission as a SD or MSP.
    In general, therefore, the Commission is required to establish 
margin requirements for all registered SDs and MSPs that are not banks, 
including nonbank subsidiaries of bank holding companies regulated by 
the Federal Reserve Board. In addition, certain swap activities 
currently engaged in by banks may be conducted in such nonbank 
subsidiaries and affiliates as a result of the prohibition on Federal 
assistance to swap entities under Section 716 of the Dodd-Frank Act. 
Generally, insured depository institutions (``IDIs'') that are required 
to register as SDs may be required to comply with Section 716 by 
``pushing-out'' to an affiliate all swap trading activities with the 
exception of: (1) The IDI's hedging or other similar risk mitigating 
activities directly related to the IDI's activities; and (2) the IDI 
acting as a SD for swaps involving rates or reference assets that are 
permissible for investment under banking law.

B. Considerations for SD and MSP Rulemaking Specified in Section 4(s)

    Section 4s(e)(3)(A) states the need to offset the greater risk that 
swaps that are not cleared pose to SDs, MSPs, and the financial system, 
and directs the Commission, United States Securities and Exchange 
Commission (``SEC''), and prudential regulators to adopt capital and 
margin requirements that: (1) Help ensure the safety and soundness of 
the registrant; and (2) are appropriate for the risk associated with 
the uncleared swaps they hold. Section 4s(e)(3)(C) permits the use of 
noncash collateral, as the Commission and the prudential regulators 
each determines to be consistent with: (1) Preserving the financial 
integrity of markets trading swaps; and (2) preserving the stability of 
the United States financial system.

C. Consultation With SEC and Prudential Regulators

    The Commission has worked closely with the prudential regulators 
and the SEC in designing these rules. Every effort has been made to be 
as consistent as possible with the rules being considered by the 
prudential authorities. Section 4s(e)(3)(D) of the CEA requires that 
the Commission, SEC, and prudential regulators (together, referred to 
as ``Agencies'') establish and maintain, to the maximum extent 
practicable, comparable minimum initial and variation margin 
requirements for SDs, MSPs, security-based swap dealers (``SSDs'') and 
major security-based swap participants (``MSSPs'') (together, referred 
to as ``swap registrants''). Section 4s(e)(3)(D) also requires the 
Agencies to periodically, but not less frequently than annually, 
consult on minimum margin requirements for swap registrants. As 
directed by Dodd-Frank, and consistent with precedent for harmonizing 
where practicable the minimum margin requirements of dual registrants, 
staff from each of the Agencies has had the opportunity to provide oral 
and written comments on the proposal and the proposed regulations 
incorporate elements of the comments provided.

D. Structure and Approach

    Consistent with the objectives set forth above, this release 
summarizes regulations that the Commission proposes in order to 
establish minimum initial and variation margin requirements for SDs and 
MSPs that are not banks. As noted in previous proposed rulemaking 
issued by the Commission, the Commission intends, where practicable, to 
consolidate regulations implementing Section 4s of CEA in a new Part 
23.\3\ By this Federal Register release, the Commission is proposing to 
adopt Subpart E of Part 23, pertaining to the capital and margin 
requirements and related financial condition reporting requirements of 
SDs and MSPs.\4\
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    \3\ See 75 FR 71379 (Nov. 23, 2010).
    \4\ As noted above, the Commission will propose rules related to 
capital and financial condition reporting in a separate release.
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II. Proposed Margin Regulations

A. Introduction

    Section 4s(e)(2)(B) of the CEA provides that:
    The Commission shall adopt rules for swap dealers and major swap 
participants, with respect to their activities as a swap dealer or 
major swap participant, for which there is not a prudential regulator 
imposing--
    (i) Capital requirements; and
    (ii) Both initial and variation margin requirements on all swaps 
that are not cleared by a registered derivatives clearing organization.
    Section 4s(e)(3)(A) of the CEA provides that:
    To offset the greater risk to the swap dealer or major swap 
participant and the financial system arising from the use of swaps that 
are not cleared, the requirements imposed under paragraph (2) shall
    (i) Help ensure the safety and soundness of the swap dealer or 
major swap participant; and
    (ii) Be appropriate for the risk associated with the non-cleared 
swaps.
    During the recent financial crisis, derivatives clearing 
organizations (``DCOs'') met all their obligations without any 
financial infusions from the government. By contrast, significant sums 
were expended as the result of losses incurred in connection with 
uncleared swaps, most notably at AIG. A key reason for this difference 
is that DCOs all use variation margin and initial margin as the 
centerpiece of their risk management programs while these tools were 
often not used in connection with uncleared swaps. Consequently, in 
designing the proposed margin rules for uncleared swaps, the Commission 
has built upon the sound practices for risk management employed by 
central counterparties for decades.
    Variation margin entails marking open positions to their current 
market value each day and transferring funds between the parties to 
reflect any change in value since the previous time the positions were 
marked. This process prevents losses from accumulating over time and 
thereby reduces both the chance of default and the size of any default 
should one occur.
    Initial margin serves as a performance bond against potential 
future losses. If a party fails to meet its obligation to pay variation 
margin, resulting in a default, the other party may use initial margin 
to cover most or all of any loss based on the need to replace the open 
position.
    Well-designed margin systems protect both parties to a trade as 
well as the overall financial system. They serve both as a check on 
risk-taking that might exceed a party's financial capacity and as a 
resource that can limit losses when there is a failure.
    The statutory provisions cited above reflect Congressional 
recognition that (i) margin is an essential risk-management tool and 
(ii) uncleared swaps pose greater risks than cleared swaps. In 
particular, it is noteworthy that Section 4s(e)(2)(B)(ii) requires both 
variation margin and initial margin for SDs and MSPs on all uncleared 
swaps and that Section 4s(e)(3)(A) explicitly refers to the greater 
risk of uncleared swaps. In addition to the disciplines of regular 
collection of initial and variation margin previously mentioned, 
central clearing

