Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants-Cross-Border Application of the Margin Requirements, 34817-34854 [2016-12612]

Download as PDF Vol. 81 Tuesday, No. 104 May 31, 2016 Part VI Commodity Futures Trading Commission asabaliauskas on DSK3SPTVN1PROD with RULES 17 CFR Part 23 Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants—Cross-Border Application of the Margin Requirements; Agency Information Collection Activities: Proposed Collection, Comment Request: Final Rule, Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants—Cross-Border Application of the Margin Requirements; Final Rule and Notice VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 PO 00000 Frm 00001 Fmt 4717 Sfmt 4717 E:\FR\FM\31MYR2.SGM 31MYR2 34818 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations COMMODITY FUTURES TRADING COMMISSION 17 CFR Part 23 RIN 3038–AC97 Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants—Cross-Border Application of the Margin Requirements Commodity Futures Trading Commission. ACTION: Final rule. AGENCY: On January 6, 2016, the Commodity Futures Trading Commission (‘‘Commission’’ or ‘‘CFTC’’) published final regulations to implement section 4s(e) of the Commodity Exchange Act, which requires the Commission to adopt initial and variation margin requirements for uncleared swaps of swap dealers and major swap participants that do not have a Prudential Regulator (collectively, ‘‘Covered Swap Entities’’ or ‘‘CSEs’’). In this release, the Commission is adopting a rule to address the cross-border application of the Commission’s margin requirements for CSEs’ uncleared swaps. DATES: The final rule is effective August 1, 2016. FOR FURTHER INFORMATION CONTACT: Laura B. Badian, Assistant General Counsel, 202–418–5969, lbadian@ cftc.gov; Paul Schlichting, Assistant General Counsel, 202–418–5884, pschlichting@cftc.gov; or Elise (Pallais) Bruntel, Counsel, (202) 418–5577, ebruntel@cftc.gov; Office of the General Counsel, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581. SUPPLEMENTARY INFORMATION: SUMMARY: asabaliauskas on DSK3SPTVN1PROD with RULES Table of Contents I. Background A. Introduction B. Key Considerations in the Cross-Border Application of the Margin Regulations II. The Final Rule A. Key Definitions 1. U.S. Person a. Proposed Rule b. Comments c. Final Rule 2. Guarantees a. Proposed Rule b. Comments c. Final Rule 3. Foreign Consolidated Subsidiary (‘‘FCS’’) a. Proposed Rule b. Comments c. Final Rule 4. Counterparty Representations VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 B. Applicability of Margin Requirements To Cross-Border Uncleared Swaps 1. Proposed Rule 2. Substituted Compliance a. Comments b. Final Rule 3. Exclusion a. Comments b. Final Rule 4. Special Provisions for Non-Segregation Jurisdictions a. Comments b. Final Rule 5. Special Provisions for Non-Netting Jurisdictions a. Comments b. Final Rule C. Comparability Determinations 1. Proposed Rule 2. Comments 3. Final Rule III. Related Matters A. Regulatory Flexibility Act B. Paperwork Reduction Act 1. Information Collection—Comparability Determinations 2. Information Collection—NonSegregation Jurisdictions 3. Information Collection—Non-Netting Jurisdictions C. Cost-Benefit Considerations 1. Introduction 2. Key Definitions a. U.S. Person b. Guarantees c. Foreign Consolidated Subsidiary 3. Application a. Substituted Compliance b. Exclusion c. Non-Segregation Jurisdictions and NonNetting Jurisdictions 4. Comparability Determinations 5. Section 15(a) Factors a. Protection of Market Participants and the Public b. Efficiency, Competitiveness, and Financial Integrity c. Price Discovery d. Sound Risk Management Practices e. Other Public Interest Considerations Table A—Application of the Final Rule I. Background A. Introduction In the wake of the 2008 financial crisis, Congress enacted Title VII of the Wall Street Reform and Consumer Protection Act (‘‘Dodd-Frank Act’’),1 which modified the Commodity Exchange Act (‘‘CEA’’) 2 to establish a comprehensive regulatory framework for swaps. A cornerstone of this framework is the reduction of systemic risk to the U.S. financial system through the establishment of margin requirements for uncleared swaps. CEA section 4s(e), added by section 731 of the Dodd-Frank Act, directs the Commission to adopt rules establishing minimum initial and variation margin 1 Public 27 PO 00000 Law 111–203, 124 Stat. 1376 (2010). U.S.C. 1 et seq. Frm 00002 Fmt 4701 Sfmt 4700 requirements on all swaps that are not cleared by a registered derivatives clearing organization (‘‘DCO’’).3 To offset the greater risk to the swap dealer or major swap participant and the financial system arising from the use of uncleared swaps, the Commission’s margin requirements must (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 uncleared swaps held as a swap dealer or major swap participant.4 Under CEA section 4s(e), the Commission’s margin requirements apply to each swap dealer or major swap participant for which there is no Prudential Regulator (collectively, ‘‘Covered Swap Entities’’ or ‘‘CSEs’’).5 The Commission published final margin requirements for CSEs in January 2016.6 In July 2015, consistent with its authority in CEA sections 4s(e) and 2(i),7 the Commission proposed a rule to address the cross-border application of the Commission’s margin requirements (the ‘‘proposed rule’’).8 The proposed rule set out the circumstances under which a CSE would be allowed to satisfy the Commission’s margin requirements by complying with comparable foreign margin requirements 3 See 7 U.S.C. 6s(e)(2)(B)(ii). U.S.C. 6s(e)(3)(A). 5 See 7 U.S.C. 6s(e)(1)(B). Swap dealers and major swap participants for which there is a Prudential Regulator must meet the margin requirements for uncleared swaps established by the applicable Prudential Regulator. 7 U.S.C. 6s(e)(1)(A). See also 7 U.S.C. 1a(39) (defining the term ‘‘Prudential Regulator’’ to include the Board of Governors of the Federal Reserve System; the Office of the Comptroller of the Currency; the Federal Deposit Insurance Corporation; the Farm Credit Administration; and the Federal Housing Finance Agency). The Prudential Regulators published final margin requirements in November 2015. See Margin and Capital Requirements for Covered Swap Entities, 80 FR 74840 (Nov. 30, 2015) (‘‘Prudential Regulators’ Final Margin Rule’’). 6 See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016) (the ‘‘Final Margin Rule’’). The Final Margin Rule, which became effective April 1, 2016, is codified in part 23 of the Commission’s regulations. See 17 CFR 23.150–159, 161. 7 See 7 U.S.C. 2(i). Section 2(i) of the CEA states that the provisions of the CEA relating to swaps that were enacted by the Wall Street Transparency and Accountability Act of 2010 (including any rule prescribed or regulation promulgated under that Act), shall not apply to activities outside the United States unless those activities (1) have a direct and significant connection with activities in, or effect on, commerce of the United States; or (2) contravene such rules or regulations as the Commission may prescribe or promulgate as are necessary or appropriate to prevent the evasion of any provision of this Act that was enacted by the Wall Street Transparency and Accountability Act of 2010. 8 See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants— Cross-Border Application of the Margin Requirements, 80 FR 41376 (July 14, 2015) (‘‘Proposal’’). 47 E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES (‘‘substituted compliance’’); offered certain CSEs a limited exclusion from the Commission’s margin requirements (the ‘‘Exclusion’’); and outlined a framework for assessing whether a foreign jurisdiction’s margin requirements are comparable to the Commission’s requirements (‘‘comparability determinations’’). The Commission developed the proposed rule after close consultation with the Prudential Regulators and in light of comments from and discussions with market participants and foreign regulators.9 The Commission requested comment on all aspects of the proposed rule. After a careful review of the comments,10 the Commission is adopting a final rule largely as proposed but with some 9 In 2014, in conjunction with reproposing its margin requirements, the Commission requested comment on three alternative approaches to the cross-border application of its margin requirements: (i) A transaction-level approach consistent with the Commission’s guidance on the cross-border application of the CEA’s swap provisions, see Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations, 78 FR 45292 (July 26, 2013) (‘‘Guidance’’); (ii) an approach consistent with the Prudential Regulators’ proposed cross-border framework for margin, see Margin and Capital Requirements for Covered Swap Entities, 79 FR 57348 (Sept. 24, 2014) (‘‘Prudential Regulators’ Proposed Margin Rule’’); and (iii) an entity-level approach that would apply margin rules on a firmwide basis (without any exclusion for swaps with non-U.S. counterparties). See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 79 FR 59898 (Oct. 3, 2014) (‘‘Proposed Margin Rule’’). Following a review of comments received in response to this release, the Commission’s Global Markets Advisory Committee (‘‘GMAC’’) hosted a public panel discussion on the cross-border application of margin requirements. 10 The Commission received eighteen comment letters in response to the Proposal: Alternative Investment Management Association and Investment Association (Sept. 11, 2015) (‘‘AIMA/ IA’’); American Bankers Association and ABA Securities Association (Sept. 14, 2015) (‘‘ABA/ ABASA’’); American Council of Life Insurers (Sept. 14, 2015) (‘‘ACLI’’); Americans for Financial Reform (Sept. 14, 2015) (‘‘AFR’’); Chris Barnard (Sept. 14, 2015) (‘‘Barnard’’); Better Markets, Inc. (Sept. 14, 2015) (‘‘Better Markets’’); Financial Services Roundtable (Sept. 14, 2015) (‘‘FSR’’); FMSWertmanagement (Sept. 14, 2015) (‘‘FMS–WM’’); Institute for Agriculture and Trade Policy (Sept. 14, 2015) (‘‘IATP’’); Investment Company Institute Global (Sept. 14, 2015) (‘‘ICI Global’’); International Swaps and Derivatives Association, Inc. (Sept. 11, 2015) (‘‘ISDA’’); Institute of International Bankers and Securities Industry and Financial Markets Association (Sept. 14, 2015) (‘‘IIB/SIFMA’’); Japanese Bankers Association (Sept. 13, 2015) (‘‘JBA’’); LCH.Clearnet Group Ltd. (Sept. 14, 2015) (‘‘LCH.Clearnet’’); Managed Funds Association (Sept. 14, 2015) (‘‘MFA’’); PensionsEurope (Sept. 14, 2015) (‘‘PensionsEurope’’); Asset Management Group of the Securities Industry and Financial Markets Association (Sept. 14, 2015) (‘‘SIFMA AMG’’); and Vanguard (Sept. 14, 2015) (‘‘Vanguard’’). The comment file is available at http://comments.cftc.gov/PublicComments/ CommentList.aspx?id=1600. VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 modifications, as described below (the ‘‘Final Rule’’).11 B. Key Considerations in the CrossBorder Application of the Margin Regulations The overarching objective of the cross-border margin framework is to further the congressional mandate to ensure the safety and soundness of CSEs in order to offset the greater risk to CSEs and the financial system arising from the use of swaps that are not cleared.12 Margin’s primary function is to protect a CSE from counterparty default, allowing it to absorb losses and continue to meet its obligations using collateral provided by the defaulting counterparty.13 While the requirement to post margin protects the counterparty in the event of the CSE’s default, it also functions as a risk management tool, limiting the amount of leverage a CSE can incur by requiring that it have adequate eligible collateral to enter into an uncleared swap. In this way, margin serves as a first line of defense not only in protecting the CSE but in containing the amount of risk in the financial system as a whole, reducing the potential for contagion arising from uncleared swaps.14 The Commission recognizes that, to achieve the goals of the Dodd-Frank Act, its cross-border framework must take into account the global state of the swap market. The nature of modern financial markets means that risk is not static or contained by geographic boundaries. Market participants engage in swaps on a 24-hour basis in global markets, and many financial entities operate through a complex web of branches, subsidiaries, and affiliates that are scattered across the globe.15 These Final Rule is codified at 17 CFR 23.160. 7 U.S.C. 6s(e)(3)(A). 13 See Proposal, 80 FR at 41377. 14 Although margin and capital are, by design, complementary, they serve equally important but different risk mitigation functions. Unlike margin, capital is difficult to rapidly adjust in response to changing risk exposures. Capital therefore can be viewed as a backstop in the event that margin is insufficient to cover losses resulting from a counterparty default. The Commission proposed capital rules in 2011. See Capital Requirements for Swap Dealers and Major Swap Participants, 76 FR 27802 (May 12, 2011) (‘‘Proposed Capital Rule’’). The Commission intends to repropose capital rules later this year. 15 The largest U.S. banks have somewhere between 2,000 to 3,000 affiliated global entities, hundreds of which are based in the Cayman Islands. Data from the National Information Center (NIC), a repository of financial data and institutional characteristics of banks and other entities regulated by the Federal Reserve, show the increasing complexity of U.S. banks’ foreign operations. See NIC, available at http:// www.ffiec.gov/nicpubweb/nicweb/nichome.aspx. For instance, in 1990, there were 1,300 foreign nonbank subsidiaries in the database; at the end of 34819 branches and affiliated entities are highly interdependent, sharing not only information technology and operational support but risk management, treasury, and custodial functions. Risks from a swap entered into by an affiliated entity in one jurisdiction may be transferred to another affiliate in a different jurisdiction through inter-affiliate transactions. As part of their risk management practices, swap dealers also commonly lay off the risk of clientfacing swaps in the interdealer market, which, as a result of consolidation among global financial institutions, has become concentrated among a relatively small number of dealers.16 These developments, along with others, have led to a highly interconnected global swap market, where risks originating in one jurisdiction and entity are easily transferred to other jurisdictions and entities, increasing the possibility of cascading defaults. As the 2008 financial crisis illustrated, the global nature of the swap market heightens the potential that risks assumed by a firm overseas stemming from its uncleared swaps can be transmitted across national borders to cause or contribute to substantial losses to U.S. persons and threaten the stability of the entire U.S. financial system. Complex financial and operational relationships among domestic and international affiliates, including guarantees from U.S. entities at entities like American International Group (AIG) and Lehman Brothers Holding Inc., demonstrated how the transfer of risk across multinational affiliated entities, including risk associated with swaps, is not always transparent and can be difficult to fully assess. More recent events, including major losses from J.P. Morgan Chase & 11 The 12 See PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 2014, there were more than 6,000. Foreign ownership is also highly concentrated in a few large firms: Goldman Sachs and Morgan Stanley own more than 2,000 foreign nonbank subsidiaries and, together with General Electric, own 63 percent of all foreign bank subsidiaries. Citigroup, JPMorgan Chase, and Bank of America account for 75 percent of all foreign branches. 16 According to the Quarterly Report on Bank Trading and Derivatives Activities issued by the Office of the Comptroller of the Currency (OCC) for the second quarter of 2015, the notional value of derivative contracts held by insured U.S. commercial banks and savings associations was $197.9 trillion. See Office of the Comptroller of the Currency, Quarterly Report on Bank Trading and Derivatives Activities Second Quarter 2015, 1 (2015), available at http://www.occ.gov/topics/ capital-markets/financial-markets/trading/ derivatives/dq215.pdf. At the same time, four large commercial banks with the most derivatives activity—Goldman Sachs, JPMorgan Chase Bank NA, Citibank, and Bank of America NA—held 91.1% of the notional amount of these derivatives contracts. Id. at 11, 16. Contracts for swaps specifically accounted for $117.5 trillion of the $197.9 trillion total notional. Id. at 16. E:\FR\FM\31MYR2.SGM 31MYR2 34820 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations Co.’s ‘‘London Whale’’ or the near failure of FCXM Inc. following trading losses at its London and Singapore affiliates, illustrate the continued potential for cross-border activities to have a significant impact on U.S. entities and markets. The global nature of the swap market, coupled with the interconnectedness of market participants, also necessitate that the Commission recognize the supervisory interests of foreign regulatory authorities and consider the impact of its choices on market efficiency and competition, which are vital to a well-functioning global swap market.17 Foreign jurisdictions are at various stages of implementing margin reforms. To the extent that other jurisdictions adopt requirements with different coverage or timelines, the Commission’s margin requirements may lead to competitive burdens for U.S. entities and deter non-U.S. persons from transacting with U.S. CSEs and their affiliates overseas. The Commission’s substituted compliance regime—a central element of the Final Rule—is intended to address these concerns without compromising the congressional mandate to protect the safety and soundness of CSEs and the stability of the U.S. financial system. Substituted compliance has long been a central element of the Commission’s cross-border policy.18 It is an approach that recognizes that market participants in a globalized swap market are subject to multiple regulators and potentially face duplicative or conflicting regulations. Under the Final Rule’s substituted compliance regime, the Commission would, under certain circumstances, allow a CSE to satisfy the Commission’s margin requirements by instead complying with the margin requirements in the relevant foreign jurisdiction. Substituted compliance helps preserve the benefits of an asabaliauskas on DSK3SPTVN1PROD with RULES 17 In determining the extent to which the DoddFrank swap provisions apply to activities overseas, the Commission strives to protect U.S. interests, as determined by Congress in Title VII, and minimize conflicts with the laws of other jurisdictions, consistent with principles of international comity. See Guidance, 78 FR at 45300–01 (referencing the Restatement (Third) of Foreign Relations Law of the United States). 18 For example, under part 30 of the Commission’s regulations, if the Commission determines that the foreign regulatory regime would offer comparable protection to U.S. customers transacting in foreign futures and options and there is an appropriate information-sharing arrangement between the home supervisor and the Commission, the Commission has permitted foreign brokers to comply with their home regulations (in lieu of the applicable Commission regulations), subject to appropriate conditions. See, e.g., Foreign Futures and Options Transactions, 67 FR 30785 (May 8, 2002); Foreign Futures and Options Transactions, 71 FR 6759 (Feb. 9, 2006). VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 integrated, global swap market by reducing the degree to which market participants will be subject to multiple sets of regulations. Further, substituted compliance encourages collaboration and coordination among U.S. and foreign regulators in establishing robust regulatory standards for the global swap market. The Commission is mindful of the challenges involved in implementing a substituted compliance framework for margin. If implemented properly, substituted compliance has the potential to enhance market efficiency and liquidity and foster global coordination of margin requirements without compromising the safety and soundness of CSEs and the U.S. financial system. However, if substituted compliance were extended to foreign jurisdictions that do not have adequate oversight or protections with regard to uncleared swaps, the effectiveness of the Commission’s margin requirements could be undermined, importing additional risk into the financial system. The Commission therefore believes that close coordination with its foreign counterparts is essential to ensuring that the benefits of substituted compliance are achieved. Consistent with the congressional mandate to coordinate rules ‘‘to the maximum extent practicable,’’ 19 in developing the Final Rule, Commission staff worked closely with staff of the Prudential Regulators to align the Final Rule with the cross-border framework in the Prudential Regulators’ Final Margin Rule.20 Aligning with the Prudential Regulators’ cross-border margin rule is particularly important given the composition of the global swap market.21 Currently, approximately 106 swap dealers and major swap participants are provisionally registered with the Commission. Of those entities, an estimated 54 are CSEs subject to the Commission’s margin rules, with the remaining 52 entities falling within the scope of the Prudential Regulators’ margin rules. Of the 54 CSEs subject to the Commission’s margin requirements, approximately 33 CSEs are affiliated 19 See 7 U.S.C. 6s(e)(3)(D)(ii). Prudential Regulators’ Final Margin Rule, 80 FR 74840. The cross-border provision is section _l.9 of the Prudential Regulators’ Final Margin Rule and is substantially similar to the Commission’s Final Rule. 21 The Securities and Exchange Commission (‘‘SEC’’) has not yet finalized similar rules imposing margin requirements for security-based swap dealers and major security-based swap participants. The SEC proposed its margin rule in October 2012. See Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital Requirements for Broker-Dealers, 77 FR 70214 (Nov. 23, 2012). 20 See PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 with a prudentially-regulated swap entity. Therefore, substantial differences between the Commission’s and Prudential Regulators’ cross-border regulations could lead to competitive disparities between affiliates within the same corporate structure, leading to market inefficiencies and incentives to restructure their businesses in order to avoid the more stringent cross-border margin framework. In granting the Commission new authority over swaps under the DoddFrank Act, Congress also called for coordination and cooperation with foreign regulatory authorities.22 Consistent with that mandate, and building on international efforts to develop a global margin framework,23 the Commission closely consulted with its foreign counterparts in developing the Final Rule. As other jurisdictions finalize their margin rules and the Commission implements its crossborder margin framework, the Commission is committed to continuing to coordinate with foreign regulators, with a view toward mitigating any conflicting or otherwise substantially divergent margin requirements for uncleared swaps across jurisdictions. II. The Final Rule The Commission is adopting rules regarding how the Commission’s margin requirements will apply to cross-border uncleared swaps. Broadly speaking, the final cross-border framework is designed to address the risks to a CSE, as an entity, associated with its uncleared swaps, consistent with CEA section 2(i) 24 and the statutory objectives of the margin requirements. As discussed above, section 4s(e) was enacted to address the risks to CSEs and to the U.S. financial system arising from uncleared swaps. The source of risk to a CSE is not confined to its uncleared 22 15 U.S.C. 8325(a) (added by section 752 of the Dodd-Frank Act). 23 In October 2011, the Basel Committee on Banking Supervision (‘‘BCBS’’) and the International Organization of Securities Commissions (‘‘IOSCO’’), in consultation with the Committee on Payment and Settlement Systems (‘‘CPSS’’) and the Committee on Global Financial Systems (‘‘CGFS’’), formed a Working Group on Margining Requirements (‘‘WGMR’’) to develop international standards for margin requirements for uncleared swaps. Representatives of 26 regulatory authorities participated, including the Commission. In September 2013, the WGMR published a final report articulating eight key principles for noncleared derivatives margin rules. These principles represent the minimum standards approved by BCBS and IOSCO and their recommendations to the regulatory authorities in member jurisdictions. See BCBS/IOSCO, Margin requirements for noncentrally cleared derivatives (updated March 2015) (‘‘BCBS/IOSCO framework’’), available at http:// www.bis.org/bcbs/publ/d317.pdf. 24 See 7 U.S.C. 2(i). E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES swaps with U.S. counterparties or to swaps transacted within the United States. Risk arising from uncleared swaps involving non-U.S. counterparties can potentially have a substantial adverse effect on a CSE and therefore the stability of the U.S. financial system. Nevertheless, certain categories of uncleared swaps will be eligible for substituted compliance or the Exclusion based on the Commission’s consideration of comity principles and the impact of the Final Rule on market efficiency and competition. The sections that follow summarize, as appropriate, the approach taken in the proposed rule, the comments received in response, and the resulting Final Rule. Section A discusses certain key definitions (‘‘U.S. person,’’ ‘‘guarantee,’’ and ‘‘Foreign Consolidated Subsidiary’’ or ‘‘FCS’’) in the Final Rule, which inform how the Commission’s margin requirements apply to market participants in the cross-border context. Section B describes the cross-border application of the Commission’s margin requirements, including the circumstances under which substituted compliance and the limited Exclusion are available and the application of two special provisions designed to accommodate swap activities in jurisdictions that do not have a legal framework to support custodial arrangements and netting in compliance with the Final Margin Rule (‘‘nonsegregation jurisdictions’’ 25 and ‘‘nonnetting jurisdictions,’’ respectively).26 Section C describes the Commission’s framework for issuing comparability determinations. As a preliminary matter, the Commission notes that several commenters requested Commission action outside the scope of the Final Rule, including modifications to the substantive margin requirements 27 or 25 As used in this release, a ‘‘non-segregation jurisdiction’’ is a jurisdiction where inherent limitations in the legal or operational infrastructure of the foreign jurisdiction make it impracticable for the CSE and its counterparty to post initial margin pursuant to custodial arrangements that comply with the Final Margin Rule, as further described in section II.B.4.b. 26 As used in this release, a ‘‘non-netting jurisdiction’’ is a jurisdiction in which a CSE cannot conclude, with a well-founded basis, that the netting agreement with a counterparty in that foreign jurisdiction meets the definition of an ‘‘eligible master netting agreement’’ set forth in the Final Margin Rule, as described in section II.B.5.b. 27 See, e.g., ACLI at 2–3 (Commission should defer to International Standards with respect to acceptable forms of collateral for margin); FMS– WM at 1–2 (legacy portfolio entity backed by full faith and credit of sovereign government should be considered a ‘‘sovereign entity’’ within scope of Commission’s margin requirements); ISDA at 14–15 (inter-affiliate swaps should be exempt from initial VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 the Guidance.28 The Commission notes that concerns regarding the general nature and application of the initial and variation margin requirements were addressed in the Final Margin Rule. Notably, the Final Margin Rule included substantial modifications from the Proposed Margin Rule that further aligned the Commission’s margin requirements with the BCBS–IOSCO framework, which should further reduce the potential for conflicts with the margin requirements of foreign jurisdictions.29 With respect to the Guidance, the Commission reiterates its intention to periodically review its cross-border policy in light of future developments, including its experience following adoption of the Final Rule.30 Commenters also requested that the Commission delay the cross-border application of its margin rules until after it has made comparability determinations.31 Although the margin requirements and accounting standards to determine consolidation should be applied throughout margin rules); JBA at 6 (Commission should work with foreign counterparts to harmonize aspects of its margin rules, including treatment of ‘‘legacy trades,’’ inter-affiliate trades, and forms of eligible collateral); LCH.Clearnet at 4 (differences in approach to margin requirements between cleared and uncleared swaps should promote central clearing). 28 See, e.g., AFR at 2 (adopting cross-border approach to margin alone would create ‘‘serious problems’’); AIMA/IA at 4 (Commission should amend Guidance to include U.S. person definition in the proposed rule); Better Markets at 6 (adopting cross-border approach to margin alone would be ‘‘a disservice to the comprehensive existing Guidance;’’ should instead make ‘‘targeted, limited changes’’ to Guidance); ICI Global at 7–8 (one U.S. person definition should apply consistently with respect to cross-border application of all swap requirements); IIB/SIFMA at 17–19 (proposed U.S. person and guarantee definitions should replace corresponding interpretations in Guidance); ISDA at 12 (same); JBA at 11–12 (same); SIFMA AMG at 4, 9–13 (same); Vanguard at 5 (same). 29 For example, the Final Margin Rule raised the material swaps exposure level from $3 billion to the BCBS–IOSCO standard of $8 billion, which reduces the number of entities that must collect and post initial margin. See Final Margin Rule, 81 FR at 644. In addition, the definition of uncleared swaps was broadened to include DCOs that are not registered with the Commission but pursuant to Commission orders are permitted to clear for U.S. persons. See id. at 638. 30 See Guidance, 78 FR at 45297. See also United States v. Edge Broadcasting Co., 509 U.S. 418, 434 (1993) (‘‘[A]n agency does not have to make progress on every front before it can make progress on any front.’’). See also Personal Watercraft Indus. Ass’n v. Dep’t of Commerce, 48 F.3d 540, 544 (D.C. Cir. 1995). 31 See, e.g., ABA/ABASA at 3 (‘‘sufficient time’’ for foreign jurisdictions to adopt margin rules); AIMA/IA at 3 (‘‘sufficient time’’ to reach agreement with foreign counterparts); ISDA at 16–17 (12 months after margin rules are finalized in U.S., EU, and Japan, or two-year ‘‘transitional comparability determination,’’ providing substituted compliance for all foreign jurisdictions that adopt rules based on BCBS–IOSCO framework, while Commission undertakes comparability analysis); JBA at 3, 4 (at least 18 months after margin rules are finalized in PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 34821 Commission declines to establish an open-ended delay in applying its margin rules, it remains committed to coordinating with foreign regulators to implement its cross-border margin framework in a workable manner. A. Key Definitions The extent to which substituted compliance and the Exclusion are available depends on whether the relevant swap involves a U.S. person, a guarantee by a U.S. person, or a ‘‘Foreign Consolidated Subsidiary’’ (or ‘‘FCS’’). The Final Rule adopts definitions of ‘‘U.S. person,’’ ‘‘guarantee,’’ and ‘‘Foreign Consolidated Subsidiary’’ solely for purposes of the margin rules. These definitions are discussed below. 1. U.S. Person Under the Final Rule, the term ‘‘U.S. person’’ is defined to include individuals or entities whose activities have a significant nexus to the U.S. market as a result of their being domiciled or organized in the United States or by virtue of the strength of their connection to the U.S. markets, even if they are domiciled or organized outside the United States. As discussed in section II.B.2.b.i. below, U.S. CSEs 32 are generally subject to the margin rules with only partial substituted compliance and are not eligible for the Exclusion. a. Proposed Rule In the proposed rule, the term ‘‘U.S. person’’ was defined to mean the following: • Any natural person who is a resident of the United States (proposed § 23.160(a)(10)(i)); • Any estate of a decedent who was a resident of the United States at the time of death (proposed § 23.160(a)(10)(ii)); • Any corporation, partnership, limited liability company, business or other trust, association, joint-stock company, fund or any form of entity similar to any of the foregoing (other than an entity as described in paragraph (a)(10)(iv) or (v) of proposed § 23.160) (a legal entity), in each case that is organized or incorporated under the laws of the United States or that has its principal place of business in the United States, including any branch of the U.S., EU, and Japan); PensionsEurope at 3 (12– 18 months); SIFMA AMG at 4, 14–15 (at least 18 months). 32 See 17 CFR 23.160(a)(8) (defining ‘‘U.S. CSE’’ as a CSE that is a ‘‘U.S. person,’’ as defined in the Final Rule). See also 17 CFR 23.160(a)(4) (defining ‘‘non-U.S. CSE’’ as a CSE that is not a U.S. person). E:\FR\FM\31MYR2.SGM 31MYR2 34822 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES the legal entity (proposed § 23.160(a)(10)(iii)); • Any pension plan for the employees, officers or principals of a legal entity as described in paragraph (a)(10)(iii) of proposed § 23.160, unless the pension plan is primarily for foreign employees of such an entity (proposed § 23.160(a)(10)(iv)); • Any trust governed by the laws of a state or other jurisdiction in the United States, if a court within the United States is able to exercise primary supervision over the administration of the trust (proposed § 23.160(a)(10)(v)); • Any legal entity (other than a limited liability company, limited liability partnership or similar entity where all of the owners of the entity have limited liability) owned by one or more persons described in paragraphs (a)(10)(i) through (v) of proposed § 23.160 who bear(s) unlimited responsibility for the obligations and liabilities of the legal entity, including any branch of the legal entity (proposed § 23.160(a)(10)(vi)); and • Any individual account or joint account (discretionary or not) where the beneficial owner (or one of the beneficial owners in the case of a joint account) is a person described in paragraphs (a)(10)(i) through (vi) of proposed § 23.160 (proposed § 23.160(a)(10)(vii)).33 The Commission explained that, as indicated in paragraphs (iii) and (vi) of the proposed rule, a legal entity’s status as a U.S. person would be determined at the entity level and would therefore include a foreign branch of a U.S. person.34 An affiliate or subsidiary of a U.S. person that is organized or incorporated outside the United States, however, would not be deemed a ‘‘U.S. person’’ solely by virtue of its affiliation with the U.S. person.35 The Commission also stated that a swap counterparty should generally be permitted to reasonably rely on its counterparty’s written representation with regard to its status as a U.S. person.36 33 See proposed 17 CFR 23.160(a)(10). See also proposed 17 CFR 23.160(a)(5) (defining ‘‘non-U.S. person’’ as any person that is not a ‘‘U.S. person’’). 34 See Proposal, 80 FR at 41383 (stating that the definition includes any foreign operations that are part of the U.S. legal person, regardless of their location); proposed 17 CFR 23.160 (a)(10)(iii), (vi) (defining such U.S. persons to include ‘‘any branch of the legal entity’’). 35 See Proposal, 80 FR at 41383 (explaining that the status of a legal person as a U.S. person would not affect whether a separately incorporated or organized legal person in the affiliated corporate group is a U.S. person). 36 See id. (recognizing that the information necessary to accurately assess a counterparty’s U.S. person status may be available only through overly burdensome due diligence). VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 The proposed rule was generally consistent with the U.S. person interpretation set forth in the Guidance, with certain exceptions.37 Notably, the proposed rule did not define ‘‘U.S. person’’ to include a commodity pool, pooled account, investment fund, or other collective investment vehicle that is majority-owned by one or more U.S. persons (the ‘‘U.S. majority-owned fund prong’’).38 The proposed rule also did not include a catchall provision, thereby limiting the definition of ‘‘U.S. person’’ for purposes of the margin rule to persons enumerated in the rule.39 Finally, paragraph (vi) of the proposed rule (the ‘‘unlimited U.S. responsibility prong’’) represented a modified version of a similar concept from the Guidance, which interprets ‘‘U.S. person’’ to include a legal entity ‘‘directly or indirectly majority-owned’’ by one or more U.S. person(s) that bear unlimited responsibility for the legal entity’s liabilities and obligations.40 The Commission requested comment on all aspects of the proposed definition of ‘‘U.S person,’’ including whether the definition should include a U.S. majority-owned fund prong or an unlimited U.S. responsibility prong and whether it should be identical to the U.S. person definition adopted by the SEC.41 b. Comments In general, commenters raised few objections to the proposed ‘‘U.S. person’’ definition. Nearly all commenters supported the absence of a U.S. majority-owned fund prong,42 and several expressly supported the absence of a catchall provision.43 With respect to 37 See Proposal, 80 FR at 41382–84. See also Guidance, 78 FR at 45308–17 (setting forth the interpretation of ‘‘U.S. person’’ for purposes of the Guidance). 38 See Proposal, 80 FR at 41383. See also Guidance, 78 FR 45313–14 (discussing the U.S. majority-ownership prong for purposes of the Guidance). The Guidance interpreted ‘‘majorityowned’’ in this context to mean the beneficial ownership of more than 50 percent of the equity or voting interests in the collective investment vehicle. See id. at 45314. 39 See Proposal, 80 FR at 41383. See also Guidance, 78 FR at 45316 (discussing the inclusion of the prefatory phrase ‘‘include, but not be limited to’’ in the interpretation of ‘‘U.S. person’’ in the Guidance). 40 See Proposal, 80 FR at 41383. See also Guidance, 78 FR at 45312–13 (discussing the unlimited U.S. responsibility prong for purposes of the Guidance). 41 See Proposal, 80 FR at 41384. See also 17 CFR 240.3a71–3(a)(4) (setting forth the definition of ‘‘U.S. person’’ adopted by the SEC for purposes of security-based swap regulation). 42 See e.g., AIMA/IA at 3–4; FSR at 2, 8; IATP at 4; IIB/SIFMA at 18; ISDA at 12; JBA at 11; MFA at 3, 5–6; SIFMA AMG at 10, Vanguard at 5. 43 See e.g., IIB/SIFMA at 17; ISDA at 12 (the absence the prefatory phrase ‘‘includes, but is not PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 the U.S. majority-owned funds prong, commenters argued that U.S. ownership alone is not indicative of whether a fund’s activities have a direct and significant effect on the U.S. financial system 44 and that identifying and tracking a fund’s beneficial ownership may pose a significant challenge in certain circumstances.45 Commenters added that characterizing such U.S. majority-owned funds as U.S. persons may lead to duplicative margin requirements because such funds will likely also be subject to foreign regulation.46 A few commenters, however, requested changes regarding the unlimited U.S. responsibility prong. ISDA and JBA recommended that, consistent with the Guidance, the Commission require that the U.S. person(s) bearing unlimited responsibility for the obligations and liabilities of the legal entity have a majority ownership stake in the entity. ISDA argued broadly that, to avoid confusion and regulatory overlap, legal entities that have multiple owners with unlimited liability for the obligations and liabilities of the legal entity should only be subject to the jurisdiction of the majority owner.47 JBA argued that the definition should be consistent with the Guidance in order to avoid the possibility that the Commission’s margin requirements would apply to a ‘‘broader scope of U.S. persons relative to other swap regulations.’’ 48 IIB/ SIFMA requested that the unlimited U.S. responsibility prong be removed altogether, arguing that unlimited responsibility is ‘‘largely equivalent’’ to a guarantee and should therefore be afforded the same treatment.49 limited to’’ would ‘‘increase legal certainty’’); SIFMA AMG at 10–11. 44 See e.g., AIMA/IA at 3; FSR at 8; IATP at 4; IIB/SIFMA at 18 (fund owners are not direct counterparties to swap and their risk of loss is limited to extent of their investment in the fund); MFA at 6. 45 See e.g., AIMA/IA at 3–4 (highlighting challenges presented by nominee accounts); IATP at 4 (ownership can be complex and variable over the life of a fund); IIB/SIFMA at 18 (highlighting challenges associated with funds formed before adoption of Guidance); SIFMA AMG at 10. But see MFA at 5–6 (funds organized or having a principal place of business in the United States are properly included in the U.S. person definition). 46 See AIMA/IA at 4 (‘‘comparable foreign rules’’ will apply to limit the likelihood and impact of a counterparty default); FSR at 8 (neither SEC nor EU regulators have proposed exercising jurisdiction over an entity on the basis of majority control); ISDA at 12 (neither BCBS–IOSCO framework nor proposed EU rules impose rules on funds based on jurisdiction of its owners). 47 See ISDA at 12. 48 See JBA at 11–12. 