[[Page 23734]]

provides additional means of risk mitigation.
    First, unlike an SD or MSP, a DCO is not in the business of taking 
positions in the market. By definition, a DCO runs a perfectly matched 
book. Second, a DCO only deals with members who must meet certain 
financial, risk management, and operational standards. Third, a DCO may 
turn to those members to help liquidate or transfer open positions in 
the event of a member default. Fourth, DCOs typically, by rule, have 
the ability to mutualize a portion of the tail risk associated with a 
clearing member default through the use of guarantee funds and similar 
mechanisms.
    Concern has been expressed that the imposition of margin 
requirements on uncleared swaps will be very costly for SDs and MSPs. 
However, margin has been, and will continue to be, required for all 
cleared products. Given the Congressional reference to the ``greater 
risk'' of uncleared swaps and the requirement that margin for such 
swaps ``be appropriate for the risk,'' the Commission believes that 
establishing margin requirements for uncleared swaps that are at least 
as stringent as those for cleared swaps is necessary to fulfill the 
statutory mandate. Within these statutory bounds the Commission has 
endeavored to limit costs appropriately. For example, as discussed 
below, the proposal would permit margin reductions for positions with 
offsetting risk characteristics.
    The proposals set forth below were developed in consultation with 
the prudential regulators. They are consistent in almost all material 
respects with provisions that the Commission understands are being 
proposed by the prudential regulators.\5\ Salient differences will be 
noted below.
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    \5\ The Commission anticipates that the prudential regulators 
will publicly post their proposed rules on their Web sites, see, 
e.g., https://www.fdic.gov/.
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    The discussion below addresses: (i) The products covered by the 
proposed rules; (ii) the market participants covered by the proposed 
rules; (iii) permissible methods of calculating initial margin; (iv) 
permissible methods of calculating variation margin; (v) permissible 
margin assets; and (vi) permissible custodial arrangements.

B. Products

    The proposal would cover only swaps executed after the effective 
date of the regulation that are not cleared by a DCO. The proposal 
would not apply to swaps executed before the effective date of the 
final regulation. The Commission believes that the pricing of existing 
swaps reflects the credit arrangements under which they were executed 
and that it would be unfair to the parties and disruptive to the 
markets to require that the new margin rules apply to those positions. 
However, the Commission requests comment on whether SDs and MSPs should 
be permitted voluntarily to include pre-effective date swaps in 
portfolios margined pursuant to the proposed rules. The Commission also 
anticipates that existing positions would be taken into account under 
the capital rule to be proposed at a later date.
    The Commission also wishes to emphasize that the proposal does not 
apply to forward contracts. Under the CEA, the CFTC does not regulate 
forward contracts. Accordingly, the Commission believes that the 
requirements of Section 4s(e) do not apply to forward contracts.

C. Market Participants

1. Overview
    The proposed regulations would impose requirements on SDs and MSPs 
for which there is no prudential regulator (``covered swap entities'' 
or ``CSEs''). Because different types of counterparties may pose 
different levels of risk, the requirements would vary in some respects 
depending on the category of counterparty. The proposed regulations 
would not impose margin requirements on non-financial end users.
    Proposed Sec.  23.151 would require each CSE to execute 
documentation regarding credit support arrangements that is consistent 
with the requirements of these rules with each counterparty. The 
documentation would specify in advance material terms such as how 
margin would be calculated, what types of assets would be permitted to 
be posted, what margin thresholds, if any, would apply, and where 
margin would be held. This provision is consistent with the 
documentation requirement recently proposed by the Commission as Sec.  
23.504.\6\ Having comprehensive documentation in advance concerning 
these matters would allow each party to a swap to manage its risks more 
effectively throughout the life of the swap and to avoid disputes 
regarding issues such as valuation. The Commission solicits comment 
regarding whether it should require SDs and MSPs to document the 
procedures by which any disputes concerning the valuation of a swap or 
the valuation of assets collected or posted as initial or variation 
margin may be resolved.
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    \6\ Swap Trading Relationship Documentation Requirements for 
Swap Dealers and Major Swap Participants, 76 FR 6715 (Feb. 8, 2011).
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    Under rules being proposed by the prudential regulators for SDs and 
MSPs that are banks, the parties are allowed to make particular 
variation margin calculations pursuant to a qualifying master netting 
agreement. The Commission understands that this term will be defined 
under rules proposed by the prudential regulators to mean a legally 
enforceable agreement to offset positive and negative mark-to-market 
values of one or more swaps or security-based swaps that meet a number 
of specific criteria designed to ensure that these offset rights are 
fully enforceable, documented, and monitored by the covered swap 
entity.
    As noted, the Commission has previously proposed Sec.  23.504, 
which requires SDs and MSPs to have swap trading relationship 
documentation with each counterparty. Under proposed Sec.  
23.504(b)(1), this documentation ``shall be in writing and shall 
include all terms governing the trading relationship between the swap 
dealer or major swap participant and its counterparty, including, 
without limitation, terms addressing payment obligations, netting of 
payments, events of default or other termination events, calculation 
and netting of obligations upon termination, transfer of rights and 
obligations, governing law, valuation, and dispute resolution 
procedures.'' \7\
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    \7\ Id.
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    Under proposed Sec.  23.600(c)(4)(v)(A), SDs and MSPs would be 
required to have risk management policies and procedures addressing 
legal risks associated with their business as swap dealers or major 
swap participants, including risks associated with ``determinations 
that transactions and netting arrangements entered into have a sound 
legal basis.'' \8\ Taken together, it is the Commission's belief that 
all SDs and MSPs entering into trading relationship documentation with 
their counterparties would be required to have a sound legal basis to 
determine that such agreements will be enforceable in accordance with 
their terms.
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    \8\ See Regulations Establishing and Governing the Duties of 
Swap Dealers and Major Swap Participants, 75 FR 71397, 71405 (Nov. 
23, 2010).
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    The Commission solicits comment regarding whether proposed 
Sec. Sec.  23.501 and 23.600 are sufficient to ensure that SDs and MSPs 
have a sound legal basis for their swap documentation or whether the 
Commission should adopt the concept of ``qualifying master netting 
agreements'' from existing banking regulations.

[[Page 23735]]

2. Positions Between CSEs and Other SDs or MSPs
    Proposed Sec.  23.152 addresses initial margin and variation margin 
requirements for positions of CSEs with other SDs or MSPs. (The latter 
would include both SD/MSPs that are CSEs and SD/MSPs for which there is 
a prudential regulator.) The regulation would require CSEs to collect 
initial margin for every uncleared swap with another SD or MSP on or 
before the date of execution of the swap.\9\ The proposed rule would 
require the CSEs to maintain initial margin from its counterparty equal 
to or greater than an amount calculated pursuant to proposed Sec.  
23.155, discussed below, until the swap is liquidated.\10\ The credit 
support arrangements between a CSE and its counterparty would be 
prohibited from containing a threshold below which the CSE was not 
required to post initial margin, i.e., zero thresholds would be 
required.
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    \9\ In previously proposed rules, execution has been defined to 
mean, ``with respect to a swap transaction, an agreement by the 
counterparties (whether orally, in writing, electronically, or 
otherwise) to the terms of the swap transaction that legally binds 
the counterparties to such terms under applicable law.'' 
Confirmation, Portfolio Reconciliation, and Portfolio Compression 
Requirements for Swap Dealers and Major Swap Participants, 75 FR 
81519, 81530 (Dec. 28, 2010). Additionally, swap transaction has 
been defined to mean ``any event that results in a new swap or in a 
change to the terms of a swap, including execution, termination, 
assignment, novation, exchange, transfer, amendment, conveyance, or 
extinguishing of rights or obligations of a swap.'' Id. at 81531.
    \10\ The use of the term ``liquidated'' in this context should 
be construed to include all ownership events related to that swap, 
including expiration or maturation.
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    (In order to reduce transaction costs, proposed Sec.  23.150 would 
establish a ``minimum transfer amount'' of $100,000. Initial and 
variation margin payments would not be required to be made if below 
that amount. This amount was selected in consultation with the 
prudential regulators. It represents an amount sufficiently small that 
the level of risk reduction might not be worth the transaction costs of 
moving the money. It only affects the timing of collection; it does not 
change the amount of margin that must be collected once the $100,000 
level is exceeded.)
    CSEs also would be required to collect variation margin for all 
trades with another SD or MSP. Again, zero thresholds would be 
required, and the obligation would continue on each business day until 
the swap is liquidated. The proposal contains a provision stating that 
a CSE would not be deemed to have violated its obligation to collect 
variation margin if it took certain steps. Specifically, if a 
counterparty failed to pay the required variation margin to the CSE, 
the CSE would be required to make the necessary efforts to attempt to 
collect the variation margin, including the timely initiation and 
continued pursuit of formal dispute resolution mechanisms, or otherwise 
demonstrate upon request to the satisfaction of the Commission that it 
has made appropriate efforts to collect the required variation margin 
or commenced termination of the swap.
    It is the nature of the dealer business that dealers are at the 
center of the markets in which they participate. Similarly, a major 
swap participant, by its terms, is a significant trader. Collectively, 
SDs and MSPs pose greater risk to the markets and the financial system 
than other swap market participants. Accordingly, under the mandate of 
Section 4s(e), the Commission believes that they should be required to 
collect margin from one another.
3. Positions Between CSEs and Financial Entities
    Proposed Sec.  23.153 addresses initial margin and variation margin 
requirements for positions between CSEs and financial entities. 
Proposed Sec.  23.150 would define a financial entity as a counterparty 
that is not an SD or MSP and that is either: (i) A commodity pool as 
defined in Section 1a(5) of the Act; (ii) a private fund as defined in 
Section 202(a) of the Investment Advisors Act of 1940; (iii) an 
employee benefit plan as defined in paragraphs (3) and (32) of section 
3 of the Employee Retirement Income and Security Act of 1974; (iv) a 
person predominantly engaged in activities that are in the business of 
banking, or in activities that are financial in nature as defined in 
Section 4(k) of the Bank Holding Company Act of 1956; (v) a person that 
would be a financial entity described in (i) or (ii) if it were 
organized under the laws of the United States or any State thereof; 
(vi) the government of any foreign country or a political subdivision, 
agency, or instrumentality thereof; or (vii) any other person the 
Commission may designate. With three modifications discussed below, 
this definition tracks the definition in Section 2(h)(7)(C) of the Act 
that is used in connection with an exception from any applicable 
clearing mandate.
    Item (v) of the proposed definition adds entities that would be a 
commodity pool or private fund if organized in the United States. The 
Commission believes that such entities would pose similar risks to 
those of similar entities located within the United States.
    Item (vi) of the proposed definition adds any government of any 
foreign country or any political subdivision, agency, or 
instrumentality thereof. The Commission notes that these types of 
sovereign counterparties do not fit easily into the proposed rule's 
categories of financial and nonfinancial entities. In comparing the 
characteristics of sovereign counterparties with those of financial and 
nonfinancial entities, the Commission preliminarily believes that the 
financial condition of a sovereign will tend to be closely linked with 
the financial condition of its domestic banking system, through common 
effects of the business cycle on both government finances and bank 
losses, as well as through the safety net that many sovereigns provide 
to banks. Such a tight link with the health of its domestic banking 
system, and by extension with the broader global financial system, 
makes a sovereign counterparty similar to a financial entity both in 
the nature of the systemic risk and the risk to the safety and 
soundness of the covered swap entity. As a result, the Commission 
preliminarily believes that sovereign counterparties should be treated 
as financial entities for purposes of the proposed rule's margin 
requirements.
    Item (vii) in the proposed definition permits the Commission to 
designate additional entities as financial entities. The Commission 
understands that the prudential regulators are proposing the same 
provision. This would enable regulators to accomplish the purposes of 
Section 4s in circumstances where they identify additional entities 
whose activities and risk profile warrant inclusion. The Commission 
solicits comment on whether these entities are appropriate, whether 
additional entities should be designated as financial entities, and 
what criteria should be applicable.
    The Commission believes that financial entities, which generally 
are not using swaps to hedge or mitigate commercial risk, potentially 
pose greater risk to CSEs than non-financial entities. Accordingly, if 
a CSE chooses to expose itself to such risk, it should take steps to 
mitigate such risks.
    Initial margin would be required to be collected by CSEs for every 
trade with a financial entity on or before the date of execution of the 
swap. The proposed rule would require the CSEs to maintain initial 
margin from its counterparty equal to or greater than an amount 
calculated pursuant to proposed Sec.  23.155, discussed below, until 
the swap is liquidated.