49 See IIB/SIFMA at 17–18 (while guarantor may have legal defenses to enforcement of guarantee, both U.S. guarantee and unlimited U.S. E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES Commenters also made certain other recommendations to further conform the U.S. person definition to the interpretation of ‘‘U.S. person’’ in the Guidance.50 ICI Global, SIFMA AMG, and Vanguard requested that the Commission confirm that, as indicated in the Guidance, a pool, fund or other collective investment vehicle that is publicly offered only to non-U.S. persons and not offered to U.S. persons would not fall within the scope of the U.S. person definition.51 SIFMA AMG also added that language in paragraphs (iii) and (vi) specifying that a legal entity deemed a U.S. person would include ‘‘any branch of the legal entity’’ was unnecessarily confusing.52 Finally, FSR and JBA requested that, in the interest of harmonizing margin requirements and reducing compliance costs, the Commission should, consistent with the SEC’s cross-border rules, exclude from the U.S. person definition certain designated international organizations.53 IATP argued, however, that such exclusion would be either unnecessary or inappropriate.54 responsibility prong create risk to U.S. persons only to the extent that legal entity incurs losses and fails to perform obligations). 50 As indicated above, several commenters recommended generally that the Commission establish a uniform definition of ‘‘U.S. person’’ that would apply both in the context of the cross-border application of the margin rules and with respect to the other swaps regulatory topics covered by the Guidance. See supra note 28. 51 See ICI Global at 5–7 (clarification is necessary to avoid imposing Dodd-Frank Act swap provisions on entities that only have ‘‘nominal nexus’’ to United States); SIFMA AMG at 10–12 (reclassifying such funds as U.S. persons solely for purposes of margin rule would be extremely complicated and burdensome for asset managers and their clients); Vanguard at 5. See also Guidance, 78 FR at 45314 (providing that a collective investment vehicle that is publicly offered only to non-U.S. persons and not offered to U.S. persons generally would not fall within any of the prongs of the ‘‘U.S. person’’ interpretation in the Guidance). 52 SIFMA AMG at 12 (such language, which is not present in corresponding prongs of U.S. person interpretation in Guidance, could ‘‘cause confusion in terms of whether a person having any branches in the United States needs to take into account its U.S. person status, including in assessing the entity’s principal place of business’’). 53 See FSR at 8; JBA at 12 (while international financial institutions ‘‘are invested by the U.S. government, financial institutions generally separate them from the U.S. country risk in evaluating their credit risk in practice’’). See also 17 CFR 240.3a71–3(a)(4)(iii) (defining ‘‘U.S. person’’ for purposes of the SEC’s regulation of security-based swaps to exclude the International Monetary Fund, the International Bank for Reconstruction and Development, the InterAmerican Development Bank, the Asian Development Bank, the African Development Bank, the United Nations, and their agencies and pension plans, and any other similar international organizations, their agencies and pension plans). 54 See IATP at 4 (intergovernmental organizations should ‘‘voluntarily practice’’ the margin VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 c. Final Rule The Final Rule defines ‘‘U.S. person’’ as proposed, but the Commission is providing some additional clarifications in response to commenters. As stated in the Proposal, the definition generally follows a traditional, territorial approach to defining a U.S. person, and the Commission believes that this definition offers a clear, objective basis for determining those individuals or entities that should be identified as U.S. persons. Under the Final Rule, a legal person’s status as a U.S. person is determined at the entity level and therefore includes any foreign operations that are part of the legal person, regardless of their location. Consistent with this approach, the definition includes any foreign branch of a U.S. person.55 The status of a legal entity as a U.S. person would not generally affect whether a separately incorporated or organized legal entity in the affiliated corporate group is a U.S. person. Therefore, an affiliate or a subsidiary of a U.S. person that is organized or incorporated in a non-U.S. jurisdiction would not be deemed a U.S. person solely by virtue of being affiliated with a U.S. person.56 Sections 23.160(a)(10)(i) through (v) and (vii) of the Final Rule identify certain persons as U.S. persons by virtue of being domiciled or organized in the United States. The Commission has traditionally looked to where a legal entity is organized or incorporated (or, in the case of a natural person, where he or she resides) to determine whether it is a U.S. person.57 Persons domiciled or organized in the United States are likely to have significant financial and legal relationships in the United States and are therefore appropriately included within the definition of ‘‘U.S. person.’’ Consistent with this traditional approach, section 23.160(a)(10)(iii) of the Final Rule includes persons that are organized or incorporated outside the United States but have their principal place of business in the United States. For purposes of this section, the Commission interprets ‘‘principal place requirements in order to ‘‘realize the objectives of the [sic] intergovernmental investment charters’’). 55 The Commission clarifies that the inclusion of ‘‘any branch of the legal entity’’ in sections 23.160(a)(10)(iii) and (vi) of the Final Rule is intended to make clear that the definition includes both foreign and U.S. branches of an entity and does not introduce any additional criteria for determining an entity’s U.S. person status. 56 See also 17 CFR 23.160(a)(5) (defining ‘‘nonU.S. person’’ as any person that is not a U.S. person). 57 See, e.g., 17 CFR 4.7(a)(1)(iv) (defining ‘‘NonUnited States person’’ for purposes of part 4 of the Commission regulations, which applies to commodity pool operators). PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 34823 of business’’ to mean the location from which the officers, partners, or managers of the legal person primarily direct, control, and coordinate the activities of the legal person. This interpretation is consistent with the Supreme Court’s decision in Hertz Corp. v. Friend, which described a corporation’s principal place of business, for purposes of diversity jurisdiction, as the ‘‘place where the corporation’s high level officers direct, control, and coordinate the corporation’s activities.’’ 58 The Commission is of the view that determining the principal place of business of an investment fund may require consideration of additional factors beyond those applicable to operating companies. In the case of a fund, the senior personnel that direct, control, and coordinate a fund’s activities are generally not the named directors or officers of the fund but rather persons employed by the fund’s investment adviser or the fund’s promoter. Therefore, consistent with the Guidance, the Commission would generally consider the principal place of business of a fund to be in the United States if the senior personnel responsible for either (1) the formation and promotion of the fund or (2) the implementation of the fund’s investment strategy are located in the United States, depending on the facts and circumstances that are relevant to determining the center of direction, control and coordination of the fund.59 Section 23.160(a)(10)(vi) of the Final Rule defines ‘‘U.S. person’’ to include certain legal entities owned by one or more U.S. person(s) and for which such person(s) bear unlimited responsibility for the obligations and liabilities of the legal entity.60 In such cases, the U.S. 58 559 U.S. 77, 80 (2010). Guidance, 78 FR at 45309–12 (providing guidance on application of the principal place of business test to funds and other collective investment vehicles in the context of cross-border swaps, including examples of how the Commission’s approach could apply to a consideration of whether the ‘‘principal place of business’’ of a fund is in the United States in particular hypothetical situations). Note that the examples included in the Guidance are for illustrative purposes only and do not purport to address all potential variations in the structure of collective investment vehicles or all factors relevant to determining whether a collective investment vehicle’s principal place of business is in the United States. 60 The Commission does not view the unlimited U.S. responsibility prong as equivalent to a U.S. guarantee (as ‘‘guarantee’’ is defined in the Final Rule). As stated in the Guidance, a guarantee does not necessarily provide for ‘‘unlimited responsibility for the obligations and liabilities of the guaranteed entity’’ in the same sense that the owner of an unlimited liability corporation bears such unlimited liability. See 78 FR at 45312. 59 See E:\FR\FM\31MYR2.SGM 31MYR2 34824 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES person owner(s) serve as a financial backstop for all of the legal entity’s obligations and liabilities. Creditors and counterparties accordingly look to the U.S. person owner(s) when assessing the risk of dealing with the entity.61 Because the U.S. person owner(s)’ responsibility is unlimited, the amount of equity the U.S. owner(s) have in the legal entity would not be relevant. In line with the proposed rule, the Final Rule does not include a U.S. majority-owned funds prong. Although the U.S. owners of such funds may be adversely impacted in the event of a counterparty default, the Commission believes that, on balance, the majorityownership test should not be included in the definition of U.S. person for purposes of the margin rules. Non-U.S. funds with U.S. majority-ownership, even if treated as a non-U.S. person, are excluded from the Commission’s margin rules only in limited circumstances (namely, when these funds transact with a non-U.S. CSE that is not a consolidated subsidiary of a U.S. entity or a U.S. branch of a non-U.S. CSE). This result, coupled with the implementation issues raised by commenters, persuade the Commission that including a U.S. majority-owned funds prong in the scope of the ‘‘U.S. person’’ definition would not be appropriate for purposes of the margin rules.62 The Final Rule’s U.S. person definition also does not include the prefatory phrase ‘‘includes, but is not limited to’’ that was included in the Guidance. As stated in the proposed rule, the Commission believes that this catchall should not be included in order to provide legal certainty regarding the application of U.S. margin requirements to cross-border swaps. The Commission notes that, as discussed in the proposed rule, the Final Rule defines ‘‘U.S. person’’ in a manner that is substantially similar to the definition used by the SEC in the context of cross-border regulation of security-based swaps.63 The 61 By extension, by virtue of their unlimited responsibility for the legal entity’s swap obligations, the U.S. person owner(s) have an interest in the swap activities of the legal entity to the same extent as if the swap activities were conducted by the U.S. person directly. 62 Such a fund may nevertheless be a U.S. person by virtue of fitting within the scope of § 23.160(a)(10)(iii) (entities organized or having a principal place of business in the United States). In response to commenters, the Commission further clarifies that whether a pool, fund or other collective investment vehicle is publicly offered only to non-U.S. persons and not offered to U.S. persons would not be relevant in applying § 23.160(a)(10)(iii). 63 See Proposal, 80 FR at 41382 n.46 (discussing the SEC’s ‘‘U.S. person’’ definition for purposes of security-based swap regulation). VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 Commission further believes that any differences, such as the inclusion of an unlimited U.S. responsibility prong, are necessary and appropriate in the context of the cross-border application of margin requirements for uncleared swaps, for the reasons discussed above.64 With respect to the designated international organizations excluded from the SEC’s U.S. person definition, the Commission notes that a similar exclusion is unnecessary in the context of the cross-border application of the Commission’s margin rules, given that such entities are generally considered non-financial end users under the Final Margin Rule and are therefore unaffected by application of the margin requirements for uncleared swaps.65 2. Guarantees Under the Final Rule, the term ‘‘guarantee’’ is defined to include arrangements, pursuant to which one party to an uncleared swap has rights of recourse against a guarantor, with respect to its counterparty’s obligations under the uncleared swap. As discussed in section II.B.2.b.i. below, non-U.S. CSEs whose obligations under the relevant swap are guaranteed by a U.S. person (‘‘U.S. Guaranteed CSEs’’) 66 are 64 The SEC does not include the U.S. responsibility prong in its U.S. person definition, but instead treats a legal entity where one or more U.S. person(s) bears unlimited responsibility for the obligations and liabilities of the legal entity as a non-U.S. person with a guarantee. The Commission believes that, for the reasons stated above, these entities should be included as a U.S. person rather than being treated as a non-U.S. person with a guarantee for purposes of the margin requirements for uncleared swaps. 65 Under the Final Margin Rule, the following international organizations are expressly considered non-financial end users: (1) The International Bank for Reconstruction and Development; (2) The Multilateral Investment Guarantee Agency; (3) The International Finance Corporation; (4) The InterAmerican Development Bank; (5) The Asian Development Bank; (6) The African Development Bank; (7) The European Bank for Reconstruction and Development; (8) The European Investment Bank; (9) The European Investment Fund; (10) The Nordic Investment Bank; (11) The Caribbean Development Bank; (12) The Islamic Development Bank; (13) The Council of Europe Development Bank; and (14) Any other entity that provides financing for national or regional development in which the U.S. government is a shareholder or contributing member or which the Commission determines poses comparable credit risk). See 17 CFR 23.151 (defining ‘‘financial end user,’’ ‘‘nonfinancial end user,’’ and ‘‘multilateral development bank’’). Under the Final Margin Rule, CSEs are not required to exchange margin with non-financial end users. 66 This release uses the term ‘‘U.S. Guaranteed CSE’’ for convenience only. Whether a non-U.S. CSE falls within the meaning of the term ‘‘U.S. Guaranteed CSE’’ varies on a swap-by-swap basis, such that a non-U.S. CSE may be considered a U.S. Guaranteed CSE for one swap and not another, depending on whether the non-U.S. CSE’s obligations under such swap are guaranteed by a U.S. person. PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 eligible for substituted compliance to the same extent as U.S. CSEs and are similarly ineligible for the Exclusion. a. Proposed Rule The proposed rule defined the term ‘‘guarantee’’ as an arrangement pursuant to which one party to a swap with a non-U.S. counterparty has rights of recourse against a U.S. person, with respect to the non-U.S. counterparty’s obligations under the swap. The proposed rule defined ‘‘rights of recourse’’ as a conditional or unconditional legally enforceable right to receive or otherwise collect payment, in whole or in part. An arrangement would constitute a ‘‘guarantee’’ regardless of whether the rights of recourse were conditioned upon the non-U.S. counterparty’s insolvency or failure to meet its obligations under the relevant swap or whether the counterparty seeking to enforce the guarantee is required to make a demand for payment or performance from the non-U.S. counterparty before proceeding against the U.S. guarantor. The Commission requested comment on all aspects of its proposed definition of ‘‘guarantee,’’ including whether it would be appropriate to distinguish guarantee arrangements with a legally enforceable right of recourse from those without direct recourse.67 b. Comments Most commenters supported the proposed definition of ‘‘guarantee.’’ 68 Commenters generally preferred it to the broader interpretation of ‘‘guarantee’’ in the Guidance, which includes other types of financial arrangements and support (e.g., keepwell agreements and liquidity puts),69 and agreed that it would promote legal certainty and lower compliance costs as a result.70 IIB/SIFMA further argued the proposed definition is appropriate in the margin context and consistent with CEA section 2(i) because, absent such a legal relationship to a U.S. person, a non-U.S. person would not have a sufficient connection with activities in U.S. commerce to warrant the application of 67 See Proposal, 80 FR at 41385. FSR at 2, 9; IATP at 5; IIB/SIFMA at 18– 19; ISDA at 12; JBA at 12; SIFMA AMG at 4, 13. 69 See IIB/SIFMA at 18–19; ISDA at 12; JBA at 12; SIFMA AMG at 13. 70 See IIB/SIFMA at 18–19; ISDA at 12 (interpretation of ‘‘guarantee’’ in Guidance requires facts-and-circumstances analysis to determine whether arrangement supports a party’s ability to pay or perform under swap); JBA at 12; SIFMA AMG at 13 (expressing approval that the proposed definition aligns with guarantee definition adopted by SEC). 68 See E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations U.S. margin rules.71 Commenters expressed concern, however, that multiple ‘‘guarantee’’ definitions could lead to confusion and recommended that the Commission apply the proposed ‘‘guarantee’’ definition throughout its cross-border policy.72 AFR and Better Markets opposed the proposed ‘‘guarantee’’ definition.73 Both expressed a preference for the broader interpretation of ‘‘guarantee’’ in the Guidance and, like other commenters, recommended that the term have one consistent meaning.74 AFR argued that both implicit guarantees, such as when a parent entity faces reputational incentives to provide financial support for a subsidiary, and other formal agreements that obligate a U.S. person to provide financial support, create a direct and significant nexus to the U.S. financial system and should be included within the scope of the term ‘‘guarantee.’’ 75 Accordingly, the proposed definition of ‘‘guarantee’’ may not fully capture the risk to the U.S. financial markets.76 AFR suggested that the policy objective of increasing the availability of substituted compliance in the margin context would be better achieved by adopting the broad interpretation of ‘‘guarantee’’ in the Guidance and instead limiting the availability of substituted compliance with respect to swaps involving an ‘‘explicit recourse guarantee.’’ 77 asabaliauskas on DSK3SPTVN1PROD with RULES c. Final Rule The Final Rule defines ‘‘guarantee’’ for purposes of the cross-border application of the Commission’s margin rules to mean an arrangement pursuant to which one party to an uncleared swap has rights of recourse against a guarantor, with respect to its counterparty’s obligations under the uncleared swap.78 For these purposes, a party to an uncleared swap has rights of recourse against a guarantor if the party has a conditional or unconditional 71 See IIB/SIFMA at 18–19. See also FSR at 9 (‘‘transaction-level’’ swap risk would not transfer back to United States absent right of recourse against a U.S. person and ‘‘entity-level’’ risk would be captured by other regulatory requirements, such as capital rules). 72 See ISDA at 12; JBA at 12; SIFMA AMG at 13. 73 AFR at 3, 5–7; Better Markets at 4. 74 See AFR at 3 (adopting different definition solely for purposes of margin rules would not only complicate overall set of cross-border rules, but establish an ‘‘extremely poor precedent’’ for narrowing guarantee concept in applying rest of Guidance); Better Markets at 4 (proposed definition is ‘‘less robust’’ than interpretation of guarantee in Guidance and should not be different in margin context). 75 See AFR at 6. 76 See id. 77 See id. at 5–6. 78 See 17 CFR 23.160(a)(2). VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 legally enforceable right to receive or otherwise collect, in whole or in part, payments from the guarantor with respect to its counterparty’s obligations under the uncleared swap. A counterparty has a right of recourse against a guarantor even if the right of recourse is conditioned upon its counterparty’s insolvency or failure to meet its obligations under the swap, and regardless of whether the counterparty seeking to enforce the guarantee is first required to make a demand for payment or performance from its counterparty before proceeding against the guarantor. Further, the term ‘‘guarantee’’ applies equally regardless of whether the U.S. guarantor is affiliated with either counterparty or is an unaffiliated third party. In addition, the terms of the guarantee need not necessarily be included within the swap documentation or even otherwise reduced to writing, so long as a party to the swap has legally enforceable rights of recourse under the laws of the relevant jurisdiction. The Final Rule’s definition of guarantee is generally consistent with the proposed rule’s definition of guarantee, but reflects certain changes that are intended to more closely align it with the definition included in the Prudential Regulators’ Final Margin Rule.79 Language has been added to the Final Rule to address the concerns of the Commission and Prudential Regulators that swaps could be structured in a manner that would avoid application of the margin requirements to swaps that are guaranteed by a U.S. person.80 Under this additional language, the term ‘‘guarantee’’ also encompasses any arrangement pursuant to which the guarantor itself has a conditional or unconditional legally enforceable right to receive or otherwise collect, in whole or in part, payments from any other guarantor with respect to the counterparty’s obligations under the uncleared swap. Under the Final Rule, such arrangement will be deemed a guarantee of the counterparty’s obligations under the uncleared swap by the other guarantor. To illustrate, consider a swap between a non-U.S. CSE (‘‘Party A’’) and a nonU.S. person (‘‘Party B’’). Party B’s obligations under the swap are guaranteed by a non-U.S. affiliate (‘‘Party C’’), who in turn has a guarantee from its U.S. CSE parent entity on Party 79 The Final Rule also includes certain technical edits that would not affect the substance of the rule as compared to the proposed rule. 80 Based on this change to the definition of ‘‘guarantee,’’ the Final Rule differs from the proposed rule in that it treats certain non-U.S. persons as if they were U.S. persons. PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 34825 C’s swap obligations (‘‘Parent D’’). The Final Rule would deem a guarantee to exist between Party B and Parent D with respect to Party B’s obligations under the swap with Party A.81 The Commission is cognizant that many other financial arrangements or support, other than a recourse guarantee as defined in the Final Rule, may be provided by a U.S. person to a non-U.S. CSE. The Commission acknowledges that these other financial arrangements or support may transfer risk directly back to the U.S. financial system, with possible significant adverse effects, in a manner similar to an arrangement that is covered by the definition of a ‘‘guarantee’’ in the Final Rule. However, the Commission believes that, in the context of the Final Rule, non-U.S. CSEs benefitting from such other forms of U.S. financial support will likely meet the definition of an FCS, a concept included in the final margin rules adopted by the Prudential Regulators, and thereby be adequately covered by the Commission’s margin requirements. In this way, the Commission believes that the Final Rule achieves the dual goals of protecting the U.S. markets while promoting a workable crossborder margin framework that closely tracks the cross-border application of the Prudential Regulators’ Final Margin Rule.82 3. Foreign Consolidated Subsidiary (‘‘FCS’’) Under the Final Rule, the term ‘‘Foreign Consolidated Subsidiary’’ identifies non-U.S. CSEs that are consolidated for accounting purposes with an ultimate parent entity that is a U.S. person (a ‘‘U.S. ultimate parent entity’’). As further discussed in section II.B.2.b.ii. below, substituted compliance would be broadly available to an FCS to the same extent as any other non-U.S. CSE, but such an FCS would not be eligible for the Exclusion. a. Proposed Rule The proposed rule defined a ‘‘Foreign Consolidated Subsidiary’’ as a non-U.S. CSE in which an ‘‘ultimate parent entity’’ 83 that is a U.S. person has a 81 This example is included for illustrative purposes only, and is not intended to cover all examples of swaps that could be affected by changes in the Final Rules. 82 The Commission has determined that using the term ‘‘explicit recourse guarantee’’ in lieu of the broader ‘‘guarantee’’ would, in light of the Prudential Regulators’ use of the comparable term ‘‘guarantee,’’ likely only cause confusion without making any substantive difference with respect to the cross-border application of the Commission’s margin requirements. 83 See proposed 17 CFR 23.160(a)(6) (defining ‘‘ultimate parent entity’’ as the parent entity in a E:\FR\FM\31MYR2.SGM Continued 31MYR2 34826 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations controlling interest, in accordance with U.S. generally accepted accounting principles (‘‘U.S. GAAP’’) such that the U.S. ultimate parent entity includes the non-U.S. CSE’s operating results, financial position and statement of cash flows in its consolidated financial statements, in accordance with U.S. GAAP.84 The Commission explained that the fact that an entity is included in the consolidated financial statements of another entity is an indication of potential risk to the other entity that offers a clear and objective standard for the application of margin requirements. The Commission further explained that, as a result of the FCS’ direct connection to, and the possible negative impact of its swap activities on, its U.S. ultimate parent entity and the U.S. financial system, an FCS raises a more substantial supervisory concern in the United States relative to other non-U.S. CSEs. The Commission requested comment on all aspects of its proposed FCS definition, including whether the Commission should instead adopt the ‘‘control test’’ proposed by the Prudential Regulators, which focused solely on the level of ownership and control a U.S. person would have over a non-U.S. subsidiary.85 b. Comments asabaliauskas on DSK3SPTVN1PROD with RULES A few commenters expressed strong support for the FCS concept.86 AFR and Better Markets characterized it as an improvement to the cross-border approach to margin taken in the Guidance, calling it a ‘‘logical and reasonable approach’’ to capturing nonU.S. subsidiaries of U.S. swap entities that may expect an implicit guarantee from a U.S. parent and an ‘‘effective remedy to evasion.’’ 87 AFR stated that, by virtue of being included in the same consolidated financial statement, an FCS has a direct financial impact on its consolidated group in which none of the other entities in the consolidated group has a controlling interest, in accordance with U.S. GAAP). 84 Under U.S. GAAP, consolidated financial statements report the financial position, results of operations and statement of cash flows of a parent entity together with subsidiaries in which the parent entity has a controlling financial interest (which are required to be consolidated under U.S. GAAP). 85 See Proposal, 80 FR at 41386. See also Prudential Regulators’ Proposed Margin Rule, 79 FR at 57379. 86 See AFR at 4–5; Better Markets at 5; IATP at 3, 5–6. 87 See AFR at 4 (FCS concept ‘‘economizes’’ Commission resources by tying regulatory coverage to ‘‘easily available’’ accounting information). See also Better Markets at 5 (Guidance should be amended to apply FCS concept to all Title VII requirements). VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 U.S. ultimate parent entity, even absent a direct recourse guarantee.88 Nevertheless, AFR and IATP expressed some concern over the reliance on U.S. GAAP, particularly with respect to its ability to capture offbalance sheet entities.89 IATP suggested that the Commission consider including in the FCS definition an option to carry out the consolidated financial reporting according to International Financial Reporting Standards (‘‘IFRS’’).90 AFR also expressed concern that reliance on U.S. GAAP may not capture all entities that could expect an implicit guarantee from a U.S. parent, including privately held entities that are not required to prepare consolidated financial statements under U.S. GAAP, and certain variable interest entities or owned funds.91 AFR and IATP therefore urged the Commission to expand the FCS definition in a few ways. Both recommended that the FCS definition include entities whose U.S. parent entity is not required to prepare consolidated financial statements (e.g., a private partnership) but that would otherwise meet the standard for consolidation.92 AFR argued that failing to include such entities within the meaning of ‘‘FCS’’ could result in entities with a similar nexus to the U.S. financial system being treated differently based on factors such as whether the ultimate parent is publicly traded.93 AFR also urged the Commission to incorporate a facts-andcircumstances test for determining when a foreign subsidiary’s relationship with its U.S. parent may create a sufficient nexus to require compliance with U.S. margin rules.94 A few commenters opposed the FCS concept altogether.95 IIB/SIFMA argued 88 See AFR at 4. See also IATP at 3 (inclusion in another’s consolidated financial statement indicates a potential risk to that entity). 89 See AFR at 5 (prior to the passage of U.S. Financial Accounting Standards Board (‘‘U.S. FASB’’) Statements Nos. 166 and 167, U.S. GAAP accounting failed to properly require the consolidation of many securitization entities and such gaps could appear in the future). 90 See IATP at 6 (reliance on IFRS should be predicated on the IFRS agreeing with U.S. FASB participation and offering improved handling of offbalance sheet entities compared to U.S. GAAP). 91 See AFR at 4–5. 92 See AFR at 4–5; IATP at 6 (it would not be ‘‘inconceivable’’ for U.S. CSE to spin off swaps trading activities as private partnerships). 93 See AFR at 5. 94 See id. 95 See, e.g., AIMA/IA at 3 (touting potential operational costs involved with obtaining counterparty representations regarding FCS status); FSR at 10 (FCS concept is ‘‘not necessary’’ because FCSs will be subject to foreign regulation); IIB/ SIFMA at 19–20 (Commission should not distinguish FCSs from other non-U.S. CSEs). PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 that, absent a legal obligation to provide support, an FCS’s potential effect on its U.S. ultimate parent entity is not sufficiently ‘‘direct’’ to create a nexus to the U.S. financial system within the meaning of CEA section 2(i).96 Nevertheless, most commenters, including IIB/SIFMA, preferred the proposed FCS definition to the control test proposed by the Prudential Regulators.97 IIB/SIFMA also appreciated that the proposed FCS definition would foreclose the possibility of such a non-U.S. CSE having multiple parent entities.98 c. Final Rule The Final Rule defines ‘‘Foreign Consolidated Subsidiary’’ as proposed.99 Specifically, ‘‘Foreign Consolidated Subsidiary’’ means a nonU.S. CSE in which an ultimate parent entity that is a U.S. person has a controlling financial interest, in accordance with U.S. GAAP, such that the U.S. ultimate parent entity includes the non-U.S. CSE’s operating results, financial position and statement of cash flows in the U.S. ultimate parent entity’s consolidated financial statements, in accordance with U.S. GAAP. The term ‘‘ultimate parent entity’’ means the parent entity in a consolidated group in which none of the other entities in the consolidated group has a controlling interest, in accordance with U.S. GAAP.100 The Commission believes that the FCS concept offers a clear, bright-line test for identifying those non-U.S. CSEs whose uncleared swap activities present a greater supervisory interest relative to other non-U.S. CSEs. Under U.S. GAAP, an FCS’ financial statements are consolidated with its U.S. ultimate parent entity by virtue of the parent’s 96 See IIB/SIFMA at 14 (‘‘chain of intervening factors and events,’’ including ‘‘materiality’’ of FCS to parent entity, that could affect a U.S. parent’s decision to provide support is too long and uncertain). 97 See FSR at 10 (a control test may not clearly identify the non-U.S. covered swap entities that are likely to raise greater supervisory concerns); IATP at 6; IIB/SIFMA at 19–20 (reliance on the familiar standards of U.S. GAAP would promote legal certainty); ISDA at 13 (a control test is not appropriate for the application of margin rules). 98 See IIB/SIFMA at 19–20. 99 See 17 CFR 23.160(a)(1). 100 See 17 CFR 23.160(a)(6). The definition of ‘‘Foreign Consolidated Subsidiary’’ refers only to the U.S ultimate parent entity. The Commission believes that this is appropriate because consolidated financial statements are the financial statements of a group under the control of the ultimate parent entity. Where the ultimate parent entity is a non-U.S. person, the non-U.S. CSE is not categorized as an FCS and therefore would be eligible for the Exclusion (assuming that the other conditions of the Exclusion are satisfied), for the reasons discussed in section II.B.3. E:\FR\FM\31MYR2.SGM 31MYR2 asabaliauskas on DSK3SPTVN1PROD with RULES Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations controlling financial interest in the FCS. By virtue of having its financial statements consolidated with those of its U.S. ultimate parent, the financial position, operating results and statement of cash flows of an FCS are included in the financial statements of its U.S. ultimate parent entity and therefore affect the financial position, risk profile and market value of the U.S. ultimate parent. Because of the FCS’ direct relationship with, and the possible negative impact of its swap activities on, its U.S. ultimate parent entity and the U.S. financial system, an FCS raises greater supervisory concern in the United States relative to other non-U.S. CSEs (in each case provided that the obligations under the relevant swap are not guaranteed by a U.S. person).101 Further, the Commission continues to believe that, in the absence of a direct recourse guarantee from a U.S. person, an FCS should not be treated in the same manner as a U.S. CSE or U.S. Guaranteed CSE. In contrast with a U.S. Guaranteed CSE, in the event of the FCS’s default, the U.S. ultimate parent entity does not have a legal obligation to fulfill the obligations of the FCS. Rather that decision would depend on the business judgment of its parent. By relying on a consolidation test, the FCS concept is intended to provide a clear, bright-line test for identifying those non-U.S. CSEs whose uncleared swaps are likely to raise greater supervisory concerns relative to other non-guaranteed non-U.S. CSEs. The Commission further believes that, as some commenters noted, reliance on familiar U.S. GAAP accounting standards will promote legal certainty. In particular, the Commission notes that consolidation accounting is a longstanding part of U.S. GAAP and that all non-U.S. CSEs with a U.S. ultimate parent entity currently prepare consolidated financial statements. With respect to the definition’s reliance on U.S. GAAP, the Commission notes that since the 2008 financial crisis, the U.S. FASB made significant changes to the consolidation model for variable interest entities (‘‘VIEs’’) and that as a result of these changes, more VIEs (including special purpose vehicles) are being consolidated with other entities (i.e., their parent entities) under U.S. GAAP. Furthermore, because the U.S. GAAP consolidation requirement adequately addresses these VIEs, the Commission believes that the 101 The Commission notes that it has a relatively greater supervisory interest in FCSs than other nonU.S. CSEs, even if they have a U.S. subsidiary or affiliate, because an FCS’s ultimate parent entity is a U.S. person. VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 addition of IFRS as an option is likely to inject unnecessary complexity and costs in many circumstances.102 Accordingly, the Commission believes that the U.S. GAAP consolidation test in the FCS definition is sufficiently similar to the IFRS consolidation standard with respect to VIEs so that additional reliance on the IFRS standard would be neither necessary nor beneficial.103 4. Counterparty Representations The proposed rule provided that market participants should generally be permitted to reasonably rely on counterparty representations with regard to their status as a U.S. person. The Commission received comments regarding its proposed reliance standard 104 and a request that the Commission also permit reliance on counterparty representations with respect to the guarantee and FCS definitions.105 The Commission acknowledges that the information necessary for a swap counterparty to accurately assess the status of its counterparties as U.S. persons or FCSs, or to determine whether a non-U.S. counterparty’s obligations under a swap are guaranteed by a U.S. person, may be unavailable, or available only through overly burdensome due diligence. For this reason, the Commission believes that a market participant should generally be permitted to reasonably rely on written counterparty representations in each of these respects. The Commission clarifies that, consistent with the reliance standard articulated in the Commission’s external business conduct 102 The Commission notes that the standards for consolidation under U.S. GAAP’s VIE model are similar to the consolidation standards that would apply under IFRS, as both consider control over one entity by the other. The Commission further notes that it does not believe that special purpose vehicles are likely to be used to conduct swaps business. Even if such vehicles transact in swaps and, consequently, register as CSEs, the ultimate parent entity would likely exercise control over them because these vehicles typically rely on parental support or guarantees to maintain their credit standards. Such control would lead to consolidation under U.S. GAAP. 103 The Commission notes that although privately held companies are not under a regulatory obligation to prepare and file consolidated financial statements pursuant to U.S. GAAP, they nevertheless are likely to prepare consolidated financial statements for other purposes (e.g., to provide to creditors as a condition to loan or to private investors), in which case their foreign subsidiaries may fall within the parameters of the FCS definition. 104 See, e.g., SIFMA AMG at 12 (standard for reliance on counterparty representations with respect to U.S. person status is consistent with that articulated in Guidance and Commission’s external business conduct rules; proposed rule could be read to require ‘‘further, unnecessary diligence’’). 105 See, e.g., id. PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 34827 rules,106 market participants may reasonably rely on such a counterparty representation unless it has information that would cause a reasonable person to question the accuracy of the representation. B. Applicability of Margin Requirements to Cross-Border Uncleared Swaps The following sections discuss the cross-border application of the margin requirements to swaps between CSEs and their counterparties, including when substituted compliance and the Exclusion are applicable. Section 1 provides a brief overview of the proposed rule; section 2 addresses the availability of substituted compliance; section 3 addresses the availability of the Exclusion; section 4 discusses a special provision in the Final Rule for non-segregation jurisdictions; and section 5 discusses a special provision in the Final Rule for non-netting jurisdictions. 1. Proposed Rule Under the proposed rule, the application of substituted compliance and the scope of the Exclusion closely tracked the Prudential Regulators’ Proposed Margin Rule.107 Specifically: • A U.S. CSE would be required to comply with the Commission’s margin rules for all uncleared swaps but would be eligible for substituted compliance with respect to the requirement to post (but not the requirement to collect) initial margin for swaps with certain non-U.S. counterparties (referred to herein as ‘‘partial substituted compliance’’).108 • A U.S. Guaranteed CSE would receive the same treatment as a U.S. CSE. • A non-U.S. CSE whose obligations under the relevant swap are not guaranteed by a U.S. person would be eligible for substituted compliance unless the counterparty to the swap is a U.S. CSE or U.S. Guaranteed CSE, in which case substituted compliance would be available with respect to the requirement to collect (but not the requirement to post) initial margin (also referred to as ‘‘partial substituted compliance’’). • A non-U.S. CSE would be eligible for an exclusion from the Final Margin Rule when trading with a non-U.S. person counterparty provided that (a) neither party’s obligations under the relevant swap are guaranteed by a U.S. 106 See 17 CFR 23.402(d). 79 FR at 57379–81. 108 U.S. CSEs would not be eligible for substituted compliance with respect to the requirement that they collect initial margin or the requirement to post or collect variation margin. 107 See E:\FR\FM\31MYR2.SGM 31MYR2 34828 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations person; (b) neither party is an FCS; and (c) the swap is not conducted by or through a U.S. branch of a non-U.S. CSE. The Commission requested comment on all aspects of the proposed rule, including how the rule should treat FCSs (e.g., whether they should be offered the same treatment as U.S. Guaranteed CSEs or conversely be offered the Exclusion), whether U.S. branches should be eligible for the Exclusion, and whether the Commission should provide exceptions related to certain ‘‘emerging markets’’ or nonnetting jurisdictions.109 2. Substituted Compliance a. Comments Most commenters argued for the greater availability of substituted compliance. Some requested that all CSEs, whether a U.S. persons or a nonU.S. person, be eligible for full substituted compliance with respect to all comparable foreign margin requirements, including any swap dealer in a BCBS–IOSCO frameworkcompliant jurisdiction.110 Others phrased their requests in narrower terms, arguing for the broader availability of substituted compliance for U.S. CSEs and/or U.S. Guaranteed CSEs when trading with non-U.S. persons.111 Commenters generally argued that requiring CSEs to comply with the Commission’s margin requirements in the face of comparable foreign margin requirements would undermine international efforts to 109 See Proposal, 80 FR at 41387, 88–91. e.g., AIMA/IA at 4–5 (substituted compliance should be ‘‘all encompassing, and applicable to all parties to a transaction’’); ICI Global at 2, 9 (substituted compliance should be made available ‘‘without qualification’’ wherever foreign jurisdiction’s margin requirements are comparable); ISDA at 2, 7–8 (substituted compliance should be available for any transaction subject to foreign requirements comparable to BCBS–IOSCO framework); SIFMA AMG 4, 6–8 (market participants should be allowed ‘‘to comply with a single set of substantive margin requirements for all uncleared swaps’’). See also ABA/ABASA at 3 (market participants should be allowed to rely on substituted compliance ‘‘to the greatest possible degree across the markets in and structures through which they operate’’). 111 See, e.g., FSR at 7 (U.S. CSEs should be able to rely on substituted compliance for both posting and collecting of initial margin when trading with non-U.S. CSEs and their foreign branches be extended full substituted compliance); IIB/SIFMA at 4–9 (substituted compliance should be available for U.S. CSEs and U.S. Guaranteed CSEs with respect to all margin requirements, including posting and collecting both initial and variation margin); JBA at 8–9 (availability of substituted compliance for U.S. Guaranteed CSEs is too limited); PensionsEurope at 2 (‘‘full substituted compliance,’’ including collection of initial margin and variation margin, should be available for transactions between U.S. Guaranteed CSEs and ‘‘financial institutions without a U.S. nexus’’). asabaliauskas on DSK3SPTVN1PROD with RULES 110 See, VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 develop a consistent global swaps regime and impose unnecessary and costly compliance burdens, resulting in competitive disparities and market inefficiencies.112 Several commenters also argued that the proposed rule would involve substantial operational costs, including categorizing market participants and developing appropriate documentation.113 With respect to U.S. CSEs and U.S. Guaranteed CSEs, IIB/SIFMA and ISDA argued that compliance with the Commission’s margin requirements was not necessary to prevent the transmission of risk to the U.S. financial system because the risk would be adequately addressed by comparable foreign margin requirements.114 IIB/ SIFMA argued that the proposed substituted compliance regime could actually increase liquidity risk by discouraging non-U.S. counterparties from trading with U.S. CSEs and U.S. Guaranteed CSEs in order to avoid costs associated with understanding and complying with the Commission’s margin requirements, and that the resulting increased concentration of bilateral credit exposures among U.S. CSEs and U.S. Guaranteed CSEs would increase the risk of contagion in U.S. markets.115 ISDA further argued that ‘‘[c]omity and respect for the supervisory interests of non-U.S. regulators’’ argue in favor of full substituted compliance or exclusion for swaps involving non-U.S. person counterparties.116 FSR argued that substituted compliance is at least necessary for foreign branches because they are likely to be subject to foreign margin requirements and pose the same concerns to foreign regulators as the 112 See, e.g., AIMA/IA at 1; FSR at 3–7; ICI Global at 8–9. See also Vanguard at 2 (applying substituted compliance on a ‘‘transaction-by-transaction basis’’ would undermine ‘‘the fundamental risk mitigation tool of cross-transactional close-out netting’’). 113 See, e.g., AIMA/IA at 1 (proposed rule would require a ‘‘significant amount of replacement and additional documentation to account for different counterparty combinations’’); ISDA at 5 (operational complexity of proposed substituted compliance regime would further increase operating costs); IIB/SIFMA at 7 (CSEs would not know sufficient information about businesses of their counterparties to categorize them, and nonU.S. counterparties would not be familiar with, and would be reluctant to hire counsel to determine, all U.S. laws relevant to making the determination); SIFMA AMG at 6 (highlighting complications in determining availability of substituted compliance on basis of counterparty status in context of block trades). 114 See IIB/SIFMA at 5; ISDA at 6–7. See also ICI Global at 9 (by not permitting substituted compliance in certain instances, Commission would effectively be determining that foreign margin requirements are not ‘‘good enough’’ despite being found comparable). 115 See IIB/SIFMA at 6–7. 116 See ISDA at 6. PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 U.S. branches of non-U.S. CSEs pose to U.S. regulators.117 Several commenters raised concerns with regard to the proposal to allow partial substituted compliance.118 SIMFA AMG argued that partial substituted compliance would be ‘‘inconsistent with the importance of bilateral margining,’’ add unnecessary costs and complexity, and increase the potential for margin disputes.119 AIMA/ IA argued that developing a legal agreement allowing for the transfer of margin amounts according to more than one margin regime would be ‘‘commercially and legally problematic.’’ 120 As a result, market participants would default to complying with the Commission’s margin requirements, negating the value of substituted compliance.121 ISDA similarly argued that developing a standardized model for initial margin that could account for different margin rules in one netting set would be ‘‘impractical’’ in the available timeframe for compliance.122 FSR argued that partial substituted compliance was not ‘‘in the spirit of the International Standards’’ 123 and pointed out that its usefulness may be questionable, given that no other foreign jurisdiction has proposed a similar approach.124 IATP, on the other hand, supported the proposed substituted compliance regime.125 IATP agreed that FCSs should be granted substituted compliance but not U.S. Guaranteed Affiliates because losses from the swaps of an FCS may have a negative impact on the foreign jurisdiction’s economy.126 IATP also agreed that U.S. Guaranteed Affiliates should not be eligible for substituted compliance with respect to the requirement to collect 117 See FSR at 7–8. See also AIMA/IA at 3 (absence of substituted compliance for foreign branches of U.S. CSEs is an ‘‘apparent gap[ ]’’). 118 See, e.g., AIMA/IA at 4; FSR at 7; ISDA at 3, 5; SIFMA AMG at 10. 119 See SIFMA AMG at 10 (highlighting additional complexities in calculating margin for clients using multiple asset managers). 120 See AIMA/IA at 4. 121 See id. 122 See ISDA at 9 (counterparties wanting to use a single custodian could face additional challenges, as the custodial arrangement would have to be drafted to accommodate overlapping and potentially inconsistent requirements for segregation). 123 See proposed 17 CFR 23.160(a)(3) (defining ‘‘International Standards’’ as based on the BCBS– IOSCO framework). 124 See FSR at 7. 125 See IATP at 3–4 (proposed rule would provide ‘‘the greatest opportunity for effective risk mitigation against swaps counterparty default’’ and would be a ‘‘critical step’’ to ensuring that ‘‘deguaranteed’’ swaps ‘‘will not continue to elude effective regulation’’). 126 See IATP at 7. E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations initial margin from a non-U.S. counterparty.127 AFR described the proposed rule as creating a ‘‘very significant scope for substituted compliance’’ with respect to non-U.S. CSEs, but suggested that the scope would not be a concern provided the substituted compliance were limited to foreign rules that are ‘‘very similar’’ to U.S. margin requirements.128 asabaliauskas on DSK3SPTVN1PROD with RULES b. Final Rule The Commission has determined to adopt a cross-border framework largely as proposed, but with certain modifications to address concerns raised by commenters and to further align the rule with the cross-border approach adopted by the Prudential Regulators. Generally speaking, the cross-border margin framework in the Final Rule reflects the Commission’s efforts to carefully tailor the application of the Commission’s margin requirements to address comity considerations and mitigate potential adverse impact on market efficiency and competition without compromising the safety and soundness of CSEs. The availability of substituted compliance under the Final Rule therefore depends on the degree of nexus the CSEs and their counterparties have to the U.S. financial system, as indicated by their status (e.g., whether they are U.S. persons or non-U.S. persons whose obligations under the relevant swap are guaranteed by a U.S. person). i. Uncleared Swaps of U.S. CSEs and U.S. Guaranteed CSEs As a general rule, the Commission believes that, in light of their position in the U.S. financial system, U.S. persons and U.S. Guaranteed CSEs should be required to comply with the Commission’s margin requirements. Under the Final Rule, however, U.S. CSEs and U.S. Guaranteed CSEs would be eligible for substituted compliance with respect to the requirement to post (but not the requirement to collect) initial margin provided that the counterparty is a non-U.S. person whose obligations under the relevant swap are not guaranteed by a U.S. person. By virtue of their being domiciled or organized in the United States, U.S. CSEs give rise to greater supervisory interests relative to other CSEs. U.S. Guaranteed CSEs create a similar supervisory interest because, as discussed in the proposed rule, the 127 See id. 128 See AFR at 7. See also id. at 4 (scope of substituted compliance could become ‘‘overbroad’’ given that proposed rule included narrow definition of ‘‘guarantee’’ and limited Foreign Consolidated Subsidiaries to subsidiaries of registered CSEs). VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 swap of a non-U.S. CSE whose obligations under the swap are guaranteed by a U.S. person is identical, in relevant aspects, to a swap entered into directly by a U.S. person. Nevertheless, the Commission believes that, in the interest of comity, permitting substituted compliance for the limited requirement of posting initial margin would be reasonable. While requiring a CSE to post initial margin protects the counterparty in the event of default by the CSE, it also serves as a risk management tool because it limits the amount of leverage a CSE can incur by requiring that it have adequate eligible collateral to enter into an uncleared swap. Accordingly, when the counterparty is a non-U.S. person (whose obligations under the swap are not guaranteed by a U.S. person), the Commission believes that substituting the foreign margin requirements with regard to the initial margin posted would be reasonable. The Commission further believes that allowing substituted compliance in this limited instance may reduce transaction costs for U.S. CSEs when trading with nonU.S. counterparties 129 and thereby mitigate potential competitive disparities (relative to other CSEs and non-CFTC registered dealers operating in the foreign jurisdiction), while ensuring that the U.S. CSE is adequately protected in the event of default of the non-U.S. counterparty. The availability of substituted compliance is limited to circumstances where the non-U.S. counterparty’s obligations under the relevant swap are not guaranteed by a U.S. person in order to avoid incentivizing market participants to structure their swaps solely for purposes of avoiding application of the Commission’s margin requirements.130 The Commission does not believe that partial substituted compliance would prohibit the use of a single netting set for calculating initial margin. Under the Final Rule, a U.S. CSE can comply with the Commission’s initial margin requirements by posting pursuant to comparable foreign margin requirements. Accordingly, from the 129 That is, if the initial margin amount required to be posted under the foreign rule is lower than the amount required under the Commission’s Final Margin Rule, and the parties elect for the CSE to post margin pursuant to the foreign margin requirements, the lower margin may reduce the U.S. CSE’s funding costs. 130 For example, if partial substituted compliance were available for non-U.S. counterparties that are guaranteed by a U.S. person, a swap between a U.S. CSE and a U.S. counterparty could be restructured as a swap between a U.S. CSE and a non-U.S. counterparty that is guaranteed by a U.S. person in order to avoid application of the Commission’s margin requirements. PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 34829 Commission’s perspective, one netting set could encompass swaps that comply with both foreign and CFTC initial margin requirements.131 The Commission understands that CSEs relying on partial substituted compliance may face certain costs or challenges not experienced by non-U.S. CSEs that are eligible for full substituted compliance. Nevertheless, as discussed above, the Commission believes that granting substituted compliance more broadly (e.g., permitting both collection and posting of initial margin pursuant to the foreign requirements) would not be appropriate for a swap transaction involving a U.S. CSE or a U.S. Guaranteed CSE. Moreover, U.S. CSEs and U.S. Guaranteed CSEs that elect to rely on partial substituted compliance may realize savings in the form of reduced funding costs (to the extent that foreign jurisdiction requires less initial margin to be posted), and their non-U.S. counterparties may experience lower operational costs as a result of only having to comply with their home jurisdiction’s requirements. Finally, the Commission does not believe it would be appropriate to broaden the scope of substituted compliance available to swaps conducted through foreign branches of U.S. CSEs. A foreign branch is legally indistinguishable from the U.S. CSE itself, such that the whole U.S. CSE, and not merely the foreign branch, holds itself out to the market and assumes the risks of any uncleared swap transactions conducted by or through the foreign branch. Accordingly, swaps conducted through a foreign branch of a U.S. CSE are appropriately treated the same as swaps of the U.S. CSE as a whole. Moreover, if the Commission were to allow broader substituted compliance for swaps conducted through foreign branches than swaps conducted domestically, U.S. CSEs could be incentivized to conduct swap activity through foreign branches to avoid direct compliance with Commission’s margin requirements. ii. Uncleared Swaps of Non-U.S. CSEs (Including FCSs) Whose Obligations Under the Relevant Swap Are Not Guaranteed by a U.S. Person Under the Final Rule, consistent with the Proposed Rule, non-U.S. CSEs (including FCSs) whose obligations under the relevant uncleared swap are 131 The Commission similarly does not expect that reliance on partial substituted compliance will hinder the development or use of a standardized model for initial margin, as the Commission believes that a single model could be developed to satisfy the initial margin requirements of multiple jurisdictions. E:\FR\FM\31MYR2.SGM 31MYR2 34830 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES not guaranteed by a U.S. person may avail themselves of substituted compliance to a greater extent than U.S. CSEs and U.S. Guaranteed CSEs. Specifically, where the obligations of a non-U.S. CSE (including an FCS) under the relevant swap are not guaranteed by a U.S. person, substituted compliance is available with respect to its uncleared swaps with any counterparty, other than a U.S. CSE or a U.S. Guaranteed CSE.132 The broad substituted compliance framework available to this category of non-U.S. CSEs reflects the Commission’s recognition of foreign jurisdictions’ supervisory interest in CSEs that are domiciled and operating in their jurisdictions. In addition, the Commission understands that compliance with two sets of margin regulations may lead to costs and burdens for non-U.S. CSEs not faced by their competitors in the local jurisdiction and may provide disincentives for foreign clients to transact with a non-U.S. CSE. The Commission believes that making substituted compliance broadly available to non-U.S. CSEs that are not guaranteed by a U.S. person may help to reduce the potential adverse impact on market efficiency and competition, without compromising the protections for the non-U.S. CSE and the U.S. financial markets. As discussed in the next section, a non-U.S. CSE that is not an FCS will be eligible for the Exclusion from the Commission’s margin rules under certain circumstances. However, uncleared swaps entered into by an FCS will not be eligible for any exclusion because of its relationship with its U.S. ultimate parent entity, and because of the possible negative impact of its swap activities on its U.S. ultimate parent entity and the U.S. financial system. As explained in section II.A.3.c. above, the financial position, operating results, and statement of cash flows of an FCS are included in the financial statements of the U.S. ultimate parent entity and therefore have a direct impact on the consolidated entity’s financial position, risk profile, and market value. The Commission is also concerned that extending the Exclusion to FCSs would incentivize U.S. entities to conduct their swap activities with non-U.S. counterparties through non-U.S. 132 With respect to uncleared swaps of a non-U.S. CSE whose obligations under the swap are not guaranteed by a U.S. person, on the one hand, with a U.S. CSE or a U.S. Guaranteed CSE, on the other hand, substituted compliance would only be available for initial margin collected by the nonU.S. CSE whose obligations under the relevant swap are not guaranteed by a U.S. person, as discussed above. VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 subsidiaries solely in order to avoid application of the Dodd-Frank Act margin requirements, leading to further bifurcation between U.S. and non-U.S. swap business. The Commission recognizes that its decision not to extend the Exclusion to FCSs could put them at a disadvantage relative to other non-U.S. market participants/swap dealers (including those that are CSEs).133 However, given the supervisory concerns raised by the nexus between FCSs and their U.S. ultimate parent entity, the Commission believes that extending the Exclusion to an FCS would not further the paramount statutory objective of ensuring the safety and soundness of a CSE and the stability of U.S. financial markets. The Commission notes that potential competitive disparities may be mitigated to the extent that the relevant foreign jurisdiction implements comparable margin requirements. 3. Exclusion a. Comments Several commenters supported the Exclusion because they believed that it recognized the absence of a U.S. jurisdictional nexus.134 Nevertheless, these commenters requested that the Exclusion be expanded to include U.S. branches of non-U.S. CSEs and FCSs.135 With respect to U.S. branches, IIB/ SIFMA argued that distinguishing them would not be necessary from a riskmitigation perspective because the risk remains with the non-U.S. CSE outside the United States regardless of whether the non-U.S. CSE involves U.S. personnel.136 ISDA and ICI Global further argued that treating U.S. branches differently from the rest of the CSE could create ‘‘significant operational issues and credit risks.’’ 137 ICI Global stated that the same ISDA Master Agreement typically governs all transactions involving both the U.S. and non-U.S. branches of a non-U.S. CSE, and that not granting the Exclusion to swaps between a non-U.S. person and a U.S. branch of a non-U.S. CSE (whose obligations are not guaranteed by a U.S. person) may require parties to document transactions with the U.S. branch under a separate master agreement, which 133 For example, a non-U.S. CSE relying on the Exclusion or non-CFTC registered swap dealers may be able to realize cost savings and offer better pricing terms to foreign clients. 134 See ICI Global at 2, 5; IIB/SIFMA at 10. 135 See id. See also ISDA at 3 (Exclusion should be expanded to include any swap between a nonU.S. CSE, whether or not guaranteed, and any nonU.S. person counterparty that is not guaranteed by a U.S. person). 136 See IIB/SIFMA at 16. 137 See IIB/SIFMA at 16; ICI Global at 10–11. PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 could create operational difficulties.138 ICI Global also expressed concern that disparate treatment of U.S. branches could lead to additional credit risk because counterparties might lose netting benefits under bankruptcy laws.139 With respect to FCSs, ICI Global argued that consolidation is insufficient to create a ‘‘direct’’ U.S. nexus because the U.S. ultimate parent is not under a legal obligation to support the FCS.140 IIB/SIFMA added that foreign jurisdictions have not proposed to apply margin rules to foreign, non-guaranteed subsidiaries and that the Commission should extend the Exclusion to avoid overlapping requirements that could lead market participants to avoid trading with an FCS.141 Although substituted compliance would potentially be available in place of the Exclusion, ISDA asserted that the difference between the Exclusion and substituted compliance is not costless, as affected swap dealers would incur costs of complying with any conditions imposed with respect to substituted compliance and with the Commission’s exercise of its related examination authority, in addition to lost business that could result if substituted compliance is not ‘‘seamless’’ and counterparties are ‘‘inconvenienced’’ by its application.142 As an alternative to extending the Exclusion to FCSs, IIB/SIFMA suggested that the Commission grant an exclusion to FCSs operating without a U.S. guarantee when transacting with nonU.S. persons operating without a U.S. guarantee, up to an aggregate 5 percent limit on the notional trading volume in uncleared swaps entered into by commonly controlled FCSs under the exclusion relative to the total notional swap trading volume of entities within the common U.S. ultimate parent entity’s consolidated group.143 IIB/ SIFMA argued that such a limited exclusion would achieve the Commission’s risk mitigation objectives 138 See ICI Global at 10–11. also ISDA at 11 (fragmenting netting sets could increase risk and discourage use and employment of U.S. personnel). 140 See ICI Global at 11. See also IIB/SIFMA at 14 (CEA section 2(i) does not authorize the Commission to regulate a foreign subsidiary solely due to potential for support from and risk to a U.S. parent entity because, absent a legal obligation to provide support, the ‘‘chain of intervening factors and events’’ that might lead to such support would not satisfy ‘‘direct’’ requirement in CEA section 2(i)). 141 See IIB/SIFMA at 15. 142 See id. at 7. 143 See IIB/SIFMA at 16. 139 See E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations without directly regulating wholly nonU.S. counterparties.144 Both AFR and Better Markets expressed support for the proposal not to extend the Exclusion to FCSs, describing it as a means of addressing the issue of de-guaranteeing.145 AFR nevertheless expressed concern that the Exclusion would apply to a non-U.S. CSE when entering into a swap with a foreign subsidiary that is a financial end user that has a U.S. ultimate parent, and suggested that the Commission also deny the Exclusion in this case.146 AFR also suggested that the Commission ‘‘supplement’’ its approach by further denying the Exclusion to a nonconsolidated, non-U.S. subsidiary that could, based on the facts and circumstances, have a ‘‘major impact on the financial well-being of the parent,’’ including circumstances where the parent does not use U.S. GAAP accounting.147 b. Final Rule The Commission has determined to adopt the Exclusion largely as proposed, with a modification that preserves the Commission’s intent with respect to the treatment of inter-affiliate swaps under the Final Margin Rule. Under the Final Rule, an uncleared swap entered into by a non-U.S. CSE with a non-U.S. counterparty (including a non-U.S. CSE) is excluded from the Commission’s margin rules, provided that neither counterparty’s obligations under the relevant swap are guaranteed by a U.S. person and neither counterparty is an FCS.148 This approach reflects the Commission’s recognition of foreign jurisdictions’ strong supervisory interest in the uncleared swaps of non-U.S. CSEs and their non-U.S. counterparties, both of which are domiciled and operate abroad. Under these circumstances, the Commission believes that it is appropriate to make a limited exception to the principle of firm-wide application of margin requirements, consistent with comity principles, so as to exclude a narrow class of uncleared swaps 144 See id. AFR at 2 (proposed rule would go ‘‘some distance’’ toward limiting evasion of Commission’s margin requirements); Better Markets at 5 (proposed rule ‘‘adequately captures’’ many foreign affiliates that may have escaped U.S. margin requirements through de-guaranteeing). 146 See AFR at 8 (foreign subsidiary of a U.S. financial end user that is not a CSE would not be defined as an FCS even if consolidated). 147 See AFR at 3. See also Better Markets at 2 (Exclusion is needlessly complicated and indirect and Commission should address issue more completely by reverting to and updating approach in Guidance). 148 The Exclusion also does not apply if the counterparty is a U.S. branch of a non-U.S. CSE. See 17 CFR 23.160(b)(2)(ii). asabaliauskas on DSK3SPTVN1PROD with RULES 145 See VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 involving a non-U.S. CSE and a nonU.S. counterparty.149 The Commission notes that a non-U.S. CSE that can avail itself of the Exclusion is still subject to the Commission’s margin rules with respect to all other uncleared swaps (i.e., those that do not qualify for the Exclusion), with the possibility of substituted compliance. And any excluded swaps may be covered by the margin requirements of another jurisdiction that adheres to the BCBS–IOSCO framework.150 Additionally, the non-U.S. CSE would be subject to the Commission’s capital requirements, which, as proposed, would impose a capital charge for uncollateralized exposures.151 The Commission considered comments urging a broader scope of the Exclusion to include, for example, any FCSs so long as their swaps are not guaranteed by a U.S. person or alternatively, do not exceed a ‘‘de minimis’’ level of swap activity. However, the Commission does not believe that extending the Exclusion to uncleared swaps of FCSs is appropriate given the nature of their relationship to their U.S. ultimate parent entity. The limited scope of the Exclusion reflects that the benefits of the margin requirement are achieved when it is applied to all CSEs and on a firm-wide basis and therefore, any exception needs to be carefully tailored to avoid creating a significant supervisory gap and inappropriate levels of risk to the CSE and the U.S. financial system. The Commission also disagrees with comments that the Exclusion is overly broad because it would extend to a swap between a non-U.S. CSE and a foreign subsidiary of a U.S. financial end user.152 The Commission notes that such a foreign subsidiary would not be 149 The Commission disagrees that the Commission lacks a jurisdictional nexus with respect to swaps subject to the Exclusion. To the contrary, as discussed above, by the terms of the relevant statutory provision, CEA section 4s(e), and the underlying purpose of that provision, the Commission’s authority to adopt margin rules applies to all CSEs, U.S. and non-U.S., and extends to all of their uncleared swaps, regardless of the counterparties’ domicile or the location of the swaps transaction. 150 In this regard, the Commission notes that, as indicated in supra note 23, representatives of 26 regulatory authorities (comprising 17 nations) participated in the WGMR that developed the BCBS–IOSCO framework. As of today, 24 of these 26 regulatory authorities that participated in the WGMR have proposed a regulatory framework for margin for uncleared swaps, all of which are consistent with the BCBS–IOSCO framework. In addition, these 24 regulatory authorities have jurisdiction over more than 90% of the swaps activities in the world by any measure. 151 See Proposed Capital Rule, 76 FR 27802. 152 The term ‘‘financial end user’’ is defined in section 23.150 of the Final Margin Rule. PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 34831 an FCS even if it is consolidated with its U.S. parent because it is not a CSE. The Commission believes that a swap between such a foreign subsidiary and a non-U.S. CSE should be eligible for the Exclusion because financial end users are not covered swap entities and are likely to include many entities that do not conduct a significant level of swap activities; as such, their swap activities would not have the same effect on the U.S. ultimate parent entity as would a covered swap entity’s. Therefore, the Exclusion applies to qualifying non-U.S. CSEs when transacting with foreign subsidiaries that are financial end users that have a U.S. ultimate parent entity. Under the Final Margin Rule, a CSE is not required to collect initial margin from its affiliate, provided, among other things, that affiliate collects initial margin on its market-facing swaps or is subject to comparable initial margin collection requirements (in the case of non-U.S. affiliates that are financial end users) on its own market-facing swaps. In order to preserve the Commission’s intent with respect to the treatment of inter-affiliate swaps under the Final Margin Rule, the Exclusion is not available if the market-facing swap of the non-U.S. CSE (that is otherwise eligible for the Exclusion) is not subject to comparable initial margin collection requirements in the home jurisdiction and any of the risk associated with the uncleared swap is transferred, directly or indirectly, through inter-affiliate transactions, to a U.S. CSE or a U.S. Guaranteed CSE. This condition is intended to ensure that inter-affiliate swaps are not used to avoid the requirement to collect initial margin from third-parties.153 The limitation on the Exclusion is consistent with that rationale. Under the Final Rule, uncleared swaps of a U.S. branch of a non-U.S. CSE are not eligible for the Exclusion. The Commission does not believe extending the Exclusion to U.S. Branches would be appropriate. Generally speaking, U.S. branches of foreign banks 154 have a Prudential Regulator and must therefore comply with the Prudential Regulators’ margin rules. The Prudential Regulators’ Final Margin Rule does not grant an exclusion for the uncleared swaps of such U.S. branches on the basis that U.S. branches of foreign banks clearly operate within the United States and could pose risk to 153 See 17 CFR 23.159. Prudential Regulators’ Final Margin Rule, 80 FR at 74901 (setting forth the definition of ‘‘foreign bank’’ for purposes of the Prudential Regulators’ Final Margin Rule). 154 See E:\FR\FM\31MYR2.SGM 31MYR2 34832 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations the U.S. financial system.155 To the extent that a U.S. branch of a non-U.S. CSE is subject to the Commission’s requirements rather than a Prudential Regulator, the Final Rule appropriately harmonizes with the Prudential Regulators.156 Additionally, given that U.S. branches operate within the United States, allowing their swaps to be excluded from application of the Commission’s margin requirements could disadvantage U.S. CSEs when competing with U.S. branches for U.S. clients 157 and create incentives for CSEs to operate through U.S. branches solely for purposes of avoiding the Dodd-Frank Act margin requirements. Accordingly, the Commission believes that a non-U.S. CSE should be subject to the Commission’s margin requirements when conducting swap activities from within the United States by or through a U.S. branch.158 4. Special Provision for Non-Segregation Jurisdictions 159 asabaliauskas on DSK3SPTVN1PROD with RULES a. Comments Several commenters supported the creation of a de minimis exception similar to the emerging markets exemption set out in the Guidance.160 Specifically, commenters recommended that U.S. CSEs be exempt from the margin requirements when trading with ‘‘emerging market counterparties’’ provided that the aggregate notional 155 See Prudential Regulators’ Final Margin Rule, 80 FR at 74883. 156 Under the International Banking Act of 1978, 12 U.S.C. 3101 et seq., U.S. branches are generally treated the same as national banks operating in that same location and are subject to the same laws, regulations, policies, and procedures that apply to national banks. 157 That is, a U.S. branch of a non-U.S. CSE that is permitted to operate outside of the Commission’s margin requirements may, by virtue of being subject to reduced or even no margin requirements, be able to offer a more competitive price to U.S. clients than a U.S. CSE. 158 As noted above in section II.B.3.a., some commenters suggested that not extending the Exclusion to U.S. branches of non-U.S. CSEs could require non-U.S. CSEs to document transactions with the U.S. branch under a separate ISDA Master Agreement, creating operational challenges. However, because such U.S. branches are eligible for substituted compliance, use of a separate credit support agreement to document transactions with a non-U.S. CSE’s U.S. branch should only be necessary where foreign margin requirements are not comparable. Although the Commission acknowledges that the non-U.S. CSE may need to use a separate credit support agreement for U.S. branch transactions in this limited case, the Commission nevertheless believes that it would not be appropriate to extend the Exclusion to U.S. branches of non-U.S. CSEs for the reasons discussed above. 159 The term ‘‘emerging market’’ is not used in the Final Rule because some jurisdictions covered by this provision of the Final Rule are not aptly described by that term. 160 See, e.g., ABA/ABASA at 3–5; IIB/SIFMA at 3, 11–13; ISDA at 2, 9–10; JBA at 10. VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 volume of its uncleared swaps with emerging market counterparties does not exceed 5 percent of the CSEs’ total notional swap trading volume, both cleared and uncleared.161 They further recommended defining ‘‘emerging market counterparty’’ as a non-U.S. person that is (a) not a registered CSE, (b) not guaranteed by a U.S. person, and (c) not located in a jurisdiction covered by a comparability determination for uncleared swaps margin rules issued by the Commission.162 Commenters generally agreed that the exception should apply to foreign branches of U.S. CSEs,163 but some commenters also recommended that it be extended to U.S. Guaranteed CSEs 164 and FCSs.165 For swaps between U.S. Guaranteed CSEs and emerging market counterparties, ABA/ABASA and IIB/ SIFMA recommended that the de minimis threshold apply to the aggregate volume of uncleared swaps guaranteed by a particular U.S. person, rather than to the trading volume of the U.S. Guaranteed CSE itself.166 In support of such an exception, commenters argued that legal and operational constraints in emerging market jurisdictions could make compliance with margin rules difficult, if not impossible.167 As a result, broad application of the margin requirements to these swaps could negatively impact the competitiveness of registered CSEs.168 Commenters argued that by 161 See ABA/ABASA at 5. See also ISDA at 9–10 (further recommending that Commission impose recordkeeping requirement as condition to exemption, as was included in Guidance). 162 See ABA/ABASA at 4–5; IIB/SIFMA at 13. See also ISDA at 9 (‘‘emerging market counterparty’’ should be defined as any non-U.S. person that is not guaranteed by a U.S. person and that is not located in one of six jurisdictions identified in Guidance as having submitted requests for comparability determinations). 163 See ABA/ABASA at 1 n.5 (exemption should apply to ‘‘U.S.-based banking organizations, however they are operating in emerging markets, including, but not limited to, through a foreign branch of a prudentially-regulated CSE’’); IIB/ SIFMA; ISDA. 164 See ABA/ABASA at 1 n.5, 3; IIB/SIFMA at 12; ISDA at 9. 165 See ISDA at 10 (availability of the exemption should be extended to FCSs if Commission does not otherwise make Exclusion available to them). 166 See ABA/ABASA at 5; IIB/SIFMA at 13 (approach would be appropriate given that risk to U.S. guarantor provides basis for extraterritorial application of margin rules to U.S. Guaranteed CSEs). 167 See, e.g., ABA/ABASA at 4 (local banking sector may lack operational infrastructure to support daily exchange of margin or third-party custodial arrangements); IIB/SIFMA (local legal regime may not recognize concept of netting); ISDA at 4 (emerging market counterparties may be unable to comply with U.S. margin requirements). 168 See ABA/ABASA at 4 (absent an exemption, U.S. CSEs could lose not only derivatives business but associated commercial and investment banking PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 limiting the exception to CSEs with a de minimis level of swaps activity, the Commission could accomplish the goal of ensuring a CSE’s safety and soundness but with less disruption to existing business relationships than the exchange of initial and variation margin would impose.169 IIB/SIFMA also argued that the exception would be consistent with CEA section 2(i), and encouraged the Commission to coordinate with foreign regulators to develop a consistent global approach to swaps with emerging market counterparties.170 b. Final Rule The Commission is adopting a special provision for swaps with counterparties in foreign jurisdictions where limitations in the legal or operational infrastructure of the jurisdiction make it impracticable for the CSE and its counterparty to comply with the custodial arrangement requirements in the Final Margin Rule (‘‘non-segregation jurisdictions’’).171 The Commission understands that CSEs may transact swaps with counterparties located in foreign jurisdictions that do not have legal or operational infrastructures to support custodial arrangements required under the Final Margin Rule.172 In the face of these legal and operational impediments, FCSs and foreign branches of U.S. CSEs would be forced to discontinue their swaps business with clients located in these jurisdictions. Taking these factors into consideration, the Commission has determined to include a special provision to accommodate this unique circumstance. The Commission notes that the Prudential Regulators adopted a similar provision in their final margin rules. Under section 23.160(e) of the Final Rule, an FCS or a foreign branch of a U.S. CSE would be eligible to engage in relationships); IIB/SIFMA at 12 (emerging market counterparties are likely to move business away from U.S. CSEs and U.S. Guaranteed CSEs in order to avoid being subject to margin requirements); ISDA at 10 (dealing activities that would fall within exemption may be an ‘‘integral element’’ of CSEs’ global business). 169 See ABA/ABASA at 3; IIB/SIFMA at 12–13; ISDA at 10. 170 See IIB/SIFMA at 12 (arguing that de minimis nature of exemption ensures that nexus of swap activity to the United States is not ‘‘significant’’). 171 For convenience, the term ‘‘non-segregation jurisdiction’’ is used in the preamble of this release. 172 The Final Margin Rule addresses the manner in which the margin collected or posted by a CSE must be held and requires, among other things, that the CSE must have a custodial agreement prohibiting rehypothecation or otherwise transfer the initial margin held by the custodian. See 17 CFR 23.157. The custodial requirements are critical to ensuring the proper segregation and protection of CSE funds. E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations uncleared swaps with certain non-U.S. counterparties in non-segregation jurisdictions, without complying with either the requirement to post initial margin 173 or the custodial arrangement requirements that pertain to initial margin collected by a CSE under the Final Margin Rule,174 subject to certain conditions.175 This special provision reflects the Commission’s recognition that CSEs would otherwise be precluded from engaging in any uncleared swaps in these foreign jurisdictions as they cannot satisfy the custodial requirements of the Final Margin Rule. The Commission clarifies that the special provision for non-segregation jurisdictions only provides relief from the specified requirements; all other margin rules in part 23 of the Commission’s regulations (with the exception of the special provision for non-netting jurisdictions) would continue to apply.176 This provision is narrowly tailored to limit its availability to FCSs (and foreign branches of U.S. CSEs) in foreign jurisdictions where compliance with the Final Margin Rule’s custodial requirements is effectively precluded due to impediments inherent in the relevant foreign jurisdiction.177 In 173 See 17 CFR 23.152(b). 17 CFR 23.157(b). The Commission notes that with respect to initial margin collected by a qualifying CSE in a non-segregation jurisdiction in reliance on § 23.160(e), § 23.157(c) also would not apply to initial margin that is collected by the CSE. Section 23.157(c) requires a CSE to enter a custodial agreement meeting specified requirements with respect to any funds that the CSE holds (i.e., initial margin posted or collected by the CSE). Because CSEs that rely on § 23.160(e) are not required to hold collateral in accordance with § 23.157(b) for initial margin that they collect, they also would not be required to comply with § 23.157(c) with respect to initial margin that they collect. 175 This provision only provides relief from the custodial requirement for collection of initial margin in § 23.157(b). Accordingly, FCSs and foreign branches of U.S. CSEs remain subject to the requirements of § 23.157(a) and (c) of the Final Margin Rule with respect to initial margin that is posted in a non-segregation jurisdiction (which the CSE would be unable to comply with in a nonsegregation jurisdiction). 