[[Page 23736]]

    Zero thresholds would be required except for certain financial 
entities \11\ that: (i) Are subject to capital requirements established 
by a prudential regulator or a State insurance regulator; (ii) 
predominantly use swaps to hedge; and (iii) do not have significant 
swaps exposure.\12\ The proposal set forth ranges within which the 
threshold would fall. These eligibility standards and ranges were 
established in consultation with the prudential regulators.
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    \11\ The prudential regulators proposed rulemaking refers to 
these financial entities as ``low-risk'' financial entities based on 
the relative risk posed by the type of counterparty.
    \12\ Significant swap exposure is defined by reference to rules 
previously proposed by the Commission. See Further Definition of 
``Swap Dealer,'' ``Security-Based Swap Dealer,'' ``Major Swap 
Participant,'' ``Major Security-Based Swap Participant'' and 
``Eligible Contract Participant'' 75 FR 80174 (Dec. 21, 2010).
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    The Commission solicits comment on whether thresholds should be 
permitted at all, and if so, what entities should be eligible, and at 
what level they should be set. If the Commission determines to permit 
thresholds, it anticipates that the final rule would establish a single 
level rather than a range.
    Similarly, variation margin would also be required to be collected 
by CSEs on all transactions with a financial entity. Zero thresholds 
would be required with the same exception discussed above for initial 
margin. Any applicable thresholds for initial and variation margin 
would be separate and therefore could be cumulative. The obligation 
would continue on each business day until the swap is liquidated.
    The Commission notes that under the proposed rule each CSE would be 
required to collect variation margin from financial entities but would 
not be required to pay variation margin to them. This approach is 
consistent with what the prudential regulators are proposing in their 
margin rules. The rationale is that when an SD pays variation margin to 
an financial entity that is not subject to capital requirements, money 
is flowing from a regulated entity to an unregulated one. By following 
this approach in its proposed rules, the Commission is endeavoring to 
follow Section 4s(e)(D)(ii)'s requirement that Commission regulations 
on margin be comparable to those of the prudential regulators ``to the 
maximum extent practicable.''
    The Commission wishes to highlight and solicits comment regarding 
the risk management effects of this approach and its appropriateness 
under Section 4s(e)(E)(3)(A) of the CEA. As noted above, two-way 
variation margin has been a keystone of the ability of DCOs to manage 
risk. Each day current exposure is removed from the market through the 
payment and collection of variation margin for all products and all 
participants regardless of their identity or financial resources.
    If two-way variation margin were not required for uncleared swaps 
between CSEs and financial entities, the CSE's exposures may be allowed 
to accumulate. In contrast to initial margin, which is designed to 
cover potential future exposures, variation margin addresses actual 
current exposures, that is, losses that have already occurred. 
Unchecked accumulation of such exposures was one of the characteristics 
of the financial crisis which, in turn, led to the enactment of the 
Dodd-Frank Act.
    Moreover, both payment and collection of variation margin help 
ensure the safety and soundness of the swap dealer or major swap 
participant. Daily collection helps the safety and soundness of the CSE 
by removing current exposure from each counterparty. But daily payment 
also helps safety and soundness by preventing the CSE from building up 
exposures that it cannot fulfill.
    Finally, two-way variation would address the risk associated with 
the non-cleared swaps held as a swap dealer or major swap participant. 
Uncleared swaps are likely to be more customized and consequently trade 
in a less liquid market than cleared swaps. As a result, uncleared 
swaps might take a longer time and require a greater price premium to 
be liquidated than cleared swaps, particularly in a distressed market 
conditions. Failure to remove current exposures in advance of such a 
situation through daily, two-way variation margin could exacerbate any 
losses in the event of a SD or MSP default.
    Accordingly, in addition to requesting comment on the proposed 
requirement for collection of variation margin set forth below as 
23.153(b)(1), the Commission also requests comment on whether it should 
adopt an additional provision as follows:

    For each uncleared swap between a covered swap entity and a 
financial entity, each covered swap entity shall pay variation 
margin as calculated pursuant to Sec.  23.156 of this part directly 
to the financial entity or to a custodian selected pursuant to Sec.  
23.158 of this part. Such payments shall start on the business day 
after the swap is executed and continue each business day until the 
swap is liquidated.