176 If the special provision for non-segregation jurisdictions is available, then the special provision for non-netting jurisdictions (discussed in the next section) would not be available even if the relevant foreign jurisdiction is also a ‘‘non-netting jurisdiction.’’ As explained in supra note 174, because CSEs that rely on § 23.160(e) are not required to hold collateral in accordance with § 23.157(b) for initial margin that they collect, they would not be required to comply with § 23.157(c) with respect to initial margin that they collect. 177 The special provision applies where inherent limitations in the legal or operational infrastructure in the applicable foreign jurisdiction make it impracticable for the FCS (or foreign branch of a U.S. CSE) and its counterparty to post initial margin in compliance with the custodial requirements of § 23.157 of the Final Margin Rule. The special provision does not apply if the CSE that is subject to the foreign regulatory restrictions is permitted to asabaliauskas on DSK3SPTVN1PROD with RULES 174 See VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 addition, this provision is only available in such jurisdictions if the following conditions are satisfied. First, the CSE’s counterparty must be a non-U.S. person that is not a CSE, and the counterparty’s obligations under the swap must not be guaranteed by a U.S. person.178 Second, the CSE must collect initial margin in cash on a gross basis, and post and collect variation margin in cash, in accordance with the Final Margin Rule.179 The collection of margin on a gross basis ensures that the CSE has adequate collateral in the event of a counterparty or custodial default; similarly, not requiring the CSE to post initial margin minimizes the amount of collateral that may not be recovered if the CSE’s counterparty defaults. Third, for each broad risk category set out in section 23.154(b)(2)(v) of the Final Margin Rule,180 the total outstanding notional value of all uncleared swaps in that broad risk category, as to which the CSE is relying on section 23.160(e), may not exceed 5 percent of the CSE’s total outstanding notional value for all uncleared swaps in the same broad risk category. Accordingly, a 5 percent limit applies to each of the four broad risk categories set forth in section 23.154(b)(2)(v): Credit, equity, foreign exchange and interest rates (considered together as a single asset class), and commodities. Fourth, the CSE must have policies and procedures ensuring that it is in compliance with all of the requirements of this exception. Fifth, the CSE must maintain books and records properly documenting that all of post collateral for the uncleared swap in compliance with the custodial arrangements of § 23.157 in the United States or a jurisdiction for which the Commission has issued a comparability determination with respect to § 23.157. See 17 CFR 23.160(e)(1) and (2). 178 The Commission would expect the CSE’s counterparty to be a local financial end user that is required to comply with the foreign jurisdiction’s laws and that is prevented by regulatory restrictions in the foreign jurisdiction from posting collateral for the uncleared swap in compliance with the custodial arrangements of § 23.157 in the United States or a jurisdiction for which the Commission has issued a comparability determination under the Final Rule, even using an affiliate. 179 The CSE must collect initial margin in accordance with § 23.152(a) on a gross basis, in the form of cash pursuant to § 23.156(a)(1)(i) and post and collect variation margin in accordance with § 23.153(a) in the form of cash pursuant to § 23.156(a)(1)(i). See § 23.160(e)(4) of the Final Rule. 180 Section 23.154(b)(2)(v) of the Final Margin Rule permits a CSE to use an internal initial margin model that reflects offsetting exposures, diversification, and other hedging benefits within four broad risk categories: Credit, equity, foreign exchange and interest rates (considered together as a single asset class), and commodities when calculating initial margin for a particular counterparty if the uncleared swaps are executed under the same ‘‘eligible master netting agreement.’’ See 17 CFR 23.154(b)(2)(v). PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 34833 the requirements of this exception are satisfied.181 In adopting this provision, the Commission considered the various alternatives endorsed by commenters, including the adoption of a blanket exclusion, subject to a transactional volume limit (e.g., using a 5 percent limit patterned after a limited exclusion for certain jurisdictions in the Guidance, as discussed in section II.B.4.a. above). However, given the importance of the Final Margin Rule’s requirements to the protection of CSEs and the broader financial system, and the potential for a blanket exclusion to incentivize market participants to structure their swap business solely to avoid application of the Commission’s margin requirements, the Commission believes that a more targeted approach that provides relief from only from the requirement to post initial margin and the custodial arrangement requirements that pertain to initial margin collected by a CSE, as described above, is appropriate. While the Commission believes that the relief provided by the special provision is appropriate because FCSs and foreign branches of U.S. CSEs would otherwise be effectively precluded from entering swaps in non-segregation jurisdictions, the Commission also believes that, in order to protect the safety and soundness of FCSs and foreign branches of U.S. CSEs relying on the special provision, the exception from the specified requirements is appropriately limited, as these CSEs are integral to the stability of the U.S. financial system. Therefore, rather than provide an exception from all of the Commission’s margin requirements to CSEs that engage in swaps activities in nonsegregation jurisdictions up to a 5% limit, as suggested by some commenters, the special provision only excepts qualifying FCSs and foreign branches of U.S. CSEs from certain specified requirements, subject to specified conditions (including a 5 percent limit in each of four broad risk categories set forth in § 23.154(b)(2)(v)), as described above. The Commission believes that imposing a 5 percent limit in each of the four broad risk categories set out in § 23.154(b)(2)(v) is necessary because the FCS (or foreign branch of a U.S. CSE) may have a large notional amount outstanding in the foreign exchange and interest rate category (which is considered together as a single class) which would effectively eviscerate any limit in other lower notional risk categories. The Commission believes that the total outstanding notional value of all 181 See E:\FR\FM\31MYR2.SGM 17 CFR 23.160(e). 31MYR2 34834 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations uncleared swaps as to which an FCS relies on § 23.160(e) should not exceed 5 percent of the FCS’s total outstanding notional amount of uncleared swaps (in each of the four broad risk categories), rather than the total notional outstanding amount of uncleared swaps of its ultimate parent entity. Using the ultimate parent entity’s swap activity as the basis for the formula could allow the FCS to engage in significant levels of swap activity in non-segregation jurisdictions based on swap activities of its affiliates, rendering the 5 percent limit meaningless. In addition, as an FCS is a registered CSE, its swap activities with U.S. persons were sufficient to require its registration in the United States, and therefore its swap activity in the non-segregation jurisdiction would never account for all of the CSE’s swap dealing activity. 5. Special Provision for Non-Netting Jurisdictions asabaliauskas on DSK3SPTVN1PROD with RULES a. Comments Commenters generally agreed that, at a minimum, the Commission should provide an exception for swaps with counterparties located in jurisdictions in which netting, collateral or third party custodial arrangements may not be legally effective, including in a counterparty’s insolvency.182 ISDA and JBA proposed that an exception for nonnetting jurisdictions should apply up to 5 percent of the aggregate notional amount of a CSE’s uncleared swaps.183 They argued that, without enforceable netting and collateral arrangements, a bankruptcy administrator could ‘‘cherry pick’’ when determining the return of posted collateral in the event of insolvency.184 ISDA further argued that imposing margin in such cases could severely limit swaps activity in nonnetting jurisdictions and cause significant disruptions in financial markets.185 ISDA and JBA further recommended that, absent an exception for non-netting jurisdictions, CSEs should have at least some exception from the requirement to collect or post margin.186 According to ISDA, without such an exception, a CSE 182 See ABA/ABASA at 5 n.14; IIB/SIFMA at 13 n.44; ISDA at 10 (requesting an exemption for jurisdictions where getting a ‘‘clean’’ netting or collateral opinion is ‘‘not possible’’); JBA at 10. 183 See ISDA at 10; JBA at 10. 184 See ISDA at 10 (further arguing that a CSE may not be able to effectively foreclose on margin in event of a counterparty default); JBA at 10. 185 See ISDA at 10. 186 See ISDA at 10–11 (requesting exemption from requirement to post initial margin); JBA at 10 (requesting exemption from both initial and variation margin requirements because, under such conditions, amount of variation margin to be posted or collected cannot be fixed). VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 could be prevented from applying collateral to the obligations of the counterparty and face difficulties in recovering it.187 ISDA argued that posting margin could therefore increase risk to the CSE, while an exception could bypass segregation problems in the non-netting jurisdiction.188 b. Final Rule The Commission is adopting a special provision, also included in the Prudential Regulators’ Final Margin Rule, for non-netting jurisdictions.189 Under the Final Rule, a CSE that cannot conclude, with a well-founded basis, that the netting agreement with a counterparty in a foreign jurisdiction meets the definition of an ‘‘eligible master netting agreement’’ set forth in the Final Margin Rule may nevertheless net uncleared swaps in determining the amount of margin that it posts, provided that certain conditions are met.190 In order to avail itself of this special provision, the CSE must treat the uncleared swaps covered by the agreement on a gross basis in determining the amount of initial and variation margin that it must collect, but may net those uncleared swaps in determining the amount of initial and variation margin it must post to the counterparty, in accordance with the netting provisions of the Final Margin Rule.191 Requiring CSEs to calculate and collect initial margin on a gross basis is intended to ensure that the CSE can obtain the collateral posted with the counterparty in the event of counterparty default. As with the special provision for non-segregation jurisdictions in section 23.160(e) of the 187 See ISDA at 11. 188 See id. 189 As used in this release, a ‘‘non-netting jurisdiction’’ is a jurisdiction in which a CSE cannot conclude, with a well-founded basis, that the netting agreement with a counterparty in that foreign jurisdiction meets the definition of an ‘‘eligible master netting agreement’’ set forth in the Final Margin Rule. See 17 CFR 23.151. 190 The Final Margin Rule permits offsets in relation to either initial margin or variation margin calculation when (among other things), the offsets related to swaps are subject to the same eligible master netting agreement. This ensures that CSEs can effectively foreclose on the margin in the event of a counterparty default, and avoids the risk that the administrator of an insolvent counterparty will ‘‘cherry-pick’’ from posted collateral to be returned. 191 As noted above, in the event that the special provision for non-segregation jurisdictions applies to a CSE, then the special provision for non-netting jurisdictions would not apply to the CSE even if the relevant jurisdiction is also a ‘‘non-netting jurisdiction.’’ In this circumstance, the CSE must collect the gross amount of initial margin in cash (but would not be required to post initial margin), and post and collect variation margin in cash in accordance with the requirements of the special provision for non-segregation jurisdictions, as discussed in section II.B.4.b. PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 Final Rule, this provision is carefully tailored to allow CSEs to enter into uncleared swaps in ‘‘non-netting’’ jurisdictions but without abandoning the key protections behind the netting requirement under the Final Margin Rule. A CSE that enters into uncleared swaps in ‘‘non-netting’’ jurisdictions in reliance on this provision must have policies and procedures ensuring that it is in compliance with the special provision’s requirements, and maintain books and records properly documenting that all of the requirements of this exception are satisfied.192 The Commission considered ISDA’s request that it adopt a blanket exclusion, subject to a percentage limitation based on the level of swap activity. However, the Commission believes that a blanket exclusion, even with a transactional limit, presents a significant risk that the safety and soundness of a CSE engaged in swaps in non-netting jurisdictions would be insufficiently protected because, without the collection of sufficient margin, the CSE could be unduly exposed to counterparty default. The Commission also considered, but determined to not adopt, ISDA’s request that posting to counterparties in nonnetting jurisdictions not be required.193 Because the posting requirement serves to limit the ability of a CSE to assume excessive risk, the Commission believes that CSEs should be required to post margin in order to advance the objectives of the margin mandate. C. Comparability Determinations As discussed above, consistent with CEA section 2(i) and comity principles, the Final Rule permits eligible CSEs to rely on substituted compliance to the extent that the Commission determines the relevant foreign jurisdiction’s margin requirements are comparable to the Commission’s. Specifically, the Final Rule outlines a framework for the Commission’s comparability determinations, including eligibility and submission requirements for requesters and the Commission’s standard of review for making comparability determinations.194 192 See § 23.160(d) of the Final Rule. Commission agrees with commenters that without enforceable netting and collateral arrangements, there is a risk that the administrator of an insolvent counterparty will ‘‘cherry-pick’’ from posted collateral to be returned in the event of insolvency. This would result in an increase in the risk in posting collateral, because a CSE may not be able to effectively foreclose on the margin in the event its counterparty defaults. 194 See 17 CFR 23.160(c). 193 The E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES 1. Proposed Rule As proposed, section 23.160(c) established a process for requesting comparability determinations. Specifically, the proposed rule identified persons eligible to request a comparability determination (CSEs eligible to rely on substituted compliance and any relevant foreign regulatory authorities) and the information and documentation they should provide the Commission, including how the relevant foreign jurisdiction’s margin requirements address the various elements of the Commission’s margin regime (e.g., the products and entities subject to margin requirements). The proposed rule also identified several factors the Commission would consider in making a comparability determination, such as how the relevant foreign margin requirements compare to International Standards 195 and whether they achieve comparable outcomes to the Commission’s requirements. The Commission explained that its analysis would follow an outcome-based approach, one that would focus on evaluating the outcomes and objectives of the foreign margin requirements and not require them to be identical to the Commission’s margin requirements.196 The Commission further explained that it would review a foreign margin regime’s comparability on an elementby-element basis, such that a foreign jurisdiction’s margin requirements could be deemed comparable with respect to some elements of the Commission’s margin requirements and not others.197 The Commission made clear, however, that consistent with its outcome-based approach, a comparability determination could be appropriate even if the foreign jurisdiction approaches an element differently.198 The proposed rule concluded by explaining the regulatory effect of complying with a foreign jurisdiction’s margin requirements in reliance on a comparability determination, such that a violation of a foreign margin requirement could constitute a violation of the Commission’s corresponding requirement. It also codified the 195 See proposed 17 CFR 23.160(a)(3) (defining ‘‘International Standards’’ as based on the BCBS– IOSCO framework). 196 See Proposal, 80 FR at 41389. 197 See id. 198 See id. (‘‘[T]he Commission would evaluate whether a foreign jurisdiction has rules and regulations that achieve comparable outcomes. If it does, the Commission believes that a comparability determination may be appropriate, even if there may be differences in the specific elements of a particular regulatory provision.’’). VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 Commission’s authority to condition or otherwise modify any comparability determination it issues. The Commission requested comment on all aspects of proposed § 23.160(c).199 2. Comments Commenters generally focused on the Commission’s proposed approach to evaluating the comparability of a foreign jurisdiction’s margin regime.200 Commenters supported an approach that would focus on the regulatory objectives and outcomes of the relevant margin regimes and not require uniformity with the Commission’s rule provisions.201 JBA, for instance, urged the Commission not to deny a comparability determination because a Commission rule is ‘‘stricter,’’ but to focus on whether the substance of the foreign jurisdiction’s rules effectively achieves the objective of mitigating risk.202 Commenters expressed concern, however, that the Commission’s proposed approach was overly complicated and would undermine an outcome-based approach.203 IIB/SIFMA described the Commission’s proposed approach as too ‘‘granular,’’ requiring ‘‘consistency at a level of detail that ignores the overall risk mitigating impact’’ of a foreign jurisdiction’s margin regime.204 IIB/SIFMA suggested that the ‘‘test for comparability’’ should 199 The Commission also requested comment on the scope of the Commission’s proposed substituted compliance regime, whether the Commission should develop an interim process for comparability determinations that would take into account differing implementation timeliness for margin rules by other foreign jurisdictions, and the need for an emerging markets exception. Comments received in response to these questions were addressed above. 200 See proposed 17 CFR 23.160(c)(2)–(3); Proposal, 80 FR at 41389–90. 201 See, e.g., AIMA/IA at 3–4 (absent ‘‘automatic substituted compliance’’ for any transaction involving an entity from a jurisdiction that participated in the WGMR, Commission should make comparability determinations based ‘‘on broad comparability of requirements rather than detailed correspondence of rules’’); ICI Global at 9– 10; IIB/SIFMA at 3; ISDA at 7; JBA at 9; Vanguard at 3. 202 See JBA at 9 (for example, while Commission’s proposed margin rule with respect to eligible collateral for variation margin was narrower in scope than rule proposed by European or Japanese authorities, foreign regulations are not necessarily less effective from a risk mitigation perspective). 203 See, e.g., ICI Global at 10 (proposed approach to determining comparability is ‘‘unnecessarily complicated’’ and effectively requires comparability with respect to ‘‘each particular aspect’’ of the foreign jurisdiction’s margin regime); ISDA at 7 (‘‘complexity and specificity’’ of Commission’s proposed approach is ‘‘not consistent with a general outcome-based approach’’). 204 See IIB/SIFMA at 9 (element-by-element approach would result in ‘‘stricter-rule-applies’’ approach). PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 34835 be ‘‘whether differences between the regimes would, in the aggregate, create a significant and unacceptable level of risk to CSEs or the U.S. financial system.’’ 205 Commenters also expressed concern that issuing comparability determinations with respect to some but not all of a foreign jurisdiction’s margin requirements would be challenging and costly to implement.206 As a result, market participants would either default to the Commission’s margin requirements, undercutting the benefits of substituted compliance,207 or modify their cross-border activities to avoid Commission regulation, increasing market fragmentation.208 ISDA further argued that an element-by-element approach would be inconsistent with the goals of the BCBS–IOSCO framework to avoid ‘‘duplicative or conflicting margin requirements’’ and ensuring ‘‘substantial certainty’’ as to which country’s margin rules apply.209 Commenters urged the Commission to evaluate and issue a comparability determination for a foreign jurisdiction’s margin regime as a whole.210 A majority of commenters also encouraged the Commission to make consistency with the BCBS–IOSCO framework the primary focus of its comparability determinations.211 FSR 205 See id. at 10 (margin regimes that comply with International Standards would likely satisfy such a test). 206 See, e.g., PensionsEurope at 2 (there are ‘‘some benefits’’ to an element-by-element approach but, by creating potential for partial comparability determinations, proposed rule would add ‘‘a significant amount of complexity’’ and ‘‘likely create more problems than it solves’’); SIFMA AMG at 8 (‘‘the potential for piecemeal comparability determinations’’ would lead to ‘‘uncertainty, compliance difficulties and the potential for margin disputes’’); Vanguard at 4–5 (market participants would be required to develop and implement a new system designed to apply the Commission’s comparability determinations and ensure simultaneous compliance with two sets of rules). 207 See, e.g., ICI Global at 10; IIB/SIFMA at 9; SIFMA at 8 (Commission’s prior issuance of partial comparability determinations with respect to swap trading relationship documentation led to confusion and disagreements regarding which rule sections may be complied with via substituted compliance). 208 See IIB/SIFMA at 9; SIFMA AMG at 7. 209 See ISDA at 8 (highlighting background discussion of element 7 of the BCBS–IOSCO framework (interaction of national regimes in crossborder transactions), which encourages cooperation among regulatory regimes to produce ‘‘sufficiently consistent and non-duplicative’’ margin requirements). 210 See, e.g., ICI Global at 2, 10 (Commission should ‘‘consider [] the margin rules of a jurisdiction in their entirety’’ and not ‘‘mak[e] determinations for each element of the margin rules’’); IIB/SIFMA at 9–10; SIFMA AMG at 8; Vanguard at 4–5. 211 See, e.g., AIMA/IA at 3; FSR at 2–5; ISDA at 7; SIFMA AMG at 8; Vanguard at 5. E:\FR\FM\31MYR2.SGM 31MYR2 34836 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations suggested that the Commission ignore whether the foreign margin requirements achieve comparable outcomes to the Commission’s margin requirements 212 and make consistency with International Standards the sole basis of its analysis.213 FSR argued that the ‘‘purpose and driving force’’ of the BCBS–IOSCO framework was to create a ‘‘uniform global standard’’ and that the Commission would undermine that goal if it were to deny a comparability determination when the foreign margin regime conforms to International Standards.214 Thus, FSR recommended that the Commission issue a comparability determination to any regime that complies with the International Standards despite any divergence from the Commission’s rules.215 IIB/SIFMA argued that margin regimes that adhere to the BCBS–IOSCO framework are ‘‘highly unlikely’’ to demonstrate ‘‘material differences’’ in the degree to which they reduce aggregate risk,216 adding that issuing comparability determinations based on consistency with the BCBS–IOSCO framework would further the goal of international harmonization promoted by BCBS–IOSCO and Congress.217 AFR, on the other hand, argued that foreign margin rules should not qualify for substituted compliance on the basis that they follow International Standards alone.218 AFR stated that the Commission’s proposed margin rules evidenced ‘‘a number of important differences’’ from the BCBS–IOSCO framework and that, given the broad availability of substituted compliance in the proposed rule, issuing comparability determinations solely on the basis of consistency with International Standards could lead to ‘‘excessive 212 See proposed 17 CFR 23.160(c)(3)(iii). FSR at 5–6. 214 See id. at 3–4 (pointing to differences in the approaches proposed by the European Market Infrastructure Regulation and the Commission with regard to certain topics (e.g., eligible collateral for variation margin) and expressing concern that, under the Proposal, the Commission would reject comparability even though both proposed approaches are consistent with BCBS–IOSCO framework). 215 See id. at 3. See also Vanguard at 5 (‘‘unique local legal or market structure issues’’ may render certain individual elements of a foreign jurisdiction’s margin regime not comparable to Commission’s margin rules but foreign regime’s ‘‘overall outcome’’ may nevertheless be consistent with BCBS–IOSCO framework). 216 See id. at 2 (BCBS–IOSCO frameworkcompliant regimes would impose ‘‘full, daily variation margin requirements and stringent initial margin requirements’’). 217 See id. at 3 (citing Dodd-Frank section 752(a)). See also SIFMA AMG 7. 218 See AFR at 7. asabaliauskas on DSK3SPTVN1PROD with RULES 213 See VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 opportunities for substituted compliance.’’ 219 3. Final Rule After a careful review of the comments, the Commission is adopting § 23.160(c) as proposed, but is providing some additional clarifications in response to commenters. The rule begins by identifying persons eligible to request a comparability determination with respect to the Commission’s margin requirements, including any CSE that is eligible for substituted compliance under rule § 23.160 220 and any foreign regulatory authority that has direct supervisory authority over one or more CSEs and that is responsible for administering the relevant foreign jurisdiction’s margin requirements.221 Eligible persons may request a comparability determination individually or collectively and with respect to some or all of the Commission’s margin requirements. Eligible CSEs may wish to coordinate with their home regulators and other CSEs in order to simplify and streamline the process. The Commission will make comparability determinations on a jurisdiction-by-jurisdiction basis. Persons requesting comparability determinations should provide the Commission with certain documents and information in support of their request. Notably, the Final Rule provides that requesters should provide copies of the relevant foreign jurisdiction’s margin requirements 222 and descriptions of their objectives,223 how they differ from the International Standards,224 and how they address the elements of the Commission’s margin requirements.225 With regard to how the 219 See id. See also IATP at 4 (provide appendix illustrating ‘‘comparable and quantitative outcomes of swaps margining in other jurisdictions with those under Commission authority, once margining requirements and margin calculation methodology are agreed in those jurisdictions’’). 220 See 17 CFR 23.160(c)(1)(i). 221 See 17 CFR 23.160(c)(1)(ii). 222 See 17 CFR 23.160(c)(2)(v). 223 See 17 CFR 23.160(c)(2)(i). 224 See 17 CFR 23.160(c)(2)(iii). See also 17 CFR 23.160(a)(3) (defining ‘‘International Standards’’ as based on the BCBS–IOSCO framework). 225 See 17 CFR 23.160(c)(2)(ii) (identifying the elements as: (A) The products subject to the foreign jurisdiction’s margin requirements; (B) the entities subject to the foreign jurisdiction’s margin requirements; (C) the treatment of inter-affiliate derivative transactions; (D) the methodologies for calculating the amounts of initial and variation margin; (E) the process and standards for approving models for calculating initial and variation margin models; (F) the timing and manner in which initial and variation margin must be collected and/or paid; (G) any threshold levels or amounts; (H) risk management controls for the calculation of initial and variation margin; (I) eligible collateral for initial and variation margin; (J) the requirements of custodial arrangements, including segregation of PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 foreign margin requirements address the elements of the Commission’s margin requirements, the description should identify the specific legal and regulatory provisions that correspond to each element and, if necessary, whether the relevant foreign jurisdiction’s margin requirements do not address a particular element.226 Requesters should also provide a description of the ability of the relevant foreign regulatory authority or authorities to supervise and enforce compliance with the relevant foreign jurisdiction’s margin requirements 227 and any other information and documentation the Commission deems appropriate.228 The Final Rule identifies certain key factors that the Commission will consider in making a comparability determination. Specifically, the Commission will consider the scope and objectives of the relevant foreign jurisdiction’s margin requirements; 229 whether the relevant foreign jurisdiction’s margin requirements achieve comparable outcomes to the Commission’s corresponding margin requirements; 230 and the ability of the relevant regulatory authority or authorities to supervise and enforce compliance with the relevant foreign jurisdiction’s margin requirements.231 As indicated in the proposed rule, the Final Rule reflects an outcome-based approach to assessing the comparability of a foreign jurisdiction’s margin margin and rehypothecation; (K) margin documentation requirements; and (L) the crossborder application of the foreign jurisdiction’s margin regime). Section 23.160(c)(2)(ii) largely tracks the elements of the BCBS–IOSCO framework, but breaks them down into their components as appropriate to ensure ease of application. 226 See id. 227 See 17 CFR 23.160(c)(2)(iv) (requesting that such description discuss the powers of the foreign regulatory authority or authorities to supervise, investigate, and discipline entities for compliance with the margin requirements and the ongoing efforts of the regulatory authority or authorities to detect and deter violations of the margin requirements). 228 See 17 CFR 23.160(c)(2)(vi). See also 17 CFR 23.160(c)(7) (delegating authority to request additional information and/or documentation to the Director of the Division of Swap Dealer and Intermediary Oversight, or such other employee or employees as the Director may designate from time to time). 229 See 17 CFR 23.160(c)(3)(i). See also 17 CFR 23.160(a)(3) (defining ‘‘International Standards’’ as based on the BCBS–IOSCO framework). 230 See proposed 17 CFR 23.160(c)(3)(ii). As discussed above, the Commission’s Final Margin Rule is based on the International Standards; therefore, the Commission expects that the relevant foreign margin requirements would conform to the International Standards at minimum in order to be deemed comparable to the Commission’s corresponding margin requirements. 231 See 17 CFR 23.160(c)(3)(iii). See also supra note 227; 17 CFR 23.160(c)(3)(iv) (indicating the Commission would also consider any other relevant facts and circumstances). E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES requirements. Instead of demanding strict uniformity with the Commission’s margin requirements, the Commission will evaluate the objectives and outcomes of the foreign margin requirements in light of foreign regulator(s)’ supervisory and enforcement authority. Recognizing that jurisdictions may adopt different approaches to achieving the same outcome, the Commission will focus on whether the foreign jurisdiction’s margin requirements are comparable to the Commission’s in purpose and effect, not whether they are comparable in every aspect or contain identical elements. As commenters noted, the Commission was actively involved in developing the BCBS–IOSCO framework, and the Commission believes that the minimum standards it establishes are consistent with the objectives of the Commission’s own margin requirements. However, while the BCBS–IOSCO framework establishes minimum standards that are consistent with the objectives of the Commission’s own margin requirements, the Commission notes that just because a foreign jurisdiction’s margin requirements are consistent with International Standards does not necessarily mean that they will be comparable to the Commission’s requirements.232 Consequently, in the Commission’s view, consistency with International Standards is necessary but may not be sufficient to finding comparability.233 As stated in the proposed rule, the Commission will review the foreign margin requirements on an element-byelement basis.234 Margin regimes are 232 The BCBS–IOSCO framework leaves certain elements open to interpretation (e.g., the definition of ‘‘derivative’’) and expressly invites regulators to build on certain principles as appropriate. See, e.g., Element 4 (eligible collateral) (national regulators should ‘‘develop their own list of eligible collateral assets based on the key principle, taking into account the conditions of their own markets’’); Element 5 (initial margin) (the degree to which margin should be protected would be affected by ‘‘the local bankruptcy regime, and would vary across jurisdictions’’); Element 6 (transactions with affiliates) (‘‘Transactions between a firm and its affiliates should be subject to appropriate regulation in a manner consistent with each jurisdiction’s legal and regulatory framework.’’). 233 As the Commission noted above, the Final Margin Rule included substantial modifications from the Proposed Margin Rule that further aligned the Commission’s margin requirements with International Standards and, as a result, the potential for conflict with foreign margin requirements should be reduced. See supra note 29. The Commission further notes that whether a particular margin requirement in a foreign jurisdiction is comparable to the Commission’s corresponding requirement entails a fact-specific analysis. 234 See 17 CFR 23.160(c)(2) (specifying that persons requesting comparability determinations VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 complex structures made up of a number of interrelated components, and differences in how jurisdictions approach and assemble those components are inevitable, even among jurisdictions that base their margin requirements on the principles and requirements set forth in the BCBS– IOSCO framework. In order to arrive at a meaningful and complete comparability determination, the Commission must therefore engage in a fact-specific analysis to develop a clear understanding of the elements of the foreign margin regime and how they interact. The Commission believes this level of review will support its outcomebased approach by aiding its assessment of whether such differences affect comparability. As indicated in the proposed rule, the Commission is allowing for the possibility that a comparability determination may not include all elements of a foreign jurisdiction’s margin regime.235 The Commission believes that this position is preferable to an all-or-nothing approach, in which the Commission would be unable to make a comparability determination for an entire jurisdiction if one or more aspects of the foreign jurisdiction’s margin regime results in an outcome that is critically different from that of the Commission’s. The Final Rule provides that any CSE that, in accordance with a comparability determination, complies with a foreign jurisdiction’s margin requirements will be deemed in compliance with the Commission’s corresponding margin requirements.236 Accordingly, if the Commission determines that a CSE has failed to comply with the relevant foreign margin requirements, it could initiate an action for a violation of the Commission’s margin requirements. In addition, all CSEs remain subject to the Commission’s examination and enforcement authority regardless of whether they rely on a comparability determination. Although the Final Rule does not obligate the Commission to consult with or rely on the advice of the foreign regulatory authority in making its determination regarding whether a violation of foreign margin requirements has occurred, the Commission notes that Commission staff may consult with the should provide the Commission with documentation and information relating to each element of the Commission’s margin requirements). 235 For example, the Commission may determine that a foreign jurisdiction’s margin regime is comparable with respect to its variation margin requirements but not with respect to custodial arrangements, including segregation and rehypothecation requirements. 236 See 17 CFR 23.160(c)(4). PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 34837 relevant foreign regulatory authority to assist the Commission in making its determination. The Final Rule concludes by codifying the Commission’s authority to impose any terms and conditions it deems appropriate in issuing a comparability determination,237 and to further condition, modify, suspend, terminate or otherwise restrict any comparability determination it has issued in its discretion.238 Comparability determinations issued by the Commission will require that the Commission be notified of any material changes to information submitted in support of a comparability determination, including, but not limited to, changes in the relevant foreign jurisdiction’s supervisory or regulatory regime. The Commission also expects that the relevant foreign regulator will enter into, or will have entered into, an appropriate memorandum of understanding (‘‘MOU’’) or similar arrangement with the Commission in connection with a comparability determination.239 As stated above, the Commission recognizes that systemic risks arising from the global and interconnected swap market must be addressed through coordinated regulatory requirements for margin across international jurisdictions. Accordingly, the Commission will continue its practice of actively engaging market participants and consulting closely with foreign regulators to encourage the international harmonization and coordination of margin requirements for uncleared swaps and to minimize market disruptions. III. Related Matters A. Regulatory Flexibility Act The Regulatory Flexibility Act (‘‘RFA’’) requires that agencies consider whether the regulations they propose will have a significant economic impact on a substantial number of small 237 See 17 CFR 23.160(c)(5). 17 CFR 23.160(c)(6). For instance, a comparability determination may require modification or termination if a key basis for the determination ceases to be true. 239 Under Commission regulations 23.203 and 23.606, registered swap dealers and major swap participants must maintain all records required by the CEA and the Commission’s regulations in accordance with Commission regulation 1.31 and keep them open for inspection by representatives of the Commission, the United States Department of Justice, or any applicable prudential regulator. See 17 CFR 23.203, 23.606. The Commission further expects that prompt access to books and records and the ability to inspect and examine a non-U.S. CSE will be a condition to any comparability determination. 238 See E:\FR\FM\31MYR2.SGM 31MYR2 34838 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations entities.240 The Commission previously has established certain definitions of ‘‘small entities’’ to be used in evaluating the impact of its regulations on small entities in accordance with the RFA.241 The final regulation establishes a mechanism for CSEs 242 to satisfy margin requirements by complying with comparable margin requirements in the relevant foreign jurisdiction as described in paragraph (c) of the Final Rule,243 but only to the extent that the Commission makes a determination that complying with the laws of such foreign jurisdiction is comparable to complying with the corresponding margin requirement(s) for which the determination is sought. The Commission previously has determined that swap dealers and major swap participants are not small entities for purposes of the RFA.244 Thus, the Commission is of the view that there will not be any small entities directly impacted by this rule. The Commission notes that under the Final Margin Rule, swap dealers and major swap participants would only be required to collect and post margin on uncleared swaps when the counterparties to the uncleared swaps are either other swap dealers and major swap participants or financial end users. As noted above, swap dealers and major swap participants are not small entities for RFA purposes. Furthermore, any financial end users that may be indirectly 245 impacted by the Final Rule would be similar to eligible contract participants (‘‘ECPs’’), and, as such, they would not be small entities.246 Further, 240 5 U.S.C. 601 et seq. 47 FR 18618 (Apr. 30, 1982) (finding that designated contract markets, future commission merchants, commodity pool operators and large traders are not small entities for RFA purposes). 242 See 17 CFR 23.151 (defining ‘‘CSE’’ as a swap dealer or major swap participant for which there is no Prudential Regulator). 243 See 17 CFR 23.160(c). 244 See 77 FR 30596, 30701 (May 23, 2012); 77 FR 2613, 2620 (Jan. 19, 2012) (noting that like future commission merchants, swap dealers will be subject to minimum capital requirements, and are expected to be comprised of large firms, and that major swap participants should not be considered to be small entities for essentially the same reasons that it previously had determined large traders not to be small entities). 245 The RFA focuses on direct impact to small entities and not on indirect impacts on these businesses, which may be tenuous and difficult to discern. See Mid-Tex Elec. Coop., Inc. v. FERC, 773 F.2d 327, 340 (D.C. Cir. 1985); Am. Trucking Assns. v. EPA, 175 F.3d 1027, 1043 (D.C. Cir. 1985). 246 As noted in paragraph (1)(xii) of the definition of ‘‘financial end user’’ in § 23.151 of the Final Margin Rule, a financial end user includes a person that would be a financial entity described in paragraphs (1)(i)–(xi) of that definition, if it were organized under the laws of the United States or any State thereof. See 17 CFR 23.151. The Commission believes that this prong of the asabaliauskas on DSK3SPTVN1PROD with RULES 241 See VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 to the extent that there are any foreign financial entities that would not be considered ECPs, the Commission expects that there would not be a substantial number of these entities significantly impacted by the Final Rule. As noted above, most foreign financial entities would likely be ECPs to the extent they would transact in uncleared swaps. The Commission expects that only a small number of foreign financial entities that are not ECPs, if any, would transact in uncleared swaps. In addition, the material swaps exposure threshold for financial end users in the Final Margin Rule reinforces the Commission’s expectation that only a small number of entities would be affected by the Final Rule. Accordingly, the Commission finds that there will not be a substantial number of small entities impacted by the Final Rule. Therefore, the Chairman, on behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that the proposed regulations will not have a significant economic impact on a substantial number of small entities. B. Paperwork Reduction Act The Paperwork Reduction Act of 1995 (‘‘PRA’’) 247 imposes certain requirements on Federal agencies, including the Commission, in connection with their conducting or sponsoring any collection of information, as defined by the PRA. This final rulemaking will result in the collection of information requirements within the meaning of the PRA, as discussed below. Responses to these collections of information will be required to obtain or retain benefits. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid control number. One of the collections of information required by this final rulemaking, which is described below under the heading ‘‘Information Collection—Comparability Determinations,’’ was previously included in the proposed rule and discussed in the Proposal. Accordingly, the Commission requested from the Office of Management and Budget (‘‘OMB’’) a control number for that information collection. OMB assigned OMB control number 3038–0111. The definition of financial end user captures the same type of U.S. financial end users that are ECPs, but for them being foreign financial entities. Therefore, for purposes of the Commission’s RFA analysis, these foreign financial end users will be considered ECPs and therefore, like ECPs in the U.S., not small entities. 247 44 U.S.C. 3501 et seq. PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 title for this collection of information is ‘‘Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants; Comparability Determinations with Margin Requirements.’’ No comments were received on the paperwork burden associated with this information collection request. In addition, this final rulemaking includes two additional collections of information that were not previously proposed, which are described below under the headings ‘‘Information Collection—NonSegregation Jurisdictions’’ and ‘‘Information Collection—Non-Netting Jurisdictions,’’ respectively. Accordingly, the Commission, by separate notice published in the Federal Register concurrently with this Final Rule, will request approval by OMB of this new information collection under OMB Control Number 3038–0111. 1. Information Collection— Comparability Determinations Section 731 of the Dodd-Frank Act amended the CEA to add, as section 4s(e) thereof, provisions concerning the setting of initial and variation margin requirements for swap dealers and major swap participants. Each swap dealer and major swap participant for which there is a Prudential Regulator, as defined in section 1a(39) of the CEA, must meet margin requirements established by the applicable Prudential Regulator, and each CSE must comply with the Commission’s regulations governing margin. With regard to the cross-border application of the swap provisions enacted by Title VII of the Dodd-Frank Act, section 2(i) of the CEA provides the Commission with express authority over activities outside the United States relating to swaps when certain conditions are met. Section 2(i) of the CEA provides that the CEA’s provisions relating to swaps enacted by Title VII of the Dodd-Frank Act (including Commission rules and regulations promulgated thereunder) shall not apply to activities outside the United States unless those activities (1) have a direct and significant connection with activities in, or effect on, commerce of the United States or (2) contravene such rules or regulations as the Commission may prescribe or promulgate as are necessary or appropriate to prevent the evasion of any provision of Title VII.248 Because margin requirements are critical to ensuring the safety and soundness of a CSE and supporting the stability of the U.S. financial markets, the Commission believes that its margin rules should 248 7 E:\FR\FM\31MYR2.SGM U.S.C. 2(i). 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES apply on a cross-border basis in a manner that effectively addresses risks to the registered CSE and the U.S. financial system. As noted above, the Final Rule establishes margin requirements for uncleared swaps of CSEs, with substituted compliance available in certain circumstances, except as to a narrow class of uncleared swaps between a non-U.S. CSE and a non-U.S. counterparty that fall within the Exclusion. The Final Rule also establishes a procedural framework in which the Commission will consider permitting compliance with comparable margin requirements in a foreign jurisdiction to substitute for compliance with the Commission’s margin requirements in certain circumstances. The Commission will consider whether the requirements of such foreign jurisdiction with respect to margin of uncleared swaps are comparable to the Commission’s margin requirements. Specifically, the Final Rule provides that a CSE that is eligible for substituted compliance may submit a request, individually or collectively, for a comparability determination.249 Persons requesting a comparability determination may coordinate their application with other market participants and their home regulators to simplify and streamline the process. Once a comparability determination is made for a jurisdiction, it will apply for all entities or transactions in that jurisdiction to the extent provided in the determination, as approved by the Commission. In providing information to the Commission for a comparability determination, applicants must include, at a minimum, information describing any differences between the relevant foreign jurisdiction’s margin requirements and International Standards,250 and the specific provisions of the foreign jurisdiction that govern: (A) The products subject to the foreign jurisdiction’s margin requirements; (B) the entities subject to the foreign jurisdiction’s margin requirements; (C) the treatment of interaffiliate derivative transactions; (D) the methodologies for calculating the amounts of initial and variation margin; 249 A CSE may apply for a comparability determination only if the uncleared swap activities of the CSE are directly supervised by the authorities administering the foreign regulatory framework for uncleared swaps. Also, a foreign regulatory agency may make a request for a comparability determination only if that agency has direct supervisory authority to administer the foreign regulatory framework for uncleared swaps in the requested foreign jurisdiction. 250 See 17 CFR 23.160(a)(3) (defining ‘‘International Standards’’ as based on the BCBS– IOSCO framework). VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 (E) the process and standards for approving models for calculating initial and variation margin models; (F) the timing and manner in which initial and variation margin must be collected and/ or paid; (G) any threshold levels or amounts; (H) risk management controls for the calculation of initial and variation margin; (I) eligible collateral for initial and variation margin; (J) the requirements of custodial arrangements, including segregation of margin and rehypothecation; (K) margin documentation requirements; and (L) the cross-border application of the foreign jurisdiction’s margin regime.251 In addition, the Commission expects the applicant, at a minimum, to describe how the foreign jurisdiction’s margin requirements address each of the abovereferenced elements, and identify the specific legal and regulatory provisions that correspond to each element (and, if necessary, whether the relevant foreign jurisdiction’s margin requirements do not address a particular element). Further, the applicant must describe the objectives of the foreign jurisdiction’s margin requirements, the ability of the relevant regulatory authority or authorities to supervise and enforce compliance with the foreign jurisdiction’s margin requirements, including the powers of the foreign regulatory authority or authorities to supervise, investigate, and discipline entities for noncompliance with the margin requirements and the ongoing efforts of the regulatory authority or authorities to detect and deter violations of the margin requirements. Finally, the applicant must furnish copies of the foreign jurisdiction’s margin requirements (including an English translation of any foreign language document) and any other information and documentation that the Commission deems appropriate.252 In issuing a comparability determination, the Commission may impose any terms and conditions it deems appropriate. In addition, the Final Rule will provide that the Commission may, on its own initiative, further condition, modify, suspend, terminate, or otherwise restrict a comparability determination in the Commission’s discretion. This could result, for example, from a situation where, after the Commission issues a comparability determination, the basis of that determination ceases to be true. In this regard, the Commission will require an applicant to notify the Commission of any material changes to information submitted in support of a 251 See 17 CFR 23.160(c)(2)(ii). 252 See 17 CFR 23.160(c)(2)(v) and (vi). PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 34839 comparability determination (including, but not limited to, changes in the foreign jurisdiction’s supervisory or regulatory regime) as the Commission’s comparability determination may no longer be valid.253 The collection of information that is proposed by this rulemaking is necessary to implement section 4s(e) of the CEA, which mandates that the Commission adopt rules establishing minimum initial and variation margin requirements for CSEs on all swaps that are not cleared by a registered derivatives clearing organization, and section 2(i) of the CEA, which provides that the provisions of the CEA relating to swaps that were enacted by Title VII of the Dodd-Frank Act (including any rule prescribed or regulation promulgated thereunder) apply to activities outside the United States that have a direct and significant connection with activities in, or effect on, commerce of the United States. Further, the information collection is necessary for the Commission to determine whether the requirements of the foreign rules are comparable to the Commission’s rules. As noted above, any CSE who is eligible for substituted compliance may make a request for a comparability determination. Currently, there are approximately 106 swap entities provisionally registered with the Commission. The Commission further estimates that of the approximately 106 swap entities that are provisionally registered, approximately 54 are CSEs that are subject to the Commission’s margin rules as they are not subject to a Prudential Regulator. The Commission notes that any foreign regulatory agency that has direct supervisory authority over one or more CSEs and that is responsible to administer the relevant foreign jurisdiction’s margin requirements may also apply for a comparability determination. Further, once a comparability determination is made for a jurisdiction, it will apply for all entities or transactions in that jurisdiction to the extent provided in the determination, as approved by the Commission. The Commission estimates that it will receive requests for a comparability determination from 17 jurisdictions, consisting of the 16 jurisdictions within the G20, plus Switzerland, and that each request will impose an average of 10 burden hours. Based upon the above, the estimated hour burden for collection is calculated as follows: 253 The Commission expects to impose this obligation as one of the conditions to the issuance of a comparability determination. E:\FR\FM\31MYR2.SGM 31MYR2 34840 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations Number of respondents: 17. Frequency of collection: Once. Estimated annual responses per registrant: 1. Estimated aggregate number of annual responses: 17. Estimated annual hour burden per registrant: 10 hours. Estimated aggregate annual hour burden: 170 hours (17 registrants × 10 hours per registrant). asabaliauskas on DSK3SPTVN1PROD with RULES 2. Information Collection—NonSegregation Jurisdictions Section 23.160(e) of the Final Rule provides that, in certain foreign jurisdictions where inherent limitations in the legal or operational infrastructure of the jurisdiction make it impracticable for the CSE and its counterparty to post initial margin for the uncleared swap pursuant to custodial arrangements that comply with the Commission’s margin rules, an FCS or a foreign branch of a U.S. CSE may be eligible to engage in uncleared swaps with certain non-U.S. counterparties without complying with the requirement to post initial margin, and without complying with the requirement to hold initial margin collected by the CSE with one or more custodians that are not the CSE, its counterparty, or an affiliate of the CSE or its counterparty, pursuant to section 23.157(b) of the Final Margin Rule,254 but only if certain conditions are satisfied.255 In order to rely on this provision, an FCS or foreign branch of a U.S. CSE will need to satisfy all of the conditions of the rule, including that (1) inherent limitations in the legal or operational infrastructure of the foreign jurisdiction make it impracticable for the CSE and its counterparty to post any form of eligible initial margin collateral for the uncleared swap pursuant to custodial arrangements that comply with the Commission’s margin rules; (2) foreign regulatory restrictions require the CSE to transact in uncleared swaps with the counterparty through an establishment within the foreign jurisdiction and do not permit the posting of collateral for the swap in compliance with the custodial arrangements of section 23.157 of the Final Margin Rule in the United States or a jurisdiction for which the Commission has issued a comparability 254 As explained further in note 174, because CSEs that rely on section 23.160(e) are not required to hold collateral in accordance with section 23.157(b) for initial margin that they collect, they also would not be required to comply with 23.157(c) with respect to initial margin that they collect. 255 CSEs that are not FCSs or foreign branches of U.S. CSEs and are not otherwise excluded from the Final Margin Rule could not engage in swap transactions in these jurisdictions. VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 determination under the Final Rule with respect to section 23.157; (3) the CSE’s counterparty is not a U.S. person and is not a CSE, and the counterparty’s obligations under the uncleared swap are not guaranteed by a U.S. person; 256 (4) the CSE collects initial margin in cash on a gross basis, in cash, and posts and collects variation margin in cash, for the uncleared swap in accordance with the Final Margin Rule; 257 (5) for each broad risk category, as set out in section 23.154(b)(2)(v) of the Final Margin Rule, the total outstanding notional value of all uncleared swaps in that broad risk category, as to which the CSE is relying on section 23.160 (e), may not exceed 5 percent of the CSE’s total outstanding notional value for all uncleared swaps in the same broad risk category; (6) the CSE has policies and procedures ensuring that it is in compliance with the requirements of this provision; and (7) the CSE maintains books and records properly documenting that all of the requirements of this provision are satisfied.258 3. Information Collection—Non-Netting Jurisdictions Section 23.160(d) of the Final Rule includes a special provision for nonnetting jurisdictions. This provision allows CSEs that cannot conclude after sufficient legal review with a wellfounded basis that the netting agreement with a counterparty in a foreign jurisdiction meets the definition of an ‘‘eligible master netting agreement’’ set forth in the Final Margin Rule to nevertheless net uncleared swaps in determining the amount of margin that they post, provided that certain conditions are met. In order to avail itself of this special provision, the CSE must treat the uncleared swaps covered by the agreement on a gross basis in determining the amount of initial and variation margin that it must collect, but may net those uncleared swaps in determining the amount of initial and variation margin it must post to the 256 As noted above, the Commission would expect the CSE’s counterparty to be a local financial end user that is required to comply with the foreign jurisdiction’s laws and that is prevented by regulatory restrictions in the foreign jurisdiction from posting collateral for the uncleared swap in the United States or a jurisdiction for which the Commission has issued a comparability determination under the Final Rule, even using an affiliate. 257 As noted above, the CSE must collect initial margin in accordance with § 23.152(a) on a gross basis, in the form of cash pursuant to § 23.156(a)(1)(i) and post and collect variation margin in accordance with section 23.153(a) in the form of cash pursuant to section 23.156(a)(1)(i). See § 23.160(e)(4) of the Final Rule. 258 See 17 CFR 23.160(e). PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 counterparty, in accordance with the netting provisions of the Final Margin Rule. A CSE that enters into uncleared swaps in ‘‘non-netting’’ jurisdictions in reliance on this provision must have policies and procedures ensuring that it is in compliance with the special provision’s requirements, and maintain books and records properly documenting that all of the requirements of this exception are satisfied.259 As noted above, the Commission is publishing a separate notice in the Federal Register concurrently with this final rule requesting comments on the burden estimates of both new information collections to amend OMB Control Number 3038–0111. C. Cost-Benefit Considerations 1. Introduction As discussed above, the Final Rule addresses the cross-border application of the Commission’s margin requirements. Specifically, the Final Rule establishes certain key definitions (‘‘U.S. person,’’ ‘‘guarantee,’’ and ‘‘Foreign Consolidated Subsidiary’’); allows CSEs to rely on substituted compliance where appropriate; provides a limited Exclusion for certain transactions between non-U.S. persons; includes special provisions for ‘‘nonsegregation jurisdictions’’ 260 and ‘‘nonnetting jurisdictions;’’ 261 and establishes a framework for making comparability determinations. In the sections that follow, the Commission discusses the costs and benefits associated with the Final Rule on CSEs and affected market participants and any reasonable alternatives.262 Given a general lack of useful data regarding the costs and benefits of the Final Rule, from commenters or otherwise, and the considerable uncertainty given that foreign jurisdictions are at different 259 See § 23.160(d) of the Final Rule. used in this release, a ‘‘non-segregation jurisdiction’’ is a jurisdiction where inherent limitations in the legal or operational infrastructure of the foreign jurisdiction make it impracticable for the CSE and its counterparty to post initial margin pursuant to custodial arrangements that comply with the Final Margin Rule, as further described in section II.B.4.b. 261 As used in this release, a ‘‘non-netting jurisdiction’’ is a jurisdiction in which a CSE cannot conclude, with a well-founded basis, that the netting agreement with a counterparty in that foreign jurisdiction meets the definition of an ‘‘eligible master netting agreement’’ set forth in the Final Margin Rule, as described in section II.B.5.b. 262 As stated above, the Commission estimates that the Final Rule will affect approximately 54 registered swap dealers and major swap participants. The Commission further estimates that it will receive requests for a comparability determination from 17 jurisdictions. 260 As E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES stages in implementing their regimes, the costs and benefits of the Final Rule are generally considered in qualitative terms. The baseline against which the costs and benefits of this Final Rule are being compared is the status quo, i.e., the swap market as it exists as if the Final Margin Rule is in full effect.263 The costbenefit considerations section of the Final Margin Rule made clear that CEA section 4s(e), read together with CEA section 2(i), applies the margin rules to a CSE’s swap activities outside the United States, regardless of the domicile of the CSE or its counterparties.264 Accordingly, in considering the costs and benefits of this Final Rule, the Commission focused on the impact of permitting substituted compliance and certain exclusions from the Final Margin Rule.265 The Commission is mindful of the potentially significant tradeoffs inherent in the Final Rule. As discussed above, given the highly-interconnected, global swap market, overseas risk can quickly manifest in the United States. The crossborder application of the Commission’s margin rules is therefore important to protecting the U.S. financial system from this risk. At the same time, competitive distortions and market inefficiencies can result—and the benefits of the Commission’s crossborder framework could be reduced—if due consideration is not given to comity principles. The Commission considered these tradeoffs and worked to carefully tailor the cross-border approach in the Final Rule to address comity considerations, mitigate the potential for 263 81 FR 636 (Jan. 6, 2016) (codified at 17 CFR parts 23 and 140). As the Commission noted above, the Final Margin Rule included substantial modifications from the Proposed Margin Rule that further aligned the Commission’s margin requirements with International Standards and, as a result, the potential for conflict with foreign margin requirements should be reduced. See supra note 29. 264 See Final Margin Rule, 81 FR at 682. The Commission notes that to the extent there may be differences in the particulars of costs to foreign CSEs or financial end users, the Commission had not been provided with information that would permit the evaluation of any such differences. 265 As noted in the Final Margin Rule, as foreign jurisdictions adopt their own margin rules, the existence of those rules may affect the costs and benefits of the Final Margin Rule. See Final Margin Rule, 81 FR at 682, n.359. For example, if certain transactions become subject to duplicative foreign regulation, that could increase costs, or reduce benefits, of compliance with the Final Margin Rule. Because of the still developing state of foreign law in this area and the absence of specific information on the subject in the record, it was not possible to evaluate such effects in detail in the Final Margin Rule release. In this rulemaking, the same limitations do not permit a detailed evaluation of such possible effects in the present proceeding and therefore, the Commission discusses these possible effects in general qualitative terms. VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 undue market distortions, and promote global coordination without compromising the safety and soundness of CSEs. Although commenters generally did not comment on the cost-benefit discussion in the proposed rule itself,266 they did discuss various costs and benefits associated with the Commission’s proposal. These comments are further addressed in the context of the Commission’s cost-benefit considerations below. 2. Key Definitions The extent to which the Commission’s margin requirements apply—and the availability of substituted compliance and the Exclusion—depends on whether the relevant swap involves a U.S. person, a guarantee by a U.S. person, or a Foreign Consolidated subsidiary. As discussed above, the Final Rule adopts definitions of ‘‘U.S. person,’’ ‘‘guarantee,’’ and ‘‘Foreign Consolidated Subsidiary’’ solely for purposes of the margin rules. The costs and benefits associated with these definitions, and any reasonable alternatives, are discussed below. In general, the Commission believes that the clear, objective nature of these terms, along with the ability to rely on related written counterparty representations, will promote legal certainty and help minimize the costs associated with applying the Final Rule. a. U.S. Person As discussed in section II.A.1., the term ‘‘U.S. person’’ identifies individuals or entities whose activities have a significant nexus to the U.S. market by virtue of being organized or domiciled in the United States or the depth of their connection to the U.S. market, even if they are domiciled or organized outside the United States. The Final Rule generally follows a traditional, territorial approach to defining a U.S. person, and the Commission believes that this definition provides an objective and clear basis for determining those individuals or entities that should be identified as a U.S. person. Accordingly, the Commission does not believe market participants will face significant costs in assessing their own U.S. person status, particularly given the broad similarities 266 But see IATP at 7 (Commission’s assumptions about costs and benefits of the Proposal were accurate considering the current ‘‘stage of foreign jurisdiction rulemaking’’ relating to margin requirements); ABA/ABASA at 3 (Proposal did not adequately take into account the costs of the proposed approach); ISDA at 5 (Proposal did not give ‘‘due weight’’ to its impact on price discovery, risk management, increased compliance and liquidity costs, market fragmentation, or comity). PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 34841 between how the Final Rule defines ‘‘U.S. person’’ and how the term is defined in the SEC’s rules. The Final Rule also makes clear that market participants may reasonably rely on counterparty representations regarding their U.S. person status absent indications to the contrary, which should further reduce any operational costs associated with assessing U.S. person status. The Final Rule addresses many of the concerns commenters raised regarding the costs and benefits of its proposed approach to defining ‘‘U.S. person.’’ As discussed above, the Final Rule does not include a U.S. majority-owned prong, which commenters argued would create operational burdens for assessing U.S. person status and result in regulatory overlap. Nor does it include a catchall provision, limiting the Rule’s application to a list of enumerated persons. The Commission recognizes that, as commenters pointed out, legal entities that fall within the unlimited U.S. responsibility prong may also be subject to regulation under a foreign margin regime, creating the potential for overlapping requirements. However, as discussed in section II.A.1.c., the Commission believes that the unique nature of the relationship between the legal entity and its U.S. person owner(s) facilitates the legal entity’s swap business and creates a significant nexus between the legal entity and U.S. financial markets. While the Commission understands that limiting application of the prong to circumstances where the U.S. persons are majority owners of the legal entity could mitigate the potential for overlapping requirements, as the Commission explained above, the U.S. person owner(s) responsibility for the legal entity’s obligations and liabilities is unlimited regardless of the amount of equity it owns in the legal entity. Furthermore, excluding such legal entities from the scope of the U.S. person definition could create incentives for U.S. persons to establish such legal entities and use them as a pass-through for their own swap activities solely for purposes of avoiding the margin requirements of the DoddFrank Act. The Commission also recognizes that further narrowing the differences between the Final Rule’s U.S. person definition and either the SEC’s definition or the ‘‘U.S. person’’ interpretation in the Guidance could provide certain benefits. Namely, market participants could enjoy reduced operational costs by relying on existing systems and U.S. person status E:\FR\FM\31MYR2.SGM 31MYR2 34842 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations determinations and not having to support multiple meanings of the term ‘‘U.S. person.’’ As discussed above, however, the Commission believes that the Final Rule’s ‘‘U.S. person’’ definition is appropriate in the context of the margin rule. The Commission further believes that the objective and clear definition set out in the Final Rule will result in a lower overall cost for assessing U.S. person status going forward. b. Guarantees asabaliauskas on DSK3SPTVN1PROD with RULES As explained in section II.A.2.c., under the Final Rule, the term ‘‘guarantee’’ is defined to include arrangements, pursuant to which one party to an uncleared swap has rights of recourse against a guarantor, with respect to its counterparty’s obligations under the uncleared swap. The Final Rule further defines what it means for a party to have rights of recourse, and further encompasses any arrangement pursuant to which the guarantor itself has a conditional or unconditional legally enforceable right to receive or otherwise collect, in whole or in part, payments from any other guarantor with respect to the counterparty’s obligations under the uncleared swap.267 As further explained in section II.B.2.b.i, ‘‘U.S. Guaranteed CSEs’’ 268 are eligible for substituted compliance, but are ineligible for the Exclusion and the special provision for non-segregation jurisdictions, to the same extent as U.S. CSEs (except that foreign branches of U.S. CSEs may be eligible for the special provision for non-segregation jurisdictions, as described in section II.B.4.b.).269 267 See 17 CFR 23.160(a)(2). As noted above, under the Final Rule, the term ‘‘guarantee’’ applies whenever a party to the swap has a legally enforceable right of recourse against a guarantor with respect to its counterparty’s obligations under the swap, regardless of whether such right of recourse is conditioned upon the counterparty’s insolvency or failure to meet its obligations under the relevant swap, or whether the counterparty seeking to enforce the guarantee is required to make a demand for payment or performance from its counterparty before proceeding against the U.S. guarantor. 268 This release uses the term ‘‘U.S. Guaranteed CSE’’ for convenience only. Whether a non-U.S. CSE falls within the meaning of the term ‘‘U.S. Guaranteed CSE’’ varies on a swap-by-swap basis, such that a non-U.S. CSE may be considered a U.S. Guaranteed CSE for one swap and not another, depending on whether the non-U.S. CSE’s obligations under such swap are guaranteed by a U.S. person. 269 As further discussed above, the Final Rule generally treats uncleared swaps of non-U.S. CSEs, where the non-U.S. CSE’s obligations under the uncleared swap are guaranteed by a U.S. person, the same as uncleared swaps of a U.S. CSE. In addition, guarantees may affect whether full or partial substituted compliance is available. Further, under the Final Rule, the Exclusion is not available if VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 As commenters noted, limiting the scope of guarantees in the context of the margin requirements to arrangements that include a right of recourse offers the benefit of legal certainty, making the definition relatively easy to apply and helping keep down the cost of determining whether a transaction involves a U.S. Guaranteed CSE. Allowing market participants to rely on counterparty representations with regard to the presence of guarantees should also help market participants keep costs down. Although the Final Rule adopts a definition of guarantee that is different than the existing interpretation in the Guidance, which may result in market participants incurring additional costs to update their current systems, those operational challenges may be mitigated given that the definition is straight-forward and similar to that previously adopted by the SEC. In addition, while the inclusion of language that addresses indirect guarantees may result in some added operational challenges or assessment costs, the Commission believes the provision is necessary to avoid creating incentives for market participants to structure guarantee arrangements in order to avoid application of the Dodd-Frank margin requirements. The Final Rule also achieves substantial benefits in harmonizing with the guarantee definitions adopted by the Prudential Regulators. The Commission recognizes that, as discussed in section II.B.2 and as pointed out by commenters, the definition of ‘‘guarantee’’ adopted in the Final Rule does not encompass all forms of financial arrangements or support that may result in a direct transfer of risk to the U.S. financial markets, such as keepwells and liquidity puts. Nor would it include instances in which a parent and a subsidiary entity are closely related and the parent faces strong reputational incentives to support the subsidiary. As discussed above, however, the Commission believes that, in the context of the Final Rule, non-U.S. CSEs benefitting from such other forms of U.S. financial support will likely meet the definition of an FCS and thus be adequately covered by the Commission’s margin requirements. Given the further either party’s obligations under the swap are guaranteed by a U.S. person. In addition, in order for an FCS or foreign branch of a U.S. CSE to engage in uncleared swaps in non-segregation jurisdictions as provided in section 23.160(e) of the Final Rule, one of the conditions that must be satisfied is that the counterparty to the swap cannot be a U.S. person and its obligations under the uncleared swap cannot be guaranteed by a U.S. person. PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 inclusion of language that addresses indirect guarantees and the mandate to coordinate with the Prudential Regulators, the Commission believes that a more limited ‘‘guarantee’’ definition is appropriate in the context of the cross-border application of the margin requirements and will not undermine the safety and soundness of CSEs or the U.S. financial markets. c. Foreign Consolidated Subsidiary As explained in section II.B.3, the Final Rule uses the term ‘‘Foreign Consolidated Subsidiary’’ to identify non-U.S. CSEs whose uncleared swaps raise substantial supervisory concern in the United States by virtue of their relationship with their U.S. ultimate parent entity and because their financial position, operating results, and statement of cash flows have a direct impact on the financial position, risk profile and market value of their U.S. ultimate parent entity. FCSs are not eligible for the Exclusion but are otherwise treated the same as any other non-U.S. CSEs whose obligations under the relevant swap are not guaranteed by a U.S. person. As commenters noted, the Final Rule’s use of a consolidation test that relies on U.S. GAAP to define ‘‘Foreign Consolidated Subsidiary’’ promotes legal certainty by articulating a clear, familiar, bright-line test. The Commission also took into account that the consolidation test is already being used in preparing financial statements, and as a result, should not result in more costs to market participants.270 The Commission further believes that allowing market participants to rely on counterparty representations with respect to their status as an FCS will reduce any operational costs that may be associated with determining whether a counterparty is an FCS, especially given that the Prudential Regulators adopted a similar definition for purposes of their margin rules. 3. Application Section II.B describes the application of the Commission’s margin rules to cross-border uncleared swaps between CSEs and their counterparties, including the availability of substituted compliance and the Exclusion. The Final Rule also includes special provisions for non-segregation 270 As discussed in greater detail in section II.A.3, although commenters suggested various modifications to the FCS definition, such as relying on IFRS instead of U.S. GAAP or including nonU.S. CSEs whose U.S. parent meets standards for consolidation, but is not required to prepare consolidated financial statements under U.S. GAAP, the Commission does not believe such modifications would offer substantial benefits. E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations a. Substituted Compliance As described in section II.B.2.b and as set out in Table A, the extent to which substituted compliance is available under the Final Rule depends on whether the relevant swap involves a U.S. person, a guarantee by a U.S. person, or an FCS. U.S. CSEs and U.S. Guaranteed CSEs are eligible for substituted compliance only with respect to the requirement to post (but not the requirement to collect) initial margin, provided that their counterparty is a non-U.S. person (including a nonU.S. CSE) whose obligations under the swap are not guaranteed by a U.S. person.271 On the other hand, non-U.S. CSEs whose obligations under the relevant swap are not guaranteed by a U.S. person are broadly eligible for substituted compliance (including for their swaps with U.S. persons that are not CSEs); however, only partial substituted compliance would be available for such non-U.S. CSE’s swaps with U.S. CSEs or U.S. Guaranteed CSEs.272 The Commission recognizes that the decision to offer any substituted compliance in the first instance carries certain trade-offs. Given the global and highly-interconnected nature of the swap market, where risk does not respect national borders, market participants are likely to be subject to the regulatory interest of more than one jurisdiction. As commenters have pointed out, allowing compliance with foreign margin requirements as an alternative to domestic requirements can therefore reduce the application of duplicative or conflicting requirements, resulting in lower compliance costs and facilitating a more level playing field. Substituted compliance also helps preserve the benefits of an integrated, global swap market by fostering and advancing efforts among U.S. and foreign regulators to collaborate in establishing robust regulatory standards, as envisioned by the BCBS–IOSCO framework. If not properly implemented, however, the Commission’s margin regime could lose some of its effectiveness. Accordingly, as commenters have recognized, the ultimate costs and benefits of substituted compliance are affected by the standard under which it is granted and the extent to which it is applied. The Commission was mindful of this dynamic in structuring a substituted compliance regime for the margin requirements and believes the Final Rule strikes an appropriate balance, enhancing market efficiency and fostering global coordination of margin requirements without compromising the safety and soundness of CSEs and the U.S. financial system. The Commission also understands that, as commenters pointed out, by not offering substituted compliance equally to all CSEs, the Final Rule may lead to certain competitive disparities between CSEs and between CSEs and non-CFTC registered dealers. For example, to the extent that non-U.S. CSEs whose obligations are not guaranteed by a U.S. person can rely on substituted compliance that is not available to U.S. CSEs or U.S. Guaranteed CSEs, they may enjoy certain cost advantages (e.g., avoiding the costs of potentially duplicative or inconsistent regulation, which could allow them to develop one enterprise-wide set of compliance and operational infrastructures). The nonU.S. CSEs may then be able to pass on these cost savings to their counterparties in the form of better pricing or some other benefit. U.S. CSEs and U.S. Guaranteed CSEs, on the other hand, could, depending on the extent to which foreign margin requirements apply, be subject to both U.S. and foreign margin requirements, and therefore be at a competitive disadvantage. Counterparties may also be incentivized to transact with CSEs that are offered substituted compliance in order to avoid being subject to duplicative or conflicting margin requirements, which could lead to increased market inefficiencies.273 Nevertheless, the Commission does not believe it is appropriate to make substituted compliance broadly available to all CSEs. As discussed above, the Commission has a strong supervisory interest in the uncleared swaps activity of all CSEs, including non-U.S. CSEs, by virtue of their registration with the Commission. Furthermore, U.S. CSEs and U.S. Guaranteed CSEs are particularly key swap market participants and their safety and soundness is critical to a well-functioning U.S. swap market and 271 Similarly, a non-U.S. CSE (including an FCS) is eligible for substituted compliance with respect to the requirement to collect initial margin if its counterparty is a U.S. CSE or a U.S. Guaranteed CSE. 272 A subset of these non-U.S. CSEs may qualify for the Exclusion, as described in section II.B.3.b above. 