    Many of the considerations discussed above also might apply to two-
way initial margin. The Commission solicits comments on whether two-way 
initial margin is appropriate for transactions between CSEs and 
financial entities.
4. Positions Between CSEs and Non-financial Entities
    The proposal would not impose margin requirements on non-financial 
entities. Proposed Sec.  23.150 would define a non-financial entity as 
a counterparty that is not a swap dealer, a major swap participant, or 
a financial entity. The Commission believes that such entities, which 
are using swaps to hedge commercial risk, pose less risk to CSEs than 
financial entities. Consistent with Congressional intent,\13\ the 
proposal would not impose margin requirements on such positions.
---------------------------------------------------------------------------

    \13\ Letter from Chairman Debbie Stabenow, Committee on 
Agriculture, Nutrition and Forestry, U.S. Senate, Chairman Frank D. 
Lucas, Committee on Agriculture, United States House of 
Representatives, Chairman Tim Johnson, Committee on Banking, 
Housing, and Urban Affairs, U.S. Senate, and Chairman Spencer 
Bachus, Committee on Financial Services, United States House of 
Representatives to Secretary Timothy Geithner, Department of 
Treasury, Chairman Gary Gensler, U.S. Commodity Futures Trading 
Commission, Chairman Ben Bernanke, Federal Reserve Board, and 
Chairman Mary Shapiro, U.S. Securities and Exchange Commission 
(April 6, 2011); Letter from Chairman Christopher Dodd, Committee on 
Banking, Housing, and Urban Affairs, U.S. Senate, and Chairman 
Blanche Lincoln, Committee on Agriculture, Nutrition, and Forestry, 
U.S. Senate, to Chairman Barney Frank, Financial Services Committee, 
United States House of Representatives, and Chairman Collin 
Peterson, Committee on Agriculture, United States House of 
Representatives (June 30, 2010); see also 156 Cong. Rec. S5904 
(daily ed. July 15, 2010) (statement of Sen. Lincoln)
---------------------------------------------------------------------------

    The proposal would require that CSEs have credit support 
arrangements in place consistent with proposed Sec.  23.504.\14\ This 
would ``help ensure the safety and soundness of the swap dealer or 
major swap participant'' by providing clarity as its rights and 
obligations. The proposal would not dictate the terms of any margin 
arrangements other than stating that each covered swap entity may 
accept as margin from non-financial entities only assets for which the 
value is reasonably ascertainable on a periodic basis in a manner 
agreed to by the parties in the credit support arrangements.
---------------------------------------------------------------------------

    \14\ Swap Trading Relationship Documentation Requirements for 
Swap Dealers and Major Swap Participants, 76 FR 6715 (Feb. 8, 2011).
---------------------------------------------------------------------------

    The parties would be free to set initial margin and variation 
margin requirements in their discretion and any thresholds agreed upon 
by the parties would be permitted. The proposal would require that CSEs 
pay and collect initial margin and variation margin as set forth in 
their agreements with their counterparties. The Commission understands 
that the proposal differs

[[Page 23737]]

from the proposal of the prudential regulators which would require that 
CSEs collect variation margin from non-financial entities at least once 
per week, if applicable thresholds were exceeded.
    The proposal would require each CSE to calculate hypothetical 
initial and variation margin amounts each day for positions held by 
non-financial entities. That is, the CSE must calculate what the margin 
amounts would be if the counterparty were another SD or MSP.\15\ These 
calculations would serve as risk management tools that would assist the 
CSE in measuring its exposure. Moreover, they would likely be necessary 
for CSEs in computing any capital requirements that might be 
applicable.
---------------------------------------------------------------------------

    \15\ This is consistent with the requirement set forth in 
Section 4s(h)(3)(B)(iii)(II) that SDs and MSPs must disclose to 
counterparties who are not SDs or MSPs a daily mark for uncleared 
swaps.
---------------------------------------------------------------------------

D. Calculation of Initial Margin

    Proposed Sec.  23.155 addresses how initial margin should be 
calculated. Models meeting specified standards would be permissible. If 
no model meeting the standards of the rule is available, the CSE would 
set margin in accordance with an alternative approach described below.
1. Models
    Proposed Sec.  23.155(b) sets forth requirements for models. Under 
proposed Sec.  23.155(b)(1), the following would be eligible: (i) A 
model currently in use for margining cleared swaps by a DCO, (ii) a 
model currently in use for margining uncleared swaps by an entity 
subject to regular assessment by a prudential regulator, or (iii) a 
model available for licensing to any market participant by a vendor. 
Unlike the banking institutions that will be overseen by the prudential 
regulators, the CSEs subject to the Commissions regulations may not 
have proprietary models. Moreover, given current budget constraints, 
the Commission does not have the resources to review numerous models 
individually. Accordingly, at this time, the Commission is proposing to 
permit the use of certain non-proprietary models. The proposal, 
however, also contains a provision which would permit the Commission to 
issue an order that would allow the use of proprietary models in the 
future should the Commission obtain sufficient resources.
    This is an aspect of the proposal that differs from the prudential 
regulators' approach. Because many banks already have proprietary 
models, and because the prudential regulators have the resources to 
review individual proprietary models, the prudential regulators would 
not permit the use of DCO models or the use of models licensed to 
market participants. The Commission solicits comment on the feasibility 
of the use of DCO models or third party models by CSEs for margining 
uncleared swaps.
    Proposed Sec.  23.155(b)(2) further requires that a model meet 
specified standards. The following are some of the elements that would 
be required in a model:
     The valuation of a swap must take into account all 
significant, identifiable risk factors, including any non-linear risk 
characteristics;
     The valuation of a swap must be based on pricing sources 
that are accurate and reliable;
     The model must set margin to cover at least 99% of price 
changes by product and by portfolio over at least a 10-day liquidation 
horizon;
     The model must be validated by an independent third party 
before being used and annually thereafter;
     The swap dealer or major swap participant must conduct 
back testing and stress testing of the model on a regular basis; and
     If the swap product is also offered for non-mandatory 
clearing by a registered DCO, the initial margin collected may not be 
less than the initial margin required by the DCO.

Parties could add individualized credit surcharges to the margin amount 
produced by the model.