273 The Commission recognizes that its framework may impose certain initial operational costs, as CSEs will be required to determine the status of their counterparties in order to determine the extent to which substituted compliance is available. The Commission however believes the ability to obtain and rely on counterparty representations should help mitigate such costs. asabaliauskas on DSK3SPTVN1PROD with RULES jurisdictions and non-netting jurisdictions. VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 34843 the stability of the U.S. financial system. Accordingly, in light of the Commission’s supervisory interest in the activities of U.S. persons and its statutory obligation to ensure the safety and soundness of CSEs and the U.S. financial markets in the context of uncleared swaps, the Commission believes that substituted compliance is generally not appropriate for U.S. CSEs and U.S. Guaranteed CSEs given their importance to the U.S. financial markets.274 With respect to other nonU.S. CSEs (including FCSs) that are not subject to a U.S. guarantee, however, the Commission believes that, in the interest of international comity, making substituted compliance broadly available is appropriate. As further discussed in section II.B.2.b.i., the Commission determined that partial substituted compliance is appropriate for U.S. CSEs and U.S. Guaranteed CSEs in the limited case of posting (but not collecting) initial margin. Contrary to commenters’ assertions, the Commission does not believe that partial substituted compliance is impractical or will hinder the development of a standardized model for initial margin. As discussed above, the Commission does not expect a CSE to have two netting sets as a result of partial substituted compliance, given that the U.S. CSE is always required to collect initial margin according to the Commission’s margin requirements while it has the option to post according to the Commission’s or its counterparty’s foreign margin requirements. If substituted compliance is elected, the U.S. CSE will be deemed to satisfy the Commission’s margin requirements by meeting the foreign jurisdiction’s margin requirements, which will result in one netting set. Furthermore, the Commission believes that permitting partial substituted compliance allows market participants to avoid some costs associated with complying with duplicative or conflicting requirements. The Commission acknowledges that foreign branches may, for the reasons raised by commenters and discussed above, be at a competitive disadvantage compared to non-U.S. CSEs, with whom they may compete in the countries in which they are established, by virtue of not being eligible for substituted compliance. However, as discussed in section II.B.2.b.i., the swap activities of a foreign branch of a U.S. CSE are 274 As discussed in section II.B.2.b.i above, because uncleared swaps of U.S. Guaranteed CSEs are identical in relevant respects to a swap entered directly by a U.S. person, the Final Rule treats these uncleared swaps the same as uncleared swaps of U.S. CSEs. E:\FR\FM\31MYR2.SGM 31MYR2 34844 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations legally indistinguishable from the swap activities of the U.S. CSE. Permitting more favorable treatment to foreign branches of U.S. CSEs than the principal U.S. entity could create an easy way for U.S. CSEs to circumvent the Commission’s margin requirements, which could undermine the safety and soundness of the U.S. CSE and the U.S. financial system.275 asabaliauskas on DSK3SPTVN1PROD with RULES b. Exclusion Under the Final Rule, the Commission excludes from its margin requirements uncleared swaps entered into by a nonU.S. CSE with a non-U.S. counterparty (including a non-U.S. CSE), provided that neither counterparty’s obligations under the relevant swap are guaranteed by a U.S. person and neither counterparty is an FCS nor a U.S. branch of a non-U.S. CSE. As discussed in section II.B.3.b above, the Commission believes that it is appropriate to tailor the application of margin requirements in the cross-border context, consistent with section 4s(e) of the CEA and comity principles, so as to exclude this narrow class of uncleared swaps involving a non-U.S. CSE and a non-U.S. counterparty. The Commission believes that such non-U.S. CSEs may benefit from the Exclusion because it allows them to avoid duplicative or conflicting regulations where a transaction is subject to more than one uncleared swap margin regime. On the other hand, to the extent the Exclusion allows a non-U.S. CSE to rely on foreign margin requirements that are not comparable to the Commission’s, the Exclusion could result in a less rigorous margin regime for such CSE or, in the extreme, the absence of any margin requirements. This would not only increase the risk posed by that CSE’s swaps activities, but could create competitive disparities between non-U.S. CSEs relying on the Exclusion and other CSEs that are not eligible for the Exclusion. That is, the Exclusion could allow these non-U.S. CSEs to offer better pricing or other terms to their non-U.S. clients and put them in a better position (than CSEs ineligible for the Exclusion) to compete with non-CFTC registered dealers in the relevant foreign jurisdiction for foreign clients. The degree of competitive disparity will depend on the degree of disparity between the Commission’s margin framework and that of the relevant foreign jurisdiction. 275 The Commission notes that the potential competitive disparities could be minimized to the degree foreign margin requirements are harmonized or otherwise comparable to the Commission’s. VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 The Commission does not generally expect that the Exclusion will result in a significant diminution in the safety and soundness of the non-U.S. CSE, as discussed in section II.B.3.b above. This is based on several considerations. First, the Commission understands that most swaps are currently transacted in jurisdictions that have agreed to adhere to the BCBS–IOSCO framework, which covers financial entities.276 Accordingly, the Commission anticipates that many excluded swaps will nevertheless be subject to margin requirements in a jurisdiction that adheres to the BCBS–IOSCO framework. Second, the potential adverse effect on a non-U.S. CSE would be mitigated by the Commission’s capital requirements which, as proposed, would impose a capital charge for uncollateralized exposures.277 Third, a non-U.S. CSE that can avail itself of the Exclusion will still be subject to the Commission’s margin rules with respect to all uncleared swaps not meeting the criteria for the Exclusion, albeit with the possibility of substituted compliance. That the nonU.S. CSE will be subject to U.S. or comparable margin requirements when entering into a swap with U.S. counterparties reduces the possibility of a cascading event affecting U.S. counterparties and the U.S. financial markets more broadly as a result of a default by the non-U.S. CSE. The unavailability of the Exclusion to FCSs could disadvantage them relative to other non-U.S. CSEs that are eligible for the Exclusion or non-CFTC registered dealers within a foreign jurisdiction. As commenters noted, nonU.S. CSEs that rely on the Exclusion or non-CFTC registered dealers could realize a cost advantage over FCSs and thus have the potential to offer better pricing terms to foreign clients. The competitive disparity between non-U.S. CSEs that rely on the Exclusion and FCSs, however, may be somewhat mitigated to the extent that the relevant foreign jurisdiction implements the BCBS–IOSCO framework.278 276 Element 2 of BCBS–IOSCO framework states: ‘‘All covered entities (i.e. financial firms and systemically important non-financial entities) that engage in non-centrally cleared derivatives must exchange initial and variation margin as appropriate to the counterparty risks posed by such transactions.’’ 277 See Proposed Capital Rule, 76 FR 27802. 278 As discussed above, a commenter’s suggestion to exclude transactions between an FCS and another non-guaranteed non-U.S. person up to an aggregate 5 percent notional trading limit would be difficult to monitor and could create incentives to ‘‘cherry-pick’’ and exclude uncleared swaps presenting the highest margin requirement, which could thereby introduce undue risk into the system. PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 As noted above in section II.B.3.a., some commenters suggested that treating U.S. branches of non-U.S. CSEs differently from the rest of the CSE with respect to eligibility for the Exclusion could present operational challenges, requiring non-U.S. CSEs to document transactions with the U.S. branch under a separate ISDA Master Agreement. However, as explained in section II.B.3.b., in most cases the Commission does not believe a separate credit support agreement will be necessary; 279 furthermore, in those cases where it is required, the Commission nevertheless believes that extending the Exclusion to U.S. branches of non-U.S. CSEs would not be appropriate for the reasons discussed in section II.B.3.b above.280 In addition, allowing U.S. branches to rely on the Exclusion would enable them to offer more competitive terms to nonU.S. clients than U.S. CSEs, thereby gaining an advantage when dealing with non-U.S. clients relative to other CSEs operating within the United States (i.e., U.S. CSEs). On the other hand, for the same reason, the Final Rule could put non-U.S. CSEs that conduct swaps business through their U.S. branches at a disadvantage relative either to nonU.S. CSEs that are eligible for the Exclusion or non-CFTC registered dealers that conduct swaps business overseas. The Commission recognizes that while substituted compliance will be broadly available to such U.S. branches of non-U.S. CSEs, more compliance costs could be incurred by these entities than if the Exclusion were made available if a foreign jurisdiction’s margin requirements are not comparable.281 In order to effectuate the Commission’s treatment of inter-affiliate swaps under the Final Margin Rule, the Exclusion is not available if the marketfacing transaction of the non-U.S. CSE (that is otherwise eligible for the Exclusion) is not subject to comparable initial margin collection requirements in the home jurisdiction and any of the 279 See supra note 158. Prudential Regulators’ Final Margin Rule does not grant an exclusion for the uncleared swaps of such U.S. branches on the basis that U.S. branches of foreign banks clearly operate within the United States and could pose risk to the U.S. financial system, and the Commission believes that harmonization with the Prudential Regulators’ Final Margin Rule is appropriate. For further discussion of the reasons that the Exclusion does not extend to U.S. branches of non-U.S. CSEs, see section II.B.3.b above. 281 As noted above, U.S. branches of foreign banks (as ‘‘foreign bank’’ is defined in section __.2 of the Prudential Regulators’ Final Margin Rule (12 CFR part 237)) must comply with the Prudential Regulators’ margin rules, as these U.S. branches have a Prudential Regulator, as defined in 1(a)(39) of the CEA. 280 The E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations risk associated with the uncleared swap is transferred, directly or indirectly, through inter-affiliate transactions, to a U.S. CSE. As a consequence, the affected non-U.S. CSEs may be placed at a cost disadvantage relative to non-U.S. CSEs that can rely on the Exclusion as well as non-CFTC registered dealers operating in the foreign jurisdiction that are not subject to similarly rigorous initial margin collection requirements. The Commission, however, believes that this limitation is necessary to ensure that the Exclusion does not facilitate the transfer of risk to a U.S. CSE through the use of inter-affiliate transactions that, per the Final Margin Rule, are generally not subject to the collection of initial margin. asabaliauskas on DSK3SPTVN1PROD with RULES c. Non-Segregation Jurisdictions and Non-Netting Jurisdictions The Final Rule includes a special provision for non-segregation jurisdictions, where custodial arrangements that comply with the Commission’s requirements set out in Commission Regulation 23.157 282 are impracticable due to the legal or operational infrastructure of the foreign jurisdiction.283 Specifically, an FCS or a foreign branch of a U.S. CSE may, in certain circumstances, be excepted from the requirement to post initial margin for the uncleared swap in compliance with the custodial requirements of the Final Margin Rule in certain foreign jurisdictions where inherent limitations in the legal or operational infrastructure of the jurisdiction make it impracticable for the CSE and its counterparty to comply with that requirement, subject to certain conditions. The Commission understands from commenters that inherent legal and operational constraints in certain jurisdictions could make compliance with the custodial requirements of the Final Margin Rule impracticable. Accordingly, absent the exception, FCSs and foreign branches of U.S. CSEs would be unable to conduct uncleared swap business with clients based in such jurisdictions, contributing to further market inefficiencies. The Commission further agrees with commenters that an exception from the requirement to post (but not from the requirement to collect) initial margin when transacting with clients in non282 See 17 CFR 23.157. used in this release, a ‘‘non-segregation jurisdiction’’ is a jurisdiction where inherent limitations in the legal or operational infrastructure of the foreign jurisdiction make it impracticable for the CSE and its counterparty to post initial margin pursuant to custodial arrangements that comply with the Final Margin Rule, as further described in section II.B.4.b. 283 As VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 segregation jurisdictions will accomplish the goal of ensuring a CSE’s safety and soundness but with less disruption to existing business relationships than the exchange of initial and variation margin would impose. After careful consideration, the Commission is adding a special provision so that FCSs and foreign branches of U.S. CSEs will not be foreclosed from engaging in uncleared swaps business in non-segregation jurisdictions, with appropriate conditions, including a 5 percent limitation, as discussed in section II.B.4.b above, to avoid compromising the safety and soundness of CSEs. The Commission does not believe a blanket de minimis exception from the Commission’s margin requirements, as suggested by commenters, is appropriate. Rather, the Commission believes that carefully tailored relief from the Final Margin Rule’s requirement to post initial margin and the custodial arrangement requirements that pertain to initial margin collected by a CSE will accomplish the goal of allowing FCSs and foreign branches of U.S. CSEs to carry on their swaps business in non-segregation jurisdictions without creating the risks that would attend wholesale exemption from margin requirements in these jurisdictions. In addition, in light of the importance of FCSs and foreign branches of U.S. CSEs to the U.S. financial system, the special provision includes certain conditions that are designed to appropriately limit the swap activities conducted by these CSEs in these jurisdictions in order to help ensure their safety and soundness. Although these conditions may place affected entities at a relative cost disadvantage when compared to nonU.S. CSEs that can rely on the Exclusion and non-CFTC registered dealers engaged in swaps activity in nonsegregation jurisdictions, and may limit the overall swap dealing activity of affected entities in these jurisdictions, the Commission believes that the special provision provides a substantial benefit to the affected entities by allowing them to conduct a limited level of swaps business in non-segregation jurisdictions where they would otherwise be foreclosed. While permitting FCSs and foreign branches of U.S. CSEs to carry on their swaps business in non-segregation jurisdictions in accordance with this special provision is not without some risk, in that the initial margin collected by FCSs and foreign branches of U.S. CSEs in reliance on this provision is not PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 34845 subject to the custodial arrangement requirements of the Final Margin Rule, the Commission believes that the conditions to using this provision (including the 5 percent limit in each of four broad risk categories set forth in § 23.154(b)(2)(v)) should be sufficient to prevent undue risk arising from uncleared swaps by FCSs and foreign branches of U.S. CSEs relying on this provision. The Final Rule also includes a special provision for ‘‘non-netting’’ jurisdictions.284 In order to avail itself of this provision, the CSE must treat the uncleared swaps covered by the netting agreement on a gross basis in determining the amount of initial and variation margin that it must collect, but may net those uncleared swaps in determining the amount of initial and variation margin it must post to the counterparty, in accordance with the netting provisions of the Final Margin Rule. The Commission agrees that, as suggested by commenters, without enforceable netting and collateral arrangements, there is a risk that a CSE may not be able to effectively foreclose on the margin in the event of a counterparty default, and a risk that the administrator of an insolvent counterparty will ‘‘cherry-pick’’ from posted collateral to be returned in the event of insolvency, which could result in an increase in the risk in posting collateral. As with the provision for non-segregation jurisdictions, this provision is carefully tailored to allow CSEs to conduct swap transactions in ‘‘non-netting’’ jurisdictions without abandoning the key protections behind the netting requirement under the Final Margin Rule.285 If the Commission were not to adopt this special provision, then a CSE would have to collect and post margin on a gross basis, which would result in greater costs to the CSE and result in additional credit risk, and put them at a competitive disadvantage. It is possible that this would lead to CSEs 284 As used in this release, a ‘‘non-netting jurisdiction’’ is a jurisdiction in which a CSE cannot conclude, with a well-founded basis, that the netting agreement with a counterparty in that foreign jurisdiction meets the definition of an ‘‘eligible master netting agreement’’ set forth in the Final Margin Rule, as described in section II.B.5.b. 285 The Commission considered a broader provision, including, as requested by commenters, excluding these transactions from its margin rule. However, as netting provisions are critical to the overall goal of margin requirements and the Commission is not requiring CSEs to post margin on a gross basis, the Commission believes that the regulatory gap that a broader provision would create would be inconsistent with the Commission’s mandate to protect the safety and soundness of CSEs. E:\FR\FM\31MYR2.SGM 31MYR2 34846 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations being effectively precluded from doing business in these jurisdictions. asabaliauskas on DSK3SPTVN1PROD with RULES 4. Comparability Determinations As noted in section II.C above, any CSE eligible for substituted compliance may make a request for a comparability determination. Currently, there are approximately 106 swap entities provisionally registered with the Commission. The Commission further estimates that of the 106 swap entities that are registered, approximately 54 are subject to the Commission’s margin rules, as they are not supervised by a Prudential Regulator. However, the Commission notes that any foreign regulatory agency that has direct supervisory authority to administer the foreign regulatory framework for margin of uncleared swaps in the requested foreign jurisdiction may apply for a comparability determination. Further, once a comparability determination is made for a jurisdiction, it will apply for all entities or transactions in that jurisdiction to the extent provided in the determination, as approved by the Commission. Although there is uncertainty regarding the number of requests for comparability determinations that will be made under the Final Rule, the Commission estimates that it will receive applications for comparability determinations from 17 jurisdictions representing 61 separate registrants, and that each request will impose an average of 10 burden hours per registrant. Based on the above, the Commission estimates that the preparation and filing of submission requests for comparability determinations should take no more than 170 hours annually in the aggregate (17 registrants × 10 hours). The Commission further estimates that the total aggregate cost of preparing such submission requests will be $64,600, based on an estimated cost of $380 per hour for an in-house attorney.286 As summarized in section II.C.2, several commenters complained that the costs and burdens to market participants associated with the Commission’s 286 Although different registrants may choose to staff preparation of the comparability determination request with different personnel, Commission staff estimates that, on average, an initial request could be prepared and submitted with 10 hours of an inhouse attorney’s time. To estimate the hourly cost of an in-house attorney’s attorney time, Commission staff reviewed data in SIFMA’s Report on Management and Professional Earnings in the Securities Industry 2013, modified by Commission staff to account for an 1800-hour work-year and multiplied by a factor of 5.35 to account for firm size, employee benefits and overhead. Commission staff believes that use of a 5.35 multiplier here is appropriate because some persons may retain outside advisors to assist in making the determinations under the rules. VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 proposed framework and standard for making comparability determinations would be minimized if the Commission were to rely on the BCBS–IOSCO framework as the sole basis for its comparability analysis and take a ‘‘holistic’’ approach to determining comparability. As the Commission explained above, however, while the BCBS–IOSCO framework establishes minimum standards that are consistent with the objectives of the Commission’s own margin requirements, consistency with International Standards is necessary but may not be sufficient to finding comparability.287 Furthermore, allowing for a comparability determination to be made based on comparable outcomes and objectives notwithstanding differences in foreign jurisdictions’ requirements ensures that substituted compliance is made available to the fullest extent possible. While the Commission recognizes that, to the extent that a foreign margin regime is not deemed comparable in all respects, CSEs eligible for substituted compliance may experience costs from being required to comply with more than one set of specified margin requirements, the Commission believes that this approach is preferable to an allor-nothing approach, in which market participants may be forced to comply with both margin regimes in their entirety. 5. Section 15(a) Factors Section 15(a) of the CEA requires the Commission to consider the costs and benefits of its actions before promulgating a regulation under the CEA or issuing certain orders. Section 15(a) further specifies that the costs and benefits shall be evaluated in light of five broad areas of market and public concern: (1) Protection of market participants and the public; (2) efficiency, competitiveness, and financial integrity of futures markets; (3) price discovery; (4) sound risk management practices; and (5) other public interest considerations. The Commission considers the costs and benefits resulting from its discretionary determinations with respect to the section 15(a) factors. 287 See supra notes 232 and 233 and accompanying text. Also, as the Commission noted above, the Final Margin Rule included substantial modifications from the Proposed Margin Rule that further aligned the Commission’s margin requirements with International Standards and, as a result, the potential for conflict with foreign margin requirements should be reduced. See supra note 29. PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 a. Protection of Market Participants and the Public As described above, CEA section 4s(e)(2)(A) requires the Commission to develop rules designed to ensure the safety and soundness of CSEs and the U.S. financial system. On the one hand, full application of the Commission’s margin requirements to all uncleared swaps of CSEs would help to ensure the safety and soundness of CSEs and the U.S. financial system by reducing counterparty credit risk and the threat of contagion. On the other hand, extending substituted compliance to certain crossborder swaps reduces the potential for conflicting or duplicative requirements, which would, in turn, reduce market distortions and promote global harmonization. In addition, where exceptions have been permitted (i.e., under the Exclusion and the special provisions for non-segregation and nonnetting jurisdictions), the Commission has limited their availability to strike a balance between international comity and the continuation of important business activity by qualifying CSEs, on the one hand, and limiting risk to CSEs and the U.S. financial system, on the other hand. While the Final Rule will allow CSEs to comply with foreign margin requirements as an alternative to the Commission’s requirements in certain circumstances, such margin requirements must be comparable in outcome and objectives, and the Commission retains the authority to modify or condition the availability of substituted compliance as necessary. Furthermore, substituted compliance is available on a more limited basis for U.S. CSEs and U.S. Guaranteed CSEs. Additionally, while the Final Rule also excludes certain uncleared swap transactions involving non-U.S. CSEs whose obligations under the relevant swap are not subject to a U.S. guarantee from the Final Margin Rule and excepts qualifying CSEs from certain requirements in non-segregation jurisdictions and non-netting jurisdictions, the Exclusion and special provisions are narrowly tailored and include safeguards to protect market participants and the public. Overall, the Commission believes that the Final Rule takes proper account of significant, and sometimes competing, factors in order to effectively address the risk posed to the safety and soundness of CSEs while creating a workable cross-border framework that reduces the potential for undue market disruptions and promoting global harmonization, thereby benefiting market participants and the public. E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations asabaliauskas on DSK3SPTVN1PROD with RULES b. Efficiency, Competitiveness, and Financial Integrity that is based on the BCBS–IOSCO framework. As discussed above, the Final Rule may have both a positive and negative effect on market efficiency and competitiveness. As an initial matter, substituted compliance and the Exclusion should improve resource allocation efficiency by allowing market participants to avoid potentially duplicative or conflicting requirements, reducing the aggregate cost to the market of dealing uncleared swaps. By granting this relief to some CSEs and not others, however, the Final Rule may afford such CSEs a cost advantage compared to other CSEs that may be required to comply with potentially duplicative or conflicting requirements. Non-U.S. counterparties may also be incentivized to transact with CSEs that are eligible for substituted compliance in order to avoid complying with more than one margin regime (or the Commission’s margin regime alone), which could contribute to market inefficiencies. In addition, as the Exclusion is not provided to all CSEs, those that are not permitted to use the Exclusion may be at a competitive disadvantage when competing in foreign jurisdictions that do not have comparable margin rules. The Commission notes, however, that to the extent that non-U.S. CSEs are domiciled in jurisdictions with comparable requirements, this may mitigate possible regulatory arbitrage by these CSEs. At the same time, however, the Commission understands that if it did not provide special accommodations for certain CSEs to enter into certain markets, such CSEs would be disadvantaged and even prohibited from engaging in swaps in these jurisdictions. Furthermore, the Commission believes that the Final Rule ensures that substituted compliance and the Exclusion are extended in a tailored fashion that is consistent with protecting the integrity of the swaps market. Substituted compliance is only provided in the event that the relevant foreign jurisdiction has a comparable margin rule; if not, the CSE must comply with the Commission’s margin rule. Even in instances where the Exclusion is available, the Commission notes that: (1) The Final Margin Rule will cover many of the swaps of the non-U.S. CSEs (eligible for the Exclusion) with other counterparties, namely, all U.S. counterparties; (2) the Exclusion is limited to a narrow set of swaps by non-U.S. CSEs; and (3) the excluded swaps may be covered by another foreign regulator’s margin rule c. Price Discovery VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 The Commission generally believes that substituted compliance, by reducing the potential for duplicative or conflicting regulations, could reduce impediments to transact uncleared swaps on a cross-border basis. This, in turn, may enhance liquidity as more market participants may be willing to enter into uncleared swaps, thereby possibly improving price discovery— and ultimately reducing market fragmentation. Alternatively, if substituted compliance or the Exclusion were not made available, CSEs could be incentivized to consider setting up their swap operations outside the Commission’s jurisdiction, and as a result, increase the potential for market fragmentation. Additionally, exceptions for non-segregation and non-netting jurisdictions could increase price discovery in such jurisdictions by opening such markets to CSEs where, by virtue of the application of the Commission’s margin requirements, such CSEs would otherwise be unable to deal uncleared swaps. d. Sound Risk Management Practices The Commission believes that the Final Rule is consistent with sound risk management practices. The Final Margin Rule promotes sound risk management practices, and this Final Rule requires U.S. CSEs and U.S. Guaranteed CSEs to apply that rule in its entirety for most cross-border transactions. To the extent substituted compliance is available in limited fashion to these entities and more broadly to non-U.S. CSEs, the foreign margin requirements must be comparable to the Commission’s in outcome and objectives. That should ensure that margin’s critical risk management function is unaffected. Although the Exclusion could potentially lead to weaker risk management for eligible non-U.S. CSEs to the extent that they are not otherwise subject to comparable foreign margin requirements, the Commission notes that in jurisdictions that are BCBS– IOSCO compliant, such CSEs will be subject to margin requirements that satisfy the minimum International Standards established by the BCBS– IOSCO framework.288 Furthermore, while the Commission recognizes that a special provision in the Final Rule will 288 As indicated in supra note 23, representatives of 26 regulatory authorities participated in the WGMR that developed the BCBS–IOSCO framework. PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 34847 excuse CSEs that are FCSs and foreign branches of U.S. CSEs from the requirement to post initial margin pursuant to custodial arrangements that comply with the Final Margin Rule, the Commission believes that the impact to risk management will be mitigated by the relatively small volume of such transactions, the conditions required to rely on this special provision, including a limit on the overall swaps using the special provision, and the continued applicability of other requirements, including margin with respect to other uncleared swaps of such FCSs and foreign branches and broader capital requirements.289 The Commission similarly believes that the risk management implications of the special provision for non-netting jurisdictions will be limited. As explained above, CSEs will still be required to calculate and collect initial margin on a gross basis to ensure that the CSE can obtain the collateral posted with the counterparty in the event of counterparty default. e. Other Public Interest Considerations The Commission has not identified any additional public interest considerations related to the costs and benefits of the Final Rule. List of Subjects in 17 CFR Part 23 Swaps, Swap dealers, Major swap participants, Capital and margin requirements. For the reasons discussed in the preamble, the Commodity Futures Trading Commission amends 17 CFR part 23 as set forth below: PART 23—SWAP DEALERS AND MAJOR SWAP PARTICIPANTS 1. The authority citation for part 23 is revised to read as follows: ■ Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b–1, 6c, 6p, 6r, 6s, 6t, 9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21. Section 23.160 also issued under 7 U.S.C. 2(i); Sec. 721(b), Pub. L. 111–203, 124 Stat. 1641 (2010). ■ 2. Add § 23.160 to read as follows: § 23.160 Cross-border application. (a) Definitions. For purposes of this section only: (1) Foreign Consolidated Subsidiary means a non-U.S. CSE in which an ultimate parent entity that is a U.S. person has a controlling financial interest, in accordance with U.S. GAAP, such that the U.S. ultimate parent entity includes the non-U.S. CSE’s operating results, financial position and statement 289 See E:\FR\FM\31MYR2.SGM Proposed Capital Rule, 76 FR 27802. 31MYR2 asabaliauskas on DSK3SPTVN1PROD with RULES 34848 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations of cash flows in the U.S. ultimate parent entity’s consolidated financial statements, in accordance with U.S. GAAP. (2) Guarantee means an arrangement pursuant to which one party to an uncleared swap has rights of recourse against a guarantor, with respect to its counterparty’s obligations under the uncleared swap. For these purposes, a party to an uncleared swap has rights of recourse against a guarantor if the party has a conditional or unconditional legally enforceable right to receive or otherwise collect, in whole or in part, payments from the guarantor with respect to its counterparty’s obligations under the uncleared swap. In addition, in the case of any arrangement pursuant to which the guarantor has a conditional or unconditional legally enforceable right to receive or otherwise collect, in whole or in part, payments from any other guarantor with respect to the counterparty’s obligations under the uncleared swap, such arrangement will be deemed a guarantee of the counterparty’s obligations under the uncleared swap by the other guarantor. (3) International standards mean the margin policy framework for noncleared, bilateral derivatives issued by the Basel Committee on Banking Supervision and the International Organization of Securities in September 2013, as subsequently updated, revised, or otherwise amended, or any other international standards, principles or guidance relating to margin requirements for non-cleared, bilateral derivatives that the Commission may in the future recognize, to the extent that they are consistent with United States law (including the margin requirements in the Commodity Exchange Act). (4) Non-U.S. CSE means a covered swap entity that is not a U.S. person. The term ‘‘non-U.S. CSE’’ includes a ‘‘Foreign Consolidated Subsidiary’’ or a U.S. branch of a non-U.S. CSE. (5) Non-U.S. person means any person that is not a U.S. person. (6) Ultimate parent entity means the parent entity in a consolidated group in which none of the other entities in the consolidated group has a controlling interest, in accordance with U.S. GAAP. (7) United States means the United States of America, its territories and possessions, any State of the United States, and the District of Columbia. (8) U.S. CSE means a covered swap entity that is a U.S. person. (9) U.S. GAAP means U.S. generally accepted accounting principles. (10) U.S. person means: (i) A natural person who is a resident of the United States; VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 (ii) An estate of a decedent who was a resident of the United States at the time of death; (iii) A corporation, partnership, limited liability company, business or other trust, association, joint-stock company, fund or any form of entity similar to any of the foregoing (other than an entity described in paragraph (a)(10)(iv) or (v) of this section) (a ‘‘legal entity’’), in each case that is organized or incorporated under the laws of the United States or that has its principal place of business in the United States, including any branch of such legal entity; (iv) A pension plan for the employees, officers or principals of a legal entity described in paragraph (a)(10)(iii) of this section, unless the pension plan is primarily for foreign employees of such entity; (v) A trust governed by the laws of a state or other jurisdiction in the United States, if a court within the United States is able to exercise primary supervision over the administration of the trust; (vi) A legal entity (other than a limited liability company, limited liability partnership or similar entity where all of the owners of the entity have limited liability) that is owned by one or more persons described in paragraphs (a)(10)(i) through (v) of this section and for which such person(s) bears unlimited responsibility for the obligations and liabilities of the legal entity, including any branch of the legal entity; or (vii) An individual account or joint account (discretionary or not) where the beneficial owner (or one of the beneficial owners in the case of a joint account) is a person described in paragraphs (a)(10)(i) through (vi) of this section. (b) Applicability of margin requirements. The requirements of §§ 23.150 through 23.161 apply as follows. (1) Uncleared swaps of U.S. CSEs or Non-U.S. CSEs whose obligations under the relevant swap are guaranteed by a U.S. person—(i) Applicability of U.S. margin requirements; availability of substituted compliance for requirement to post initial margin. With respect to each uncleared swap entered into by a U.S. CSE or a non-U.S. CSE whose obligations under the swap are guaranteed by a U.S. person, the U.S. CSE or non-U.S. CSE whose obligations under the swap are guaranteed by a U.S. person shall comply with the requirements of §§ 23.150 through 23.161 of this part, provided that the U.S. CSE or non-U.S. CSE whose obligations under the swap are PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 guaranteed by a U.S. person may satisfy its requirement to post initial margin to certain counterparties to the extent provided in paragraph (b)(1)(ii) of this section. (ii) Compliance with foreign initial margin collection requirement. A covered swap entity that is covered by paragraph (b)(1)(i) of this section may satisfy its requirement to post initial margin under this part by posting initial margin in the form and amount, and at such times, that its counterparty is required to collect initial margin pursuant to a foreign jurisdiction’s margin requirements, but only to the extent that: (A) The counterparty is neither a U.S. person nor a non-U.S. person whose obligations under the relevant swap are guaranteed by a U.S. person; (B) The counterparty is subject to such foreign jurisdiction’s margin requirements; and (C) The Commission has issued a comparability determination under paragraph (c) of this section (‘‘Comparability Determination’’) with respect to such foreign jurisdiction’s requirements regarding the posting of initial margin by the covered swap entity (that is covered in paragraph (b)(1) of this section). (2) Uncleared swaps of Non-U.S. CSEs whose obligations under the relevant swap are not guaranteed by a U.S. person—(i) Applicability of U.S. Margin requirements except where an exclusion applies; Availability of substituted compliance. With respect to each uncleared swap entered into by a nonU.S. CSE whose obligations under the relevant swap are not guaranteed by a U.S. person, the non-U.S. CSE shall comply with the requirements of §§ 23.150 through 23.161 except to the extent that an exclusion is available under paragraph (b)(2)(ii) of this section, provided that a non-U.S. CSE whose obligations under the relevant swap are not guaranteed by a U.S. person may satisfy its margin requirements under this part to the extent provided in paragraphs (b)(2)(iii) and (b)(2)(iv) of this section. (ii) Exclusion. (A) Except as provided in paragraph (b)(2)(ii)(B) of this section, a non-U.S. CSE shall not be required to comply with the requirements of §§ 23.150 through 23.161 with respect to each uncleared swap it enters into to the extent that the following conditions are met: (1) The non-U.S. CSE’s obligations under the relevant swap are not guaranteed by a U.S. person; (2) The non-U.S. CSE is not a U.S. branch of a non-U.S. CSE; E:\FR\FM\31MYR2.SGM 31MYR2 asabaliauskas on DSK3SPTVN1PROD with RULES Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations (3) The non-U.S. CSE is not a Foreign Consolidated Subsidiary; and (4) The counterparty to the uncleared swap is a non-U.S. person (excluding a Foreign Consolidated Subsidiary or the U.S. branch of a non-U.S. CSE), whose obligations under the relevant swap are not guaranteed by a U.S. person. (B) Notwithstanding paragraph (b)(2)(ii)(A) of this section, any uncleared swap of a non-U.S. CSE that meets the conditions for the Exclusion set forth in paragraph (b)(2)(ii)(A) must nevertheless comply with §§ 23.150 through 23.161 if: (1) The uncleared swap of the nonU.S. CSE is not covered by a Comparability Determination with respect to the initial margin collection requirements in the relevant foreign jurisdiction in accordance with paragraph (c) of this section; and (2) The non-U.S. CSE enters into an inter-affiliate swap(s), transferring any risk arising out of the uncleared swap described in paragraph (b)(2)(ii)(B)(1) of this section directly or indirectly, to a margin affiliate (as the term ‘‘margin affiliate’’ is defined in § 23.151 of this part) that is a U.S. CSE or a U.S. Guaranteed CSE. (iii) Availability of substituted compliance where the counterparty is not a U.S. CSE or a non-U.S. CSE whose obligations under the relevant swap are guaranteed by a U.S. person. Except to the extent that an exclusion is available under paragraph (b)(2)(ii) of this section, with respect to each uncleared swap entered into by a non-U.S. CSE whose obligations under the relevant swap are not guaranteed by a U.S. person with a counterparty (except where the counterparty is either a U.S. CSE or a non-U.S. CSE whose obligations under the relevant swap are guaranteed by a U.S. person), the non-U.S. CSE whose obligations under the relevant swap are not guaranteed by a U.S. person may satisfy margin requirements under this part by complying with the margin requirements of a foreign jurisdiction to which such non-U.S. CSE (whose obligations under the relevant swap are not guaranteed by a U.S. person) is subject, but only to the extent that the Commission has issued a Comparability Determination under paragraph (c) of this section for such foreign jurisdiction. (iv) Availability of substituted compliance where the counterparty is a U.S. CSE or a non-U.S. CSE whose obligations under the relevant swap are guaranteed by a U.S. person. With respect to each uncleared swap entered into by a non-U.S. CSE whose obligations under the relevant swap are not guaranteed by a U.S. person with a counterparty that is a U.S. CSE or a non- VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 U.S. CSE whose obligations under the relevant swap are guaranteed by a U.S. person, the non-U.S. CSE (whose obligations under the relevant swap are not guaranteed by a U.S. person) may satisfy its requirement to collect initial margin under this part by collecting initial margin in the form and amount, and at such times and under such arrangements, that the non-U.S. CSE (whose obligations under the relevant swap are not guaranteed by a U.S. Person) is required to collect initial margin pursuant to a foreign jurisdiction’s margin requirements, provided that: (A) The non-U.S. CSE (whose obligations under the relevant swap are not guaranteed by a U.S. person) is subject to the foreign jurisdiction’s regulatory requirements; and (B) The Commission has issued a Comparability Determination with respect to such foreign jurisdiction’s margin requirements. (c) Comparability determinations—(1) Eligibility requirements. The following persons may, either individually or collectively, request a Comparability Determination with respect to some or all of the Commission’s margin requirements: (i) A covered swap entity that is eligible for substituted compliance under this section; or (ii) A foreign regulatory authority that has direct supervisory authority over one or more covered swap entities and that is responsible for administering the relevant foreign jurisdiction’s margin requirements. (2) Submission requirements. Persons requesting a Comparability Determination should provide the Commission (either by hard copy or electronically): (i) A description of the objectives of the relevant foreign jurisdiction’s margin requirements; (ii) A description of how the relevant foreign jurisdiction’s margin requirements address, at minimum, each of the following elements of the Commission’s margin requirements. Such description should identify the specific legal and regulatory provisions that correspond to each element and, if necessary, whether the relevant foreign jurisdiction’s margin requirements do not address a particular element: (A) The products subject to the foreign jurisdiction’s margin requirements; (B) The entities subject to the foreign jurisdiction’s margin requirements; (C) The treatment of inter-affiliate derivative transactions; PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 34849 (D) The methodologies for calculating the amounts of initial and variation margin; (E) The process and standards for approving models for calculating initial and variation margin models; (F) The timing and manner in which initial and variation margin must be collected and/or paid; (G) Any threshold levels or amounts; (H) Risk management controls for the calculation of initial and variation margin; (I) Eligible collateral for initial and variation margin; (J) The requirements of custodial arrangements, including segregation of margin and rehypothecation; (K) Margin documentation requirements; and (L) The cross-border application of the foreign jurisdiction’s margin regime. (iii) A description of the differences between the relevant foreign jurisdiction’s margin requirements and the International Standards; (iv) A description of the ability of the relevant foreign regulatory authority or authorities to supervise and enforce compliance with the relevant foreign jurisdiction’s margin requirements. Such description should discuss the powers of the foreign regulatory authority or authorities to supervise, investigate, and discipline entities for compliance with the margin requirements and the ongoing efforts of the regulatory authority or authorities to detect and deter violations of, and ensure compliance with, the margin requirements; and (v) Copies of the foreign jurisdiction’s margin requirements (including an English translation of any foreign language document); (vi) Any other information and documentation that the Commission deems appropriate. (3) Standard of review. The Commission will issue a Comparability Determination to the extent that it determines that some or all of the relevant foreign jurisdiction’s margin requirements are comparable to the Commission’s corresponding margin requirements. In determining whether the requirements are comparable, the Commission will consider all relevant factors, including: (i) The scope and objectives of the relevant foreign jurisdiction’s margin requirements; (ii) Whether the relevant foreign jurisdiction’s margin requirements achieve comparable outcomes to the Commission’s corresponding margin requirements; (iii) The ability of the relevant regulatory authority or authorities to E:\FR\FM\31MYR2.SGM 31MYR2 34850 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations supervise and enforce compliance with the relevant foreign jurisdiction’s margin requirements; and (iv) Any other facts and circumstances the Commission deems relevant. (4) Reliance. Any covered swap entity that, in accordance with a Comparability Determination, complies with a foreign jurisdiction’s margin requirements, would be deemed to be in compliance with the Commission’s corresponding margin requirements. Accordingly, if the Commission determines that a covered swap entity has failed to comply with the foreign jurisdiction’s margin requirements, it could initiate an action for a violation of the Commission’s margin requirements. All covered swap entities, regardless of whether they rely on a Comparability Determination, remain subject to the Commission’s examination and enforcement authority. (5) Conditions. In issuing a Comparability Determination, the Commission may impose any terms and conditions it deems appropriate. (6) Modifications. The Commission reserves the right to further condition, modify, suspend, terminate or otherwise restrict a Comparability Determination in the Commission’s discretion. (7) Delegation of authority. The Commission hereby delegates to the Director of the Division of Swap Dealer and Intermediary Oversight, or such other employee or employees as the Director may designate from time to time, the authority to request information and/or documentation in connection with the Commission’s issuance of a Comparability Determination. (d) Non-netting jurisdiction requirements. Except as provided in paragraph (e) of this section, if a CSE cannot conclude after sufficient legal review with a well-founded basis that the netting agreement described in § 23.152(c) meets the definition of ‘‘eligible master netting agreement’’ set forth in § 23.151, the CSE must treat the uncleared swaps covered by the agreement on a gross basis for the purposes of calculating and complying with the requirements of § 23.152(a) and § 23.153(a) to collect margin, but the CSE may net those uncleared swaps in accordance with § 23.152(c) and § 23.153(d) for the purposes of calculating and complying with the requirements of this part to post margin. A CSE that relies on this paragraph (d) must have policies and procedures ensuring that it is in compliance with the requirements of this paragraph, and maintain books and records properly documenting that all of the requirements of this paragraph (d) are satisfied. (e) Jurisdictions Where Compliance with Custodial Arrangement Requirements is Unavailable. Sections 23.152(b), 23.157(b), and paragraph (d) of this section do not apply to an uncleared swap entered into by a Foreign Consolidated Subsidiary or a foreign branch of a U.S. CSE if: (1) Inherent limitations in the legal or operational infrastructure in the applicable foreign jurisdiction make it impracticable for the CSE and its counterparty to post any form of eligible initial margin collateral recognized pursuant to § 23.156 in compliance with the custodial arrangement requirements of § 23.157; (2) The CSE is subject to foreign regulatory restrictions that require the CSE to transact in uncleared swaps with the counterparty through an establishment within the foreign jurisdiction and do not accommodate the posting of collateral for the uncleared swap in compliance with the custodial arrangements of § 23.157 in the United States or a jurisdiction for which the Commission has issued a comparability determination under paragraph (c) of this section with respect to § 23.157; (3) The counterparty to the uncleared swap is a non-U.S. person that is not a CSE, and the counterparty’s obligations under the uncleared swap are not guaranteed by a U.S. person; (4) The CSE collects initial margin for the uncleared swap in accordance with § 23.152(a) in the form of cash pursuant to § 23.156(a)(1)(i), and posts and collects variation margin in accordance with § 23.153(a) in the form of cash pursuant to § 23.156(a)(1)(i); (5) For each broad risk category, as set out in § 23.154(b)(2)(v), the total outstanding notional value of all uncleared swaps in that broad risk category, as to which the CSE is relying on this paragraph (e), may not exceed 5% of the CSE’s total outstanding notional value for all uncleared swaps in the same broad risk category; (6) The CSE has policies and procedures ensuring that it is in compliance with the requirements of this paragraph (e); and (7) The CSE maintains books and records properly documenting that all of the requirements of this paragraph (e) are satisfied. Issued in Washington, DC, on May 24, 2016, by the Commission. Christopher J. Kirkpatrick, Secretary of the Commission. Note: The following table and appendices will not appear in the Code of Federal Regulations. Table A—Application of the Final Rule The following table should be read in conjunction with the rest of the preamble and the text of the Final Rule, as well as the footnotes at the end of the table. Counterparty U.S. CSE ............................................................ or Non-U.S. CSE (including U.S. branch of a nonU.S. CSE and a Foreign Consolidated Subsidiary (‘‘FCS’’)) whose obligations under the relevant swap are guaranteed by a U.S. person. asabaliauskas on DSK3SPTVN1PROD with RULES CSE • U.S. person (including U.S. CSE) ................ • Non-U.S. person (including non-U.S. CSE, FCS, and U.S. branch of a non-U.S. CSE) whose obligations under the relevant swap are guaranteed by a U.S. person. U.S. (All). • Non-U.S. person (including non-U.S. CSE, FCS and U.S. branch of a non-U.S. CSE) whose obligations under the relevant swap are not guaranteed by a U.S. person. U.S. (Initial Margin collected by CSE in column 1). Substituted Compliance (Initial Margin posted by CSE in column 1). U.S. (Variation Margin). U.S. (Initial Margin posted by CSE in column 1). Substituted Compliance (Initial Margin collected by CSE in column 1). U.S. (Variation Margin). FCS whose obligations under the relevant swap are not guaranteed by a U.S. person. or U.S. branch of a non-U.S. CSE whose obligations under the relevant swap are not guaranteed by a U.S. person. VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 Applicable margin requirements • U.S. CSE ...................................................... • Non-U.S. CSE (including U.S. branch of a non-U.S. CSE and FCS) whose obligations under the relevant swap are guaranteed by a U.S. person. PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations CSE Counterparty Non-U.S. CSE (that is not an FCS or a U.S. branch of a non-U.S. CSE) whose obligations under the relevant swap are not guaranteed by a U.S. person. 34851 Applicable margin requirements • U.S. person (except as noted above for a CSE). • Non-U.S. person whose obligations under the swap are guaranteed by a U.S. person (except a non-U.S. CSE, U.S. branch of a non-U.S. CSE, and FCS whose obligations are guaranteed, as noted above). • Non-U.S. person (including non-U.S. CSE, U.S. branch of a non-U.S. CSE, and a FCS) whose obligations under the relevant swap are not guaranteed by a U.S. person. • U.S. CSE ...................................................... • Non-U.S. CSE (including U.S. branch of a non-U.S. CSE and FCS) whose obligations under the swap are guaranteed by a U.S. person. • U.S. person (except as noted above for a CSE). • Non-U.S. person whose obligations under the swap are guaranteed by a U.S. person (except a non-U.S. CSE whose obligations are guaranteed, as noted above). • U.S. branch of a non-U.S. CSE or FCS, in each case whose obligations under the relevant swap are not guaranteed by a U.S. person. • Non-U.S. person (including a non-U.S. CSE, but not an FCS or a U.S. branch of a non-U.S. CSE) whose obligations under the relevant swap are not guaranteed by a U.S. person. Substituted Compliance (All). U.S. (Initial Margin posted by CSE in column 1). Substituted Compliance (Initial Margin collected by CSE in column 1). U.S. (Variation Margin). Substituted Compliance (All). Excluded (except in connection with certain inter-affiliate swaps). asabaliauskas on DSK3SPTVN1PROD with RULES 1 The term ‘‘U.S. person’’ is defined in § 23.160(a)(10) of the Final Rule. A ‘‘non-U.S. person’’ is any person that is not a ‘‘U.S. person.’’ The term swap means an uncleared swap and is defined in § 23.151 of the Final Margin Rule. See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 FR 636 (Jan. 6, 2016). 2 As used in this table, the term ‘‘Foreign Consolidated Subsidiary’’ or ‘‘FCS’’ refers to a non-U.S. CSE in which an ultimate parent entity that is a U.S. person has a controlling financial interest, in accordance with U.S. GAAP, such that the U.S. ultimate parent entity includes the non-U.S. CSE’s operating results, financial position and statement of cash flows in the U.S. ultimate parent entity’s consolidated financial statements, in accordance with U.S. GAAP. The term ‘‘ultimate parent entity’’ means the parent entity in a consolidated group in which none of the other entities in the consolidated group has a controlling interest, in accordance with U.S. GAAP. 3 Under § 23.160(e) of the Final Rule, in certain foreign jurisdictions where inherent limitations in the legal or operational infrastructure of the jurisdiction make it impracticable for the CSE and its counterparty to post initial margin for the uncleared swap in compliance with the custodial arrangement requirements of the Final Margin Rule, an FCS (or non-U.S. branch of a U.S. CSE) may be eligible to engage in uncleared swaps with certain non-U.S. counterparties, subject to a limit, but only if certain conditions are satisfied. Under the limit, for each broad risk category set out in § 23.154(b)(2)(v), the total outstanding notional value of all uncleared swaps in that broad risk category, as to which the CSE is relying on § 23.160(e), may not exceed 5% of the CSE’s total outstanding notional value for all uncleared swaps in the same broad risk category. The specified conditions include collecting the gross amount of initial margin in cash, and posting and collecting variation margin in cash, in accordance with the Final Margin Rule. The CSE’s counterparty must be a non-U.S. person that is not a CSE, and the counterparty’s obligations under the swap must not be guaranteed by a U.S. person. This provision does not apply if the CSE that is subject to the foreign regulatory restrictions is permitted to post collateral for the uncleared swap in compliance with the custodial arrangements of § 23.157 in the United States or a jurisdiction for which the Commission has issued a comparability determination with respect to § 23.157. An FCS (or non-U.S. branch of a U.S. CSE) that relies on this special provision would not post initial margin in qualifying foreign jurisdictions, and would not be required to hold initial margin that they collect with one or more custodians that are not the CSE, its counterparty, or an affiliate of the CSE or its counterparty as would otherwise be required by § 23.157(b) of the Final Margin Rule. CSEs that rely on this special provision must have policies and procedures to ensure compliance and maintain books and records properly documenting that all of the requirements of this provision are satisfied. If a CSE cannot conclude after sufficient legal review with a well-founded basis that the netting agreement with a counterparty in a foreign jurisdiction meets the definition of an ‘‘eligible master netting agreement’’ set forth in the Final Margin Rule, the CSE must treat the uncleared swaps covered by the netting agreement on a gross basis in determining the amount of initial and variation margin that it must collect, but the CSE may net those uncleared swaps in accordance with the netting provisions of the Final Margin Rule in determining the amount of initial and variation margin that it must post to the counterparty. The CSE must have policies and procedures to ensure compliance and maintain books and records properly documenting that all of the requirements of this provision are satisfied. 4 In order to preserve the Commission’s intent with respect to the treatment of inter-affiliate swaps under the Final Margin Rule, the Exclusion is not available if the market-facing swap of the non-U.S. CSE (that is otherwise eligible for the Exclusion) is not subject to comparable initial margin collection requirements in the home jurisdiction and any of the risk associated with the uncleared swap is transferred, directly or indirectly, through inter-affiliate swaps, to a U.S. CSE or a U.S. Guaranteed CSE. Under the Final Margin Rule, a CSE is not required to collect initial margin from its affiliate, provided, among other things, that affiliate collects initial margin on its market-facing swaps or is subject to comparable initial margin collection requirements (in the case of non-U.S. affiliates that are financial end-users) on their own market-facing swaps. VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 E:\FR\FM\31MYR2.SGM 31MYR2 34852 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations Appendices to Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants—CrossBorder Application of the Margin Requirements—Commission Voting Summary, Chairman’s Statement, and Commissioners’ Statements Appendix 1—Commission Voting Summary On this matter, Chairman Massad and Commissioner Bowen voted in the affirmative. Commissioner Giancarlo voted in the negative. asabaliauskas on DSK3SPTVN1PROD with RULES Appendix 2—Statement of Chairman Timothy G. Massad I am pleased that today, the Commission has adopted a cross-border approach to our rule setting margin for uncleared swaps. Our margin rule is one of the most important elements of swaps market regulation set forth in the Dodd-Frank Act. Margin requirements help ensure that uncleared swaps, which will always remain a sizable portion of the market, do not generate excessive uncollateralized risk. Last December, the Commission adopted a strong and sensible margin rule. It requires swap dealers and major swap participants to post and collect margin in their transactions with one another, and with financial entities with which they have significant exposures. The risks our margin rule seeks to prevent do not only originate in the United States. The interconnected nature of the global swaps market means that risks created across the globe have the potential to flow back into the United States. We recognize that having a global swaps market is beneficial to all users. Therefore, one of the most important objectives we already accomplished was to ensure our margin rule is substantially similar to comparable international rules. Harmonization is critical to creating a sound international framework for regulation. We also recognize that not all jurisdictions will adopt strong margin rules. And even where rules are substantially harmonized, there will still be some differences. Because cross-border transactions are commonplace, we must clarify which rules apply in different situations. Today, the Commission has acted to provide that clarification. First, we have drawn a clear, reasonable line as to when the CFTC should take offshore risk into account. Today’s action ensures that our rule, or a comparable international measure, applies to swap dealers that are foreign consolidated subsidiaries of a U.S. parent. This helps address the risk that can flow back into the United States from that offshore activity, even when the subsidiary is not explicitly guaranteed by the U.S. parent. This treatment of foreign consolidated subsidiaries—and our general cross-border approach—is also consistent with the approach taken by the U.S. prudential regulators. At the same time, to further our efforts toward harmonization, and to avoid conflicts with the rules of other jurisdictions, we have provided for a broad scope of substituted compliance. Not only will non-U.S. swap dealers be eligible for substituted VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 compliance, so will U.S. swap dealers with respect to the margin they post to non-U.S. persons. This approach is an appropriate response to the complex world created by the swap industry, where global swap dealers can book a swap in a variety of ways. Dealers may book swaps through different subsidiaries, branches or affiliates all over the world, and they may do so based on a number of considerations, such as the most favorable legal treatment. Our approach is intended to protect our markets against risk coming from these cross-border transactions, while taking into account the interests of other regulators. The process for conducting a comparability assessment of another jurisdiction’s rules is similar to what we have done in other areas. The rule specifies the various factors that should be considered, and indeed there is no reasonable way one can make a determination without evaluating those factors. One important consideration will be compliance with the international framework developed by the Basel Committee on Banking Supervision and the International Organization of Securities Commissions. Our approach will look at the elements of each jurisdiction’s rule set with an eye towards a flexible, outcome-based determination. The process of making comparability assessments can take time. In light of the impending September 1 compliance date, I have asked the CFTC staff to work closely with other domestic and international regulators, as well as industry participants, and endeavor to effect a smooth transition. The approach we have finalized today helps ensure the safety and soundness of registered swap dealers, and reduces the potential for conflict with the rules of other international regulators. I thank all those who provided us with important feedback on these issues. I also thank CFTC staff for their work on this rule, and my fellow Commissioners for their careful consideration of this measure. Appendix 3—Concurring Statement of Commissioner Sharon Y. Bowen Margin and Capital as the Pillars of Market Safety Margin and capital are two of the most important tools for risk mitigation for the derivatives markets. Thus it is very important that we get our rules on margin and capital right in order to accomplish the reform required under the Dodd-Frank Wall Street Reform and Consumer Protection Act.290 As many of you know, last December, I voted against the final margin for uncleared swaps rule because I did not believe that it was strong enough to fully protect our system. As I said in December, adequate margin is fundamental to market safety as it is a ‘‘critical shock absorber for the bumps and potholes of our financial markets and for the risk of contagion and spillovers.’’ 291 I am even more confident in that view today. Today we vote on a critical supplement to that margin rule. Specifically, today’s rule would allow registered dealers to substitute 290 Public Law 111–203, 124 Stat. 1376 (2010). 291 http://www.cftc.gov/PressRoom/ SpeechesTestimony/bowenstatement121615a. PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 the margin rules of comparable jurisdictions for our rules, when dealing with non-US counterparties, under certain conditions. Needless to say, cross-border regulation is central to our margin rule functioning effectively since our markets are global. I intend to vote yes for this cross-border rule because I want to give the market legal certainty, as the first compliance date for our margin rules, as well as those of regulators across jurisdictions—September 1, 2016— looms.292 It is important that market participants have enough time to prepare in advance of this date so as to minimize market instability. We also want to minimize the risk of creating regulatory arbitrage across jurisdictions. While my concerns about our margin regime remain, I recognize that there is no opportunity in today’s cross-border margin decision to remedy those errors. One of the major drawbacks of our margin rulemaking is that it was not done in conjunction with our capital rulemaking. Margin and capital are intertwined—if our margin rule is weak, our capital rule needs to be stronger to compensate. If both are strong, investors and consumers can be confident that we have learned the lessons of the past, and have placed adequate protections in place against future financial instability. But, if both are weak, we have surrendered our best defenses against contagion. We put the interests of our investors at risk when we view regulation in a piecemeal and non-comprehensive fashion, because we are not seeing the whole picture. So, as I vote today on cross-border margin, my mind is on our upcoming capital rule proposal. Any firm that aspires to be a swap dealer is aspiring to be a significant player in our economy. They must have the capacity to not only stand ready to be the buyer to each seller and the seller to each buyer, but to maintain those positions over years. Their creditworthiness must be above reproach. In that way, market participants, including commercial end-users who need to hedge, can be confident that their dealer will be there during times of stability and crisis. It is therefore critical to the health of our economy that the market trusts, and with good reason, that our dealers are robust and steadfast—that they are able to withstand the financial swings that are endemic to today’s economy. Thus while strong capital rules may prevent some entities from entering the dealing business, they ultimately benefit the dealers, their customers and the whole economy. In order to create a capital rule that appropriately manages risk for the American people and our critical economy, our capital rule proposal must: (1) Not Be Weaker Than Our Comparable Prudential Regulators’ Rule: The capital proposal, and subsequent final rule, must be as strong as those of the Prudential Regulators. We are required under law to establish minimum capital requirements that are ‘‘comparable’’ to our Prudential Regulator counterparts ‘‘to the maximum extent 292 Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 FR 636, 675 (Jan. 6, 2016). E:\FR\FM\31MYR2.SGM 31MYR2 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations practicable.’’ 293 Not only is this our legal obligation, but it is a sensible one as it prevents entities from gaming the system, and organizing their businesses in order to have the lowest capital requirements possible. We do not want our regulatory framework to be an escape hatch from strong risk management. (2) Account for the Entire Risk to the Dealer: The capital proposal should also require dealers to hold sufficient capital to cover the entirety of the risk posed by the full gamut of derivatives products that they hold—including those products, which, for various reasons, we did not impose a margin requirement, such as inter-affiliate swaps and swaps with financial counterparties that are below the $8 billion threshold. This is consistent with our mandate under law to ‘‘take into account the risks associated with other types of swaps or classes of swaps or categories of swaps engaged in and the other activities conducted by that person that are not otherwise subject to regulation. . . .’’ 294 This is an important requirement. The Congressional authors understood that just because a particular category of swaps that a dealer holds are not subject to a regulatory requirement, does not mean that the dealers, and therefore their customers, are not vulnerable to the risk posed by them. (3) Include Effective Elements of Strong Capital Models: Our capital proposal should take into consideration respected, and effective capital models from other regulators. As of now, we have two wellregarded capital models: The Basel rules for banks, and the Securities and Exchange Commission’s (SEC’s) rule for Broker-Dealers. The Basel rule has many positive attributes— including the fact that it not only has strong capital requirements but also a liquidity, leverage and funding ratio.295 We need look no further than financial companies before the 2008 crisis to understand the need for leverage requirements. For instance, it was estimated that, prior to the crisis, some firms had debt that was 30 to 40 times their net capital.296 And we have very present examples of commercial companies that evidence the need for funding requirements.297 The SEC’s broker dealer rule 293 Commodity Exchange Act (CEA) 6s(e)(3)(D). 6s(e)(2)(C). 295 With the exception of the capital charge to the segregated customer funds that have been set aside to secure cleared products. See ‘‘Speech of Commissioner Sharon Y. Bowen at George Washington Law, 2016 Manuel F. Cohen Lecture,’’ Feb. 4, 2016, available at http://www.cftc.gov/ PressRoom/SpeechesTestimony/opabowen-8. 296 E.g., Julie Satow, ‘‘Ex-SEC Official Blames Agency for Blow-Up of Broker-Dealers,’’ The New York Sun (September 18, 2008) (‘‘[B]roker dealers . . . [had] debt-to-net-capital ratios, sometimes, as in the case of Merrill Lynch, to as high as 40-to1.’’), available at http://www.nysun.com/business/ ex-sec-official-blames-agency-for-blow-up/86130/; Alan S. Blinder, ‘‘Six Errors on the Path to the Financial Crisis,’’ New York Times (January 25, 2009) (stating that in 2008, securities firms had leverage ratios of ‘‘33 to 1’’), available at http:// www.nytimes.com/2009/01/25/business/economy/ 25view.html?_r=0. 297 Jasmine Ng and David Yong, ‘‘Noble Group Gets $3 Billion in Credit Facilities,’’ Bloomberg.com (May 12, 2016), available at http:// asabaliauskas on DSK3SPTVN1PROD with RULES 294 CEA VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 also has its positives including that it does not allow for internal models, which came under fire after the crisis for allowing excessive leverage,298 and it is liquiditybased such that the dealer is obligated to maintain highly liquid assets to cover its liabilities.299 Our capital rule proposal should be as strong, if not stronger, than these models. (4) Address Risks Posed by Swap-Dealing of Non-Financial Companies: Some commercial entities are also registered as swap dealers, and others may decide to do so in the future. Having commercial endusers that are engaging in more than a de minimis amount of swap dealing may increase market risk. Thus it is important that we are able to isolate their swap dealing business from the regular business, so that we can properly track their activities as a dealer. (5) Be Based on Data-Driven Risk Assessment, Not Industry Preference: As a regulator, anything that we propose needs to be based on our data-driven risk assessment, not on the desire to ensure that all entities that want to be dealers are able to maintain their current business models without any changes. In response to our proposal, market participants are then free to provide data to explain why our risk assessment may be inappropriate and to inform us of the pragmatic restraints. While encouraging more entrants into the market maybe a regulatory goal, doing all we can to prevent the next catastrophic financial crisis that wipes out pensions, is our fundamental goal. Experience has taught us that comprehensive, well-considered review is critical when considering major regulations. Ten years ago, too many people in industry did not engage in such well-considered review when crafting complicated financial deals. In the end, that lack of consideration came back to haunt us all when the mortgage bubble burst and unexpectedly exposed many large financial institutions to massive losses that threatened the entire financial system. In the end, the American public had to save the system at great expense, and the ensuing rescue left many angry, alienated, and disaffected. Today, nearly eight years later, that anger still exists. We all pay a great price when we move forward in finance with insufficient analysis and review. Thus, for the sake of market certainty, I am voting yes to this rule. But I encourage my fellow Commissioners to work with me to develop a strong, comprehensive capital rule so that the American people can have the appropriate safeguards to secure our economy. Thank you. www.bloomberg.com/news/articles/2016-05-12/ noble-group-agrees-3-billion-credit-facilities-withlenders. See also Sarah Kent, Scott Patterson, and Margot Patrick, ‘‘Glencore Discloses More Details on Financing,’’ The Wall Street Journal (October 7, 2015), available at http://www.wsj.com/articles/ glencore-reveals-financing-deals-to-fend-off-critics1444137982. 298 See supra note 7. 299 Securities Exchange Act (SEA) Rule 15c3–1. PO 00000 Frm 00037 Fmt 4701 Sfmt 4700 34853 Appendix 4—Statement of Dissent by Commissioner J. Christopher Giancarlo I respectfully dissent from the final rule on the cross-border application of margin requirements for uncleared swaps. In September 2009, the leaders of the G– 20 countries agreed to launch a framework for ‘‘strong, sustainable and balanced global growth’’ to generate ‘‘a durable recovery that creates the good jobs our people need.’’ 1 The agreement included a commitment ‘‘to take action at the national and international level to raise standards together so that our national authorities implement global standards consistently in a way that ensures a level playing field and avoids fragmentation of markets, protectionism, and regulatory arbitrage.’’ 2 In keeping with that agreement, representatives of more than 20 regulatory authorities, including the CFTC, participated in consultations with the Basel Committee on Banking Supervision (‘‘BCBS’’) and the Board of the International Organization of Securities Commissions (‘‘IOSCO’’) to develop an international framework setting margin standards for uncleared derivatives (‘‘BCBS–IOSCO framework’’).3 That 2013 framework stresses the importance of developing consistent requirements across jurisdictions to avoid conflicting or duplicative standards.4 Today, instead of recognizing and building upon the strong foundation for mutual recognition of foreign regulatory regimes created by the G–20 commitments and the BCBS–IOSCO framework, as well as the CFTC’s own history of using a principlesbased, holistic approach to comparability determinations,5 the Commission is adopting a set of preconditions to substituted 1 G–20 Leaders’ Statement, The Pittsburgh Summit, Preamble at par. 13 (Sept. 24–25, 2009). 2 Id. at par. 12. 3 Margin Requirements for Non-centrally Cleared Derivatives (Sept. 2013), available at http:// www.bis.org/publ/bcbs261.pdf, revised Mar. 2015, available at http://www.bis.org/bcbs/publ/d317.pdf. 4 Id. at 23. 5 The CFTC has a long history of working collaboratively with foreign regulators to facilitate cross-border business. For example, under Commission Regulation 30.10, adopted in 1987, if the CFTC determines that a foreign regulatory regime offers comparable protections to U.S. customers transacting in foreign futures and options, and there is an appropriate informationsharing arrangement in place, the CFTC has allowed foreign brokers to comply with their home-country regulations in lieu of Commission regulations. Similarly, since 1996 the Commission has permitted direct access by U.S. customers to foreign boards of trade (‘‘FBOTs’’) without requiring the FBOT to register with the CFTC as a derivatives contract market (‘‘DCM’’). In determining the comparability of the foreign regulatory regime the Commission does not engage in a line-by-line examination of the foreign regulator’s approach to supervising the FBOT it regulates. Rather, the Commission conducts a principles-based review to determine whether the foreign regime supports and enforces regulatory oversight of the FBOT and its clearing organization in a substantially equivalent manner as that used by the CFTC in its oversight of DCMs and clearing organizations. See Registration of Foreign Boards of Trade, 76 FR 80674, 80680 (Dec. 23, 2011). E:\FR\FM\31MYR2.SGM 31MYR2 34854 Federal Register / Vol. 81, No. 104 / Tuesday, May 31, 2016 / Rules and Regulations compliance that is overly complex, unduly narrow and operationally impractical. First, the rule establishes a complicated matrix of potential cross-border counterparties under which substituted compliance is either not permitted, is partially permitted, or is fully permitted, depending upon the category in which the particular transaction fits. Next, where permitted, the CFTC will conduct an ‘‘element-by-element’’ analysis of CFTC and foreign margin rules under which a transaction may be subject to a patchwork of U.S. and foreign regulation.6 The CFTC will follow this ‘‘element-by-element’’ approach instead of assessing a foreign authority’s margin regime as a whole. In response to commenters who observed that today’s approach will undermine the BCBS–IOSCO framework, the Commission acknowledges that consistency with the framework is necessary, but argues that the framework leaves certain elements open to interpretation by each regulator, including a result would be antithetical to element seven of the BCBS–IOSCO framework, which requires that there be no application of duplicative or conflicting margin requirements to the same transaction or activity. The framework advises that ‘‘[w]hen a transaction is subject to two sets of rules (duplicative requirements), the home and the host regulators should endeavor to (1) harmonize the rules to the extent possible or (2) apply only one set of rules, by recognizing the equivalence and comparability of their respective rules.’’ BCBS– IOSCO framework at 23. asabaliauskas on DSK3SPTVN1PROD with RULES 6 Such VerDate Sep<11>2014 23:13 May 27, 2016 Jkt 238001 the CFTC.7 For these elements, the Commission undertakes to use an outcomebased analysis, but will also engage in a factspecific inquiry of each legal and regulatory provision that corresponds to each element. In effect, the Commission’s approach is somewhat principles-based, except when it is rules-based and somewhat objective, except when it is subjective. Today’s muddled methodology invites foreign regulators to respond in kind. It may well set us off down the same protracted, circuitous and uncertain path that the CFTC and the European Union took in the context of U.S. central counterparty clearinghouse equivalence. The approach is impractical, unnecessary and contrary to the cooperative spirit of the 2009 G–20 Pittsburgh Accords.8 Rather than conducting a granular rule-byrule comparison, the CFTC should focus on whether a foreign regulator’s margin regime, in the aggregate, provides a sufficient level of risk mitigation in connection with the 7 In footnote 232 of the preamble the Commission cites, for example, the definition of ‘‘derivative,’’ the list of assets eligible to post as collateral, the degree to which margin would be protected under the local bankruptcy regime, and how transactions with affiliates are treated. 8 I am also concerned about the Commission’s unwillingness to delay the cross-border application of its margin rules until after it has made comparability determinations. This will bring into the CFTC’s regulatory ambit many cross-border transactions over which U.S. jurisdiction is inappropriate and an undue drain on precious regulatory resources. PO 00000 Frm 00038 Fmt 4701 Sfmt 9990 execution of uncleared swaps. The BCBS– IOSCO framework does just that. Compliance with it should be straightforward and unconditional to prevent the ‘‘fragmentation of markets, protectionism, and regulatory arbitrage’’ that global regulators were charged to avoid. As confusing as this rule is, what is important is not that hard to understand. American workers need quality American jobs. They need them in factories, farms and offices across the United States. The businesses that employ them want to sell their goods and services both here and abroad. To succeed globally, American businesses need U.S.-based financial institutions to support them around the world with competitively priced risk management services. Unfortunately, this complicated rule will make it harder for U.S. financial institutions to compete globally and serve American businesses. When businesses are placed at a competitive disadvantage, they hire fewer workers. With over 94 million Americans now out of the workforce,9 that is unacceptable. Therefore, I oppose this rule— it’s that simple. [FR Doc. 2016–12612 Filed 5–27–16; 8:45 am] BILLING CODE 6351–01–P 9 Bureau of Labor Statistics, The Employment Situation—April 2016, U.S. DEPARTMENT OF LABOR, May 6, 2016, http://www.bls.gov/ news.release/empsit.nr0.htm. E:\FR\FM\31MYR2.SGM 31MYR2