    These standards are consistent with the standards that the 
Commission understands that the prudential regulators are proposing. 
They are also similar to the standards the Commission has used in 
evaluating DCO margin models, and that prudential regulators have used 
in assessing bank margin models.
    Proposed Sec.  23.155(b)(3) would require that models be filed with 
the Commission. The filing would include a complete explanation of:
     The manner in which the model meets the requirements of 
this section;
     The mechanics of the model;
     The theoretical basis of the model;
     The empirical support for the model; and
     Any independent third party validation of the model.
    Under proposed Sec.  23.155(b)(4), the Commission could approve or 
deny the application by an SD or MSP to use an initial margin model, or 
approve an amendment to the application, in whole or in part, subject 
to any conditions or limitations the Commission may require, if the 
Commission finds the approval to be necessary or appropriate in the 
public interest after determining, among other things, whether the 
applicant had met the requirements of the section and was in compliance 
with other applicable rules promulgated under the Act and by self-
regulatory organizations.
    Under proposed Sec.  23.155(b)(4), the Commission also could at any 
time require a CSE to provide further data or analysis concerning the 
amount of initial margin required or on deposit. In addition, the 
Commission could at any time require a CSE to modify the model to 
address potential vulnerabilities. These measures are designed to be 
prudent safeguards to be used to address weaknesses that may only 
become apparent over time.
2. Alternative Method
    Proposed Sec.  23.155(c) provides that if a model meeting the 
standards of the rule is not used, margin must be calculated in 
accordance with a specified alternative method. The Commission 
determined that a potentially effective way to measure the risk of 
uncleared swaps in cases where models were unavailable would be to base 
the margin requirements on the margin requirements for related cleared 
products.
    Proposed Sec.  23.155(c)(1) provides that the CSE identify in the 
credit support arrangements the swap cleared by a DCO in the same asset 
class as the uncleared swap for which the terms and conditions most 
closely approximate the terms and conditions of the uncleared swap. If 
there is no cleared swap whose terms and conditions closely approximate 
the uncleared swap, the swap dealer or major swap participant must 
identify in the credit support arrangements the futures contract 
cleared by a DCO in the same asset class as the uncleared swap which 
most closely approximates the uncleared swap and would be most likely 
to be used to hedge the uncleared swap.
    The CSE would ascertain the margin the DCO would require for the 
position. The CSE would then multiply the amount for a cleared swap by 
2.0 in order to determine the margin required for the uncleared swap or 
multiply the amount for a cleared futures contract by 4.4 in order to 
determine the margin required for the uncleared swap.
    The multiplier is calculated by comparing the anticipated 
liquidation time horizon for the cleared product to the anticipated 
liquidation time horizon for the uncleared swap and then applying 
several add-ons for additional risk factors. To illustrate, typically, 
a cleared futures contract is margined

[[Page 23738]]

using a one-day liquidation time period, while under the proposal, an 
uncleared swap would be margined using a 10-day period. A standard way 
to measure the increase in risk over the longer period is to multiply 
the margin for the shorter period by the square root of the longer 
period. The square root of 10 is 3.162.
    The proposal would increase this number to address several 
additional risks. A 10% cushion would be added to reflect that a 10-day 
period may be insufficient for some customized products. An additional 
10% cushion would be added to reflect that the square root method 
assumes a normal distribution of prices which might not be true for 
customized products. An additional 20% cushion would be added to 
reflect the basis risk between the cleared and uncleared products. 
Taking into account these add-ons yields a total multiplier of 4.4.
    A similar calculation for cleared swaps yields a multiplier of 2.0. 
The margin for cleared swaps generally would be higher than the margin 
for cleared futures because cleared swaps generally would be subject to 
a 5-day liquidation time.\16\ The greater similarity in the anticipated 
liquidation time results in a smaller multiplier when comparing 
uncleared swaps to cleared swaps than when comparing uncleared swaps to 
cleared futures.
---------------------------------------------------------------------------

    \16\ In rules the Commission previously proposed for DCOs, 
cleared swaps traded on a swap execution facility or executed 
bilaterally would be subject to a minimum five-day liquidation 
period for purposes of calculating initial margin, whereas swaps 
traded on a designated contract market may be subject to a minimum 
one-day requirement. Risk Management Requirements for Derivatives 
Clearing Organizations, 76 FR 3698, 3704-05 (Jan. 20, 2011). To the 
extent that a cleared swap was subject to the one-day requirement, 
the appropriate multiplier would be the same as the futures 
multiplier.
---------------------------------------------------------------------------

    This alternative model is another aspect of the proposal that 
differs from the prudential regulators' approach. Their alternative 
uses percentages of notional value. The Commission considered using a 
similar approach but recognized that the use of notional percentages is 
an imprecise measure that does not capture the nuances of risk and it 
appeared to be more appropriate to base initial margins for uncleared 
swaps on those required by DCOs for similar cleared swaps. The 
Commission invites comment on the relative merits of the two 
alternative approaches. In this regard, the Commission requests comment 
on the appropriateness of the levels of initial margin set forth in the 
prudential regulators' alternative approach.
    Proposed Sec.  23.155(c)(2) addresses portfolio offsets for swaps 
with correlated risk profiles under the alternative method. Again, the 
proposal is conservative. Reductions in margin based on offsetting risk 
characteristics of products would not be permitted across asset classes 
except between currencies and interest rates. Any reductions in margin 
based on offsetting risk characteristics of products within an asset 
class must have a sound theoretical basis and significant empirical 
support. No reduction may exceed 50% of the amount that would be 
required for the swap in the absence of a reduction.
    Proposed Sec.  23.155(c)(3) provides for modifications for 
particular products or positions. Each CSE would be required to monitor 
the coverage provided by margin established pursuant to this paragraph 
(c) and collect additional margin if appropriate to address the risk 
posed by particular products or positions.
    Under proposed Sec.  23.155(c)(4), the Commission could at any time 
require the CSE to post or collect additional margin because of 
additional risk posed by a particular product. Furthermore, the 
Commission could at any time require a CSE to post or collect 
additional margin because of additional risk posed by a particular 
party to the swap. For example, if the Commission were to learn that a 
particular counterparty was experiencing financial difficulty, it might 
need to take steps to ensure that the CSE held margin appropriate for 
the risk associated with the position. These measures are designed to 
be prudent safeguards similar to those discussed above.

E. Calculation of Variation Margin

    Proposed Sec.  23.156 addresses how variation margin should be 
calculated. Proposed Sec.  23.156(b) sets forth several requirements. 
The valuation of each swap must be determined pursuant to a method 
agreed upon by the parties in the credit support arrangements. It must 
be consistent with the requirements set forth in proposed Section 
23.504(b) of this part.\17\ It must be set forth with sufficient 
specificity to allow the counterparty, the Commission, and any 
applicable prudential regulator to calculate the requirement 
independently.
---------------------------------------------------------------------------

    \17\ Swap Trading Relationship Documentation Requirements for 
Swap Dealers and Major Swap Participants, 76 FR 6715 (Feb. 8, 2011).
---------------------------------------------------------------------------

    Under proposed Sec.  23.155(c), the Commission could at any time 
require the CSE to provide further data or analysis concerning the 
methodology. Furthermore, the Commission could at any time require a 
CSE to modify the methodology to address potential vulnerabilities. 
These measures are designed to be prudent safeguards to be used to 
address weaknesses that may only become apparent over time.
    As noted above, the Commission previously proposed Sec.  
23.504(b)(4), which would require that the swap trading documentation 
include written documentation in which the parties agree on the 
methods, procedures, rules and inputs for determining the value of each 
swap at any time from execution to the termination, maturity, or 
expiration of the swap. The agreed methods, procedures, rules and 
inputs would be required to constitute a complete and independently 
verifiable methodology for valuing each swap entered into between the 
parties. Proposed Sec.  23.504(b)(4)(iii) would require that the 
methodology include complete alternative methods for determining the 
value of the swap in the event that one or more inputs to the 
methodology become unavailable or fail, such as during times of market 
stress or illiquidity. The provisions proposed in this release are 
intended together with those previously proposed rules to ensure that 
all swap positions are accurately and reliably marked to market and all 
valuation disputes are resolved in a timely manner, thereby reducing 
risk.

F. Forms of Margin

    Proposed Sec.  23.157 addresses the types of assets that would be 
acceptable as margin in transactions involving CSEs. There are 
differences between initial margin and variation margin and within each 
category depending on counterparties.
1. Initial Margin
    Proposed Sec.  23.157(a)(2) provides that CSEs may only accept as 
initial margin from SDs, MSPs, or financial entities, the following 
assets:
     Immediately available cash funds denominated in U.S. 
dollars or the currency in which payment obligations under the swap are 
required to be settled;
     Any obligation which is a direct obligation of, or fully 
guaranteed as to principal and interest by, the United States or an 
agency of the United States; or
     Any senior debt obligation of the Federal National 
Mortgage Association, the Federal Home Loan Mortgage Corporation, a 
Federal Home Loan Bank, the Federal Agricultural Mortgage Corporation, 
or any obligation that is an ``insured obligation,'' as that term is 
defined in 12 U.S.C. 2277a(3), of a Farm Credit System bank.

[[Page 23739]]

    These are assets for which there are deep and liquid markets and, 
therefore, assets that can be readily valued and easily liquidated. The 
Commission requests comment on whether additional types of assets 
should be acceptable.
    To the extent a non-financial entity and a CSE have agreed that the 
non-financial entity will post initial margin, proposed Sec.  
23.157(a)(3) provides flexibility for initial margin posted by non-
financial entities with CSEs as to what assets are permissible. The 
standard is simply that the value of the asset is reasonably 
ascertainable on a periodic basis. This is in accordance with the 
statement in Section 4s(e)(3)(C) that the Commission permit the use of 
non-cash collateral as it determines consistent with preserving the 
financial integrity of the markets and preserving the stability of the 
United States financial system. The Commission understands that current 
market practice would support a periodic valuation of the assets used 
as noncash collateral, but solicits comment from market participants 
regarding how practical the requirement is. In particular, the 
Commission requests comment on how frequently such collateral could and 
should be valued.
    The Commission understands that this differs from the proposal of 
the prudential regulators. The prudential regulators would require CSEs 
to collect as initial margin for non-financial entities only the assets 
listed previously to cover any exposure above the credit exposure 
limit.
2. Variation Margin
    Proposed Sec.  23.157(b) would require that variation payments by 
CSEs, or financial entities be in cash or United States Treasury 
securities. This is consistent with the general purpose of variation 
margin of eliminating current exposure through the use of liquid, 
easily valued assets.
    To the extent a non-financial entity and a CSE have agreed that the 
non-financial entity will post variation margin, proposed Sec.  
23.157(b)(3) provides flexibility for variation margin posted by non-
financial entities with CSEs as to what assets are permissible. The 
standard is simply that the value of the asset is reasonably 
ascertainable on a periodic basis. As was the case for initial margin, 
this is in accordance with the statement in Section 4s(e)(3)(C) that 
the Commission permit the use of non-cash collateral.
    Proposed Sec.  23.157(c) establishes haircuts for assets received 
by a CSE from an SD, MSP, or financial entity as follows:

               Margin Value Ranges for Non-Cash Collateral
                           [% of market value]
------------------------------------------------------------------------
                                              Duration (years)
                                  --------------------------------------
                                       0-5          5-10         > 10
------------------------------------------------------------------------
U.S. Treasuries and Fully
 Guaranteed Agencies:
    Bills/Notes/Bonds/Inflation       [98-100]      [95-99]      [94-98]
     Indexed.....................
    Zero Coupon, STRIPs..........      [97-99]      [94-98]      [90-94]
FHFA-Regulated Institutions
 Obligations and Insured
 Obligations of FCS Banks:
    Bills/Notes/Bonds............     [96-100]      [94-98]      [93-97]
    Zero Coupon..................      [95-99]      [93-97]      [89-93]
------------------------------------------------------------------------

These haircuts were based on a consultation with prudential regulators 
who use them in other contexts.

    Proposed Sec.  23.157(d) would authorize certain actions by the 
Commission regarding margin assets. The Commission could:
     Require a CSE to provide further data or analysis 
concerning any margin asset posted or received;
     Require a CSE to replace a margin asset posted to a 
counterparty with a different margin asset to address potential risks 
posed by the asset;
     Require a CSE to require a counterparty that is an SD, 
MSP, or a financial entity to replace a margin asset posted with the 
CSE with a different margin asset to address potential risks posed by 
the asset;
     Require a CSE to provide further data or analysis 
concerning margin haircuts; or
     Require a CSE to modify a margin haircut applied to an 
asset received from an SD or MSP, or a financial entity to address 
potential risks posed by the asset.

All these actions are intended to be methods for ensuring the safety 
and soundness of the CSE and protecting the financial system.

G. Custodial Arrangements

    Proposed Sec.  23.158 addresses custodial arrangements. The 
proposal is intended to safeguard margin assets.
    Under proposed Sec.  23.158(a) each CSE must offer each 
counterparty the opportunity to select a custodian that is not 
affiliated with the CSE. Further, each CSE must hold initial margin 
received from a counterparty that is an SD or MSP at a custodian that 
is independent of the CSE and the counterparty. Similarly, a CSE that 
posts initial margin with a counterparty that is an SD or MSP must 
require the counterparty to hold the initial margin at a custodian that 
is independent of the SD or MSP and the counterparty.
    Further, the proposal would require that the custodian be subject 
to the same insolvency regime as the CSE. This would facilitate quicker 
recovery of margin assets.
    Under proposed Sec.  23.158(b)(1) each CSE must specify in each 
custodial agreement that the custodian may not rehypothecate margin 
assets or reinvest them in assets that are not permitted forms of 
margin. Further, upon certification to the custodian in accordance with 
the provisions of 23.602(b)(1) by a party that it is entitled to 
receipt of margin, the custodian must release margin to the certifying 
party.\18\
---------------------------------------------------------------------------

    \18\ Protection of Collateral of Counterparties to Uncleared 
Swaps; Treatment of Securities in a Portfolio Margining Account in a 
Commodity Broker Bankruptcy, 75 FR 75432 (Dec. 3, 2010).
---------------------------------------------------------------------------

    Under proposed Sec.  23.158(b)(2), upon receipt of initial margin 
from a counterparty, no CSE may post such assets as margin for a swap, 
a security-based swap, a commodity for future delivery, a security, a 
security futures product, or any other product subject to margin. These 
provisions are designed to prevent the same asset from being passed 
around as margin for multiple positions.
    Under proposed Sec.  23.158(c), the Commission may at any time 
require a CSE to provide further data or analysis concerning any 
custodian. Further, the Commission may at any time require a CSE 
participant to move assets held on behalf of a counterparty to another 
custodian to address risks posed by the

[[Page 23740]]

original custodian. These provisions are designed to protect the assets 
of the parties to the contract.

H. Request for Comment

    The Commission requests comment on all aspects of the proposed 
rules regarding margin. In particular, the Commission requests comment 
on the following:
     Are proposed Sec. Sec.  23.501 and 23.600 sufficient to 
ensure that SDs and MSPs have a sound legal basis for their swap 
documentation, or should the Commission adopt the concept of 
``qualifying master netting agreements'' from existing banking 
regulations?
     It is the Commission's understanding that the prudential 
regulators would require SDs and MSPs that are banks to appropriately 
take into account and address the credit risk posed by the counterparty 
and the risks of uncleared swaps, and further the prudential 
authorities would require SDs and MSPs that are banks to enforce those 
credit limit policies, or credit thresholds, with regard to the banks' 
counterparties. The Commission previously proposed Sec.  
23.600(c)(1),\19\ which would require SDs and MSPs to set risk 
tolerance limits for themselves. One of the critical risk limits in any 
risk management program would relate to credit risk. The Commission 
solicits comment regarding whether it should adopt a requirement, 
similar to the one proposed by the prudential authorities, requiring 
non-bank SDs and MSPs to enforce their credit risk limits as a matter 
of policy.
---------------------------------------------------------------------------

    \19\ See Regulations Establishing and Governing the Duties of 
Swap Dealers and Major Swap Participants, 75 FR 71397, 71404 (Nov. 
23, 2010) (requiring that SDs and MSPs ``take into account market, 
credit, liquidity, foreign currency, legal, operational, settlement, 
and any other applicable risks together with a description of the 
risk tolerance limits set by the swap dealer or major swap 
participant and the underlying methodology''). Additionally, the 
risk tolerance limits would have to be reviewed and approved 
quarterly by senior management and annually by the governing body, 
and exceptions to risk tolerance limits would require prior approval 
of a supervisor in the risk management unit.
---------------------------------------------------------------------------

     What effects will the proposed rules have on the overall 
liquidity of the financial markets?
     Would the proposed rules have differing effects on 
liquidity by asset class?
     Would the proposed rules have differing effects on 
liquidity by class of participant?
     Should the Commission permit thresholds for either initial 
margin or variation margin?
     If so, what standards should apply?
     Is the proposed definition of financial entity 
appropriate?
     Should the Commission instead define financial entity as a 
person that is not eligible to claim an exception from mandatory 
clearing under section 2(h)(7) of the Act?
     Should the Commission exercise authority to designate 
additional persons as financial entities?
     If so, what standards should appl