Agencies

[Federal Register Volume 81, Number 104 (Tuesday, May 31, 2016)]
[Rules and Regulations]
[Pages 34817-34854]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-12612]



[[Page 34817]]

Vol. 81

Tuesday,

No. 104

May 31, 2016

Part VI





Commodity Futures Trading Commission





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17 CFR Part 23





Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap 
Participants--Cross-Border Application of the Margin Requirements; 
Agency Information Collection Activities: Proposed Collection, Comment 
Request: Final Rule, Margin Requirements for Uncleared Swaps for Swap 
Dealers and Major Swap Participants--Cross-Border Application of the 
Margin Requirements; Final Rule and Notice

Federal Register / Vol. 81 , No. 104 / Tuesday, May 31, 2016 / Rules 
and Regulations

[[Page 34818]]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 23

RIN 3038-AC97


Margin Requirements for Uncleared Swaps for Swap Dealers and 
Major Swap Participants--Cross-Border Application of the Margin 
Requirements

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: On January 6, 2016, the Commodity Futures Trading Commission 
(``Commission'' or ``CFTC'') published final regulations to implement 
section 4s(e) of the Commodity Exchange Act, which requires the 
Commission to adopt initial and variation margin requirements for 
uncleared swaps of swap dealers and major swap participants that do not 
have a Prudential Regulator (collectively, ``Covered Swap Entities'' or 
``CSEs''). In this release, the Commission is adopting a rule to 
address the cross-border application of the Commission's margin 
requirements for CSEs' uncleared swaps.

DATES: The final rule is effective August 1, 2016.

FOR FURTHER INFORMATION CONTACT: Laura B. Badian, Assistant General 
Counsel, 202-418-5969, lbadian@cftc.gov; Paul Schlichting, Assistant 
General Counsel, 202-418-5884, pschlichting@cftc.gov; or Elise 
(Pallais) Bruntel, Counsel, (202) 418-5577, ebruntel@cftc.gov; Office 
of the General Counsel, Commodity Futures Trading Commission, Three 
Lafayette Centre, 1155 21st Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background
    A. Introduction
    B. Key Considerations in the Cross-Border Application of the 
Margin Regulations
II. The Final Rule
    A. Key Definitions
    1. U.S. Person
    a. Proposed Rule
    b. Comments
    c. Final Rule
    2. Guarantees
    a. Proposed Rule
    b. Comments
    c. Final Rule
    3. Foreign Consolidated Subsidiary (``FCS'')
    a. Proposed Rule
    b. Comments
    c. Final Rule
    4. Counterparty Representations
    B. Applicability of Margin Requirements To Cross-Border 
Uncleared Swaps
    1. Proposed Rule
    2. Substituted Compliance
    a. Comments
    b. Final Rule
    3. Exclusion
    a. Comments
    b. Final Rule
    4. Special Provisions for Non-Segregation Jurisdictions
    a. Comments
    b. Final Rule
    5. Special Provisions for Non-Netting Jurisdictions
    a. Comments
    b. Final Rule
    C. Comparability Determinations
    1. Proposed Rule
    2. Comments
    3. Final Rule
III. Related Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act
    1. Information Collection--Comparability Determinations
    2. Information Collection--Non-Segregation Jurisdictions
    3. Information Collection--Non-Netting Jurisdictions
    C. Cost-Benefit Considerations
    1. Introduction
    2. Key Definitions
    a. U.S. Person
    b. Guarantees
    c. Foreign Consolidated Subsidiary
    3. Application
    a. Substituted Compliance
    b. Exclusion
    c. Non-Segregation Jurisdictions and Non-Netting Jurisdictions
    4. Comparability Determinations
    5. Section 15(a) Factors
    a. Protection of Market Participants and the Public
    b. Efficiency, Competitiveness, and Financial Integrity
    c. Price Discovery
    d. Sound Risk Management Practices
    e. Other Public Interest Considerations

Table A--Application of the Final Rule

I. Background

A. Introduction

    In the wake of the 2008 financial crisis, Congress enacted Title 
VII of the Wall Street Reform and Consumer Protection Act (``Dodd-Frank 
Act''),\1\ which modified the Commodity Exchange Act (``CEA'') \2\ to 
establish a comprehensive regulatory framework for swaps. A cornerstone 
of this framework is the reduction of systemic risk to the U.S. 
financial system through the establishment of margin requirements for 
uncleared swaps. CEA section 4s(e), added by section 731 of the Dodd-
Frank Act, directs the Commission to adopt rules establishing minimum 
initial and variation margin requirements on all swaps that are not 
cleared by a registered derivatives clearing organization (``DCO'').\3\ 
To offset the greater risk to the swap dealer or major swap participant 
and the financial system arising from the use of uncleared swaps, the 
Commission's margin requirements must (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 uncleared swaps held as a 
swap dealer or major swap participant.\4\ Under CEA section 4s(e), the 
Commission's margin requirements apply to each swap dealer or major 
swap participant for which there is no Prudential Regulator 
(collectively, ``Covered Swap Entities'' or ``CSEs'').\5\ The 
Commission published final margin requirements for CSEs in January 
2016.\6\
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    \1\ Public Law 111-203, 124 Stat. 1376 (2010).
    \2\ 7 U.S.C. 1 et seq.
    \3\ See 7 U.S.C. 6s(e)(2)(B)(ii).
    \4\ 7 U.S.C. 6s(e)(3)(A).
    \5\ See 7 U.S.C. 6s(e)(1)(B). Swap dealers and major swap 
participants for which there is a Prudential Regulator must meet the 
margin requirements for uncleared swaps established by the 
applicable Prudential Regulator. 7 U.S.C. 6s(e)(1)(A). See also 7 
U.S.C. 1a(39) (defining the term ``Prudential Regulator'' to include 
the Board of Governors of the Federal Reserve System; the Office of 
the Comptroller of the Currency; the Federal Deposit Insurance 
Corporation; the Farm Credit Administration; and the Federal Housing 
Finance Agency). The Prudential Regulators published final margin 
requirements in November 2015. See Margin and Capital Requirements 
for Covered Swap Entities, 80 FR 74840 (Nov. 30, 2015) (``Prudential 
Regulators' Final Margin Rule'').
    \6\ See Margin Requirements for Uncleared Swaps for Swap Dealers 
and Major Swap Participants, 81 FR 636 (Jan. 6, 2016) (the ``Final 
Margin Rule''). The Final Margin Rule, which became effective April 
1, 2016, is codified in part 23 of the Commission's regulations. See 
17 CFR 23.150-159, 161.
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    In July 2015, consistent with its authority in CEA sections 4s(e) 
and 2(i),\7\ the Commission proposed a rule to address the cross-border 
application of the Commission's margin requirements (the ``proposed 
rule'').\8\ The proposed rule set out the circumstances under which a 
CSE would be allowed to satisfy the Commission's margin requirements by 
complying with comparable foreign margin requirements

[[Page 34819]]

(``substituted compliance''); offered certain CSEs a limited exclusion 
from the Commission's margin requirements (the ``Exclusion''); and 
outlined a framework for assessing whether a foreign jurisdiction's 
margin requirements are comparable to the Commission's requirements 
(``comparability determinations''). The Commission developed the 
proposed rule after close consultation with the Prudential Regulators 
and in light of comments from and discussions with market participants 
and foreign regulators.\9\
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    \7\ See 7 U.S.C. 2(i). Section 2(i) of the CEA states that the 
provisions of the CEA relating to swaps that were enacted by the 
Wall Street Transparency and Accountability Act of 2010 (including 
any rule prescribed or regulation promulgated under that Act), shall 
not apply to activities outside the United States unless those 
activities (1) have a direct and significant connection with 
activities in, or effect on, commerce of the United States; or (2) 
contravene such rules or regulations as the Commission may prescribe 
or promulgate as are necessary or appropriate to prevent the evasion 
of any provision of this Act that was enacted by the Wall Street 
Transparency and Accountability Act of 2010.
    \8\ See Margin Requirements for Uncleared Swaps for Swap Dealers 
and Major Swap Participants--Cross-Border Application of the Margin 
Requirements, 80 FR 41376 (July 14, 2015) (``Proposal'').
    \9\ In 2014, in conjunction with reproposing its margin 
requirements, the Commission requested comment on three alternative 
approaches to the cross-border application of its margin 
requirements: (i) A transaction-level approach consistent with the 
Commission's guidance on the cross-border application of the CEA's 
swap provisions, see Interpretive Guidance and Policy Statement 
Regarding Compliance with Certain Swap Regulations, 78 FR 45292 
(July 26, 2013) (``Guidance''); (ii) an approach consistent with the 
Prudential Regulators' proposed cross-border framework for margin, 
see Margin and Capital Requirements for Covered Swap Entities, 79 FR 
57348 (Sept. 24, 2014) (``Prudential Regulators' Proposed Margin 
Rule''); and (iii) an entity-level approach that would apply margin 
rules on a firm-wide basis (without any exclusion for swaps with 
non-U.S. counterparties). See Margin Requirements for Uncleared 
Swaps for Swap Dealers and Major Swap Participants, 79 FR 59898 
(Oct. 3, 2014) (``Proposed Margin Rule''). Following a review of 
comments received in response to this release, the Commission's 
Global Markets Advisory Committee (``GMAC'') hosted a public panel 
discussion on the cross-border application of margin requirements.
---------------------------------------------------------------------------

    The Commission requested comment on all aspects of the proposed 
rule. After a careful review of the comments,\10\ the Commission is 
adopting a final rule largely as proposed but with some modifications, 
as described below (the ``Final Rule'').\11\
---------------------------------------------------------------------------

    \10\ The Commission received eighteen comment letters in 
response to the Proposal: Alternative Investment Management 
Association and Investment Association (Sept. 11, 2015) (``AIMA/
IA''); American Bankers Association and ABA Securities Association 
(Sept. 14, 2015) (``ABA/ABASA''); American Council of Life Insurers 
(Sept. 14, 2015) (``ACLI''); Americans for Financial Reform (Sept. 
14, 2015) (``AFR''); Chris Barnard (Sept. 14, 2015) (``Barnard''); 
Better Markets, Inc. (Sept. 14, 2015) (``Better Markets''); 
Financial Services Roundtable (Sept. 14, 2015) (``FSR''); FMS-
Wertmanagement (Sept. 14, 2015) (``FMS-WM''); Institute for 
Agriculture and Trade Policy (Sept. 14, 2015) (``IATP''); Investment 
Company Institute Global (Sept. 14, 2015) (``ICI Global''); 
International Swaps and Derivatives Association, Inc. (Sept. 11, 
2015) (``ISDA''); Institute of International Bankers and Securities 
Industry and Financial Markets Association (Sept. 14, 2015) (``IIB/
SIFMA''); Japanese Bankers Association (Sept. 13, 2015) (``JBA''); 
LCH.Clearnet Group Ltd. (Sept. 14, 2015) (``LCH.Clearnet''); Managed 
Funds Association (Sept. 14, 2015) (``MFA''); PensionsEurope (Sept. 
14, 2015) (``PensionsEurope''); Asset Management Group of the 
Securities Industry and Financial Markets Association (Sept. 14, 
2015) (``SIFMA AMG''); and Vanguard (Sept. 14, 2015) (``Vanguard''). 
The comment file is available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1600.
    \11\ The Final Rule is codified at 17 CFR 23.160.
---------------------------------------------------------------------------

B. Key Considerations in the Cross-Border Application of the Margin 
Regulations

    The overarching objective of the cross-border margin framework is 
to further the congressional mandate to ensure the safety and soundness 
of CSEs in order to offset the greater risk to CSEs and the financial 
system arising from the use of swaps that are not cleared.\12\ Margin's 
primary function is to protect a CSE from counterparty default, 
allowing it to absorb losses and continue to meet its obligations using 
collateral provided by the defaulting counterparty.\13\ While the 
requirement to post margin protects the counterparty in the event of 
the CSE's default, it also functions as a risk management tool, 
limiting the amount of leverage a CSE can incur by requiring that it 
have adequate eligible collateral to enter into an uncleared swap. In 
this way, margin serves as a first line of defense not only in 
protecting the CSE but in containing the amount of risk in the 
financial system as a whole, reducing the potential for contagion 
arising from uncleared swaps.\14\
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    \12\ See 7 U.S.C. 6s(e)(3)(A).
    \13\ See Proposal, 80 FR at 41377.
    \14\ Although margin and capital are, by design, complementary, 
they serve equally important but different risk mitigation 
functions. Unlike margin, capital is difficult to rapidly adjust in 
response to changing risk exposures. Capital therefore can be viewed 
as a backstop in the event that margin is insufficient to cover 
losses resulting from a counterparty default. The Commission 
proposed capital rules in 2011. See Capital Requirements for Swap 
Dealers and Major Swap Participants, 76 FR 27802 (May 12, 2011) 
(``Proposed Capital Rule''). The Commission intends to repropose 
capital rules later this year.
---------------------------------------------------------------------------

    The Commission recognizes that, to achieve the goals of the Dodd-
Frank Act, its cross-border framework must take into account the global 
state of the swap market. The nature of modern financial markets means 
that risk is not static or contained by geographic boundaries. Market 
participants engage in swaps on a 24-hour basis in global markets, and 
many financial entities operate through a complex web of branches, 
subsidiaries, and affiliates that are scattered across the globe.\15\ 
These branches and affiliated entities are highly interdependent, 
sharing not only information technology and operational support but 
risk management, treasury, and custodial functions. Risks from a swap 
entered into by an affiliated entity in one jurisdiction may be 
transferred to another affiliate in a different jurisdiction through 
inter-affiliate transactions. As part of their risk management 
practices, swap dealers also commonly lay off the risk of client-facing 
swaps in the interdealer market, which, as a result of consolidation 
among global financial institutions, has become concentrated among a 
relatively small number of dealers.\16\ These developments, along with 
others, have led to a highly interconnected global swap market, where 
risks originating in one jurisdiction and entity are easily transferred 
to other jurisdictions and entities, increasing the possibility of 
cascading defaults.
---------------------------------------------------------------------------

    \15\ The largest U.S. banks have somewhere between 2,000 to 
3,000 affiliated global entities, hundreds of which are based in the 
Cayman Islands. Data from the National Information Center (NIC), a 
repository of financial data and institutional characteristics of 
banks and other entities regulated by the Federal Reserve, show the 
increasing complexity of U.S. banks' foreign operations. See NIC, 
available at http://www.ffiec.gov/nicpubweb/nicweb/nichome.aspx. For 
instance, in 1990, there were 1,300 foreign nonbank subsidiaries in 
the database; at the end of 2014, there were more than 6,000. 
Foreign ownership is also highly concentrated in a few large firms: 
Goldman Sachs and Morgan Stanley own more than 2,000 foreign nonbank 
subsidiaries and, together with General Electric, own 63 percent of 
all foreign bank subsidiaries. Citigroup, JPMorgan Chase, and Bank 
of America account for 75 percent of all foreign branches.
    \16\ According to the Quarterly Report on Bank Trading and 
Derivatives Activities issued by the Office of the Comptroller of 
the Currency (OCC) for the second quarter of 2015, the notional 
value of derivative contracts held by insured U.S. commercial banks 
and savings associations was $197.9 trillion. See Office of the 
Comptroller of the Currency, Quarterly Report on Bank Trading and 
Derivatives Activities Second Quarter 2015, 1 (2015), available at 
http://www.occ.gov/topics/capital-markets/financial-markets/trading/derivatives/dq215.pdf. At the same time, four large commercial banks 
with the most derivatives activity--Goldman Sachs, JPMorgan Chase 
Bank NA, Citibank, and Bank of America NA--held 91.1% of the 
notional amount of these derivatives contracts. Id. at 11, 16. 
Contracts for swaps specifically accounted for $117.5 trillion of 
the $197.9 trillion total notional. Id. at 16.
---------------------------------------------------------------------------

    As the 2008 financial crisis illustrated, the global nature of the 
swap market heightens the potential that risks assumed by a firm 
overseas stemming from its uncleared swaps can be transmitted across 
national borders to cause or contribute to substantial losses to U.S. 
persons and threaten the stability of the entire U.S. financial system. 
Complex financial and operational relationships among domestic and 
international affiliates, including guarantees from U.S. entities at 
entities like American International Group (AIG) and Lehman Brothers 
Holding Inc., demonstrated how the transfer of risk across 
multinational affiliated entities, including risk associated with 
swaps, is not always transparent and can be difficult to fully assess. 
More recent events, including major losses from J.P. Morgan Chase &

[[Page 34820]]

Co.'s ``London Whale'' or the near failure of FCXM Inc. following 
trading losses at its London and Singapore affiliates, illustrate the 
continued potential for cross-border activities to have a significant 
impact on U.S. entities and markets.
    The global nature of the swap market, coupled with the 
interconnectedness of market participants, also necessitate that the 
Commission recognize the supervisory interests of foreign regulatory 
authorities and consider the impact of its choices on market efficiency 
and competition, which are vital to a well-functioning global swap 
market.\17\ Foreign jurisdictions are at various stages of implementing 
margin reforms. To the extent that other jurisdictions adopt 
requirements with different coverage or timelines, the Commission's 
margin requirements may lead to competitive burdens for U.S. entities 
and deter non-U.S. persons from transacting with U.S. CSEs and their 
affiliates overseas. The Commission's substituted compliance regime--a 
central element of the Final Rule--is intended to address these 
concerns without compromising the congressional mandate to protect the 
safety and soundness of CSEs and the stability of the U.S. financial 
system.
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    \17\ In determining the extent to which the Dodd-Frank swap 
provisions apply to activities overseas, the Commission strives to 
protect U.S. interests, as determined by Congress in Title VII, and 
minimize conflicts with the laws of other jurisdictions, consistent 
with principles of international comity. See Guidance, 78 FR at 
45300-01 (referencing the Restatement (Third) of Foreign Relations 
Law of the United States).
---------------------------------------------------------------------------

    Substituted compliance has long been a central element of the 
Commission's cross-border policy.\18\ It is an approach that recognizes 
that market participants in a globalized swap market are subject to 
multiple regulators and potentially face duplicative or conflicting 
regulations. Under the Final Rule's substituted compliance regime, the 
Commission would, under certain circumstances, allow a CSE to satisfy 
the Commission's margin requirements by instead complying with the 
margin requirements in the relevant foreign jurisdiction. Substituted 
compliance helps preserve the benefits of an integrated, global swap 
market by reducing the degree to which market participants will be 
subject to multiple sets of regulations. Further, substituted 
compliance encourages collaboration and coordination among U.S. and 
foreign regulators in establishing robust regulatory standards for the 
global swap market.
---------------------------------------------------------------------------

    \18\ For example, under part 30 of the Commission's regulations, 
if the Commission determines that the foreign regulatory regime 
would offer comparable protection to U.S. customers transacting in 
foreign futures and options and there is an appropriate information-
sharing arrangement between the home supervisor and the Commission, 
the Commission has permitted foreign brokers to comply with their 
home regulations (in lieu of the applicable Commission regulations), 
subject to appropriate conditions. See, e.g., Foreign Futures and 
Options Transactions, 67 FR 30785 (May 8, 2002); Foreign Futures and 
Options Transactions, 71 FR 6759 (Feb. 9, 2006).
---------------------------------------------------------------------------

    The Commission is mindful of the challenges involved in 
implementing a substituted compliance framework for margin. If 
implemented properly, substituted compliance has the potential to 
enhance market efficiency and liquidity and foster global coordination 
of margin requirements without compromising the safety and soundness of 
CSEs and the U.S. financial system. However, if substituted compliance 
were extended to foreign jurisdictions that do not have adequate 
oversight or protections with regard to uncleared swaps, the 
effectiveness of the Commission's margin requirements could be 
undermined, importing additional risk into the financial system. The 
Commission therefore believes that close coordination with its foreign 
counterparts is essential to ensuring that the benefits of substituted 
compliance are achieved.
    Consistent with the congressional mandate to coordinate rules ``to 
the maximum extent practicable,'' \19\ in developing the Final Rule, 
Commission staff worked closely with staff of the Prudential Regulators 
to align the Final Rule with the cross-border framework in the 
Prudential Regulators' Final Margin Rule.\20\ Aligning with the 
Prudential Regulators' cross-border margin rule is particularly 
important given the composition of the global swap market.\21\ 
Currently, approximately 106 swap dealers and major swap participants 
are provisionally registered with the Commission. Of those entities, an 
estimated 54 are CSEs subject to the Commission's margin rules, with 
the remaining 52 entities falling within the scope of the Prudential 
Regulators' margin rules. Of the 54 CSEs subject to the Commission's 
margin requirements, approximately 33 CSEs are affiliated with a 
prudentially-regulated swap entity. Therefore, substantial differences 
between the Commission's and Prudential Regulators' cross-border 
regulations could lead to competitive disparities between affiliates 
within the same corporate structure, leading to market inefficiencies 
and incentives to restructure their businesses in order to avoid the 
more stringent cross-border margin framework.
---------------------------------------------------------------------------

    \19\ See 7 U.S.C. 6s(e)(3)(D)(ii).
    \20\ See Prudential Regulators' Final Margin Rule, 80 FR 74840. 
The cross-border provision is section __.9 of the Prudential 
Regulators' Final Margin Rule and is substantially similar to the 
Commission's Final Rule.
    \21\ The Securities and Exchange Commission (``SEC'') has not 
yet finalized similar rules imposing margin requirements for 
security-based swap dealers and major security-based swap 
participants. The SEC proposed its margin rule in October 2012. See 
Capital, Margin, and Segregation Requirements for Security-Based 
Swap Dealers and Major Security-Based Swap Participants and Capital 
Requirements for Broker-Dealers, 77 FR 70214 (Nov. 23, 2012).
---------------------------------------------------------------------------

    In granting the Commission new authority over swaps under the Dodd-
Frank Act, Congress also called for coordination and cooperation with 
foreign regulatory authorities.\22\ Consistent with that mandate, and 
building on international efforts to develop a global margin 
framework,\23\ the Commission closely consulted with its foreign 
counterparts in developing the Final Rule. As other jurisdictions 
finalize their margin rules and the Commission implements its cross-
border margin framework, the Commission is committed to continuing to 
coordinate with foreign regulators, with a view toward mitigating any 
conflicting or otherwise substantially divergent margin requirements 
for uncleared swaps across jurisdictions.
---------------------------------------------------------------------------

    \22\ 15 U.S.C. 8325(a) (added by section 752 of the Dodd-Frank 
Act).
    \23\ In October 2011, the Basel Committee on Banking Supervision 
(``BCBS'') and the International Organization of Securities 
Commissions (``IOSCO''), in consultation with the Committee on 
Payment and Settlement Systems (``CPSS'') and the Committee on 
Global Financial Systems (``CGFS''), formed a Working Group on 
Margining Requirements (``WGMR'') to develop international standards 
for margin requirements for uncleared swaps. Representatives of 26 
regulatory authorities participated, including the Commission. In 
September 2013, the WGMR published a final report articulating eight 
key principles for non-cleared derivatives margin rules. These 
principles represent the minimum standards approved by BCBS and 
IOSCO and their recommendations to the regulatory authorities in 
member jurisdictions. See BCBS/IOSCO, Margin requirements for non-
centrally cleared derivatives (updated March 2015) (``BCBS/IOSCO 
framework''), available at http://www.bis.org/bcbs/publ/d317.pdf.
---------------------------------------------------------------------------

II. The Final Rule

    The Commission is adopting rules regarding how the Commission's 
margin requirements will apply to cross-border uncleared swaps. Broadly 
speaking, the final cross-border framework is designed to address the 
risks to a CSE, as an entity, associated with its uncleared swaps, 
consistent with CEA section 2(i) \24\ and the statutory objectives of 
the margin requirements. As discussed above, section 4s(e) was enacted 
to address the risks to CSEs and to the U.S. financial system arising 
from uncleared swaps. The source of risk to a CSE is not confined to 
its uncleared

[[Page 34821]]

swaps with U.S. counterparties or to swaps transacted within the United 
States. Risk arising from uncleared swaps involving non-U.S. 
counterparties can potentially have a substantial adverse effect on a 
CSE and therefore the stability of the U.S. financial system. 
Nevertheless, certain categories of uncleared swaps will be eligible 
for substituted compliance or the Exclusion based on the Commission's 
consideration of comity principles and the impact of the Final Rule on 
market efficiency and competition.
---------------------------------------------------------------------------

    \24\ See 7 U.S.C. 2(i).
---------------------------------------------------------------------------

    The sections that follow summarize, as appropriate, the approach 
taken in the proposed rule, the comments received in response, and the 
resulting Final Rule. Section A discusses certain key definitions 
(``U.S. person,'' ``guarantee,'' and ``Foreign Consolidated 
Subsidiary'' or ``FCS'') in the Final Rule, which inform how the 
Commission's margin requirements apply to market participants in the 
cross-border context. Section B describes the cross-border application 
of the Commission's margin requirements, including the circumstances 
under which substituted compliance and the limited Exclusion are 
available and the application of two special provisions designed to 
accommodate swap activities in jurisdictions that do not have a legal 
framework to support custodial arrangements and netting in compliance 
with the Final Margin Rule (``non-segregation jurisdictions'' \25\ and 
``non-netting jurisdictions,'' respectively).\26\ Section C describes 
the Commission's framework for issuing comparability determinations.
---------------------------------------------------------------------------

    \25\ As used in this release, a ``non-segregation jurisdiction'' 
is a jurisdiction where inherent limitations in the legal or 
operational infrastructure of the foreign jurisdiction make it 
impracticable for the CSE and its counterparty to post initial 
margin pursuant to custodial arrangements that comply with the Final 
Margin Rule, as further described in section II.B.4.b.
    \26\ As used in this release, a ``non-netting jurisdiction'' is 
a jurisdiction in which a CSE cannot conclude, with a well-founded 
basis, that the netting agreement with a counterparty in that 
foreign jurisdiction meets the definition of an ``eligible master 
netting agreement'' set forth in the Final Margin Rule, as described 
in section II.B.5.b.
---------------------------------------------------------------------------

    As a preliminary matter, the Commission notes that several 
commenters requested Commission action outside the scope of the Final 
Rule, including modifications to the substantive margin requirements 
\27\ or the Guidance.\28\ The Commission notes that concerns regarding 
the general nature and application of the initial and variation margin 
requirements were addressed in the Final Margin Rule. Notably, the 
Final Margin Rule included substantial modifications from the Proposed 
Margin Rule that further aligned the Commission's margin requirements 
with the BCBS-IOSCO framework, which should further reduce the 
potential for conflicts with the margin requirements of foreign 
jurisdictions.\29\ With respect to the Guidance, the Commission 
reiterates its intention to periodically review its cross-border policy 
in light of future developments, including its experience following 
adoption of the Final Rule.\30\
---------------------------------------------------------------------------

    \27\ See, e.g., ACLI at 2-3 (Commission should defer to 
International Standards with respect to acceptable forms of 
collateral for margin); FMS-WM at 1-2 (legacy portfolio entity 
backed by full faith and credit of sovereign government should be 
considered a ``sovereign entity'' within scope of Commission's 
margin requirements); ISDA at 14-15 (inter-affiliate swaps should be 
exempt from initial margin requirements and accounting standards to 
determine consolidation should be applied throughout margin rules); 
JBA at 6 (Commission should work with foreign counterparts to 
harmonize aspects of its margin rules, including treatment of 
``legacy trades,'' inter-affiliate trades, and forms of eligible 
collateral); LCH.Clearnet at 4 (differences in approach to margin 
requirements between cleared and uncleared swaps should promote 
central clearing).
    \28\ See, e.g., AFR at 2 (adopting cross-border approach to 
margin alone would create ``serious problems''); AIMA/IA at 4 
(Commission should amend Guidance to include U.S. person definition 
in the proposed rule); Better Markets at 6 (adopting cross-border 
approach to margin alone would be ``a disservice to the 
comprehensive existing Guidance;'' should instead make ``targeted, 
limited changes'' to Guidance); ICI Global at 7-8 (one U.S. person 
definition should apply consistently with respect to cross-border 
application of all swap requirements); IIB/SIFMA at 17-19 (proposed 
U.S. person and guarantee definitions should replace corresponding 
interpretations in Guidance); ISDA at 12 (same); JBA at 11-12 
(same); SIFMA AMG at 4, 9-13 (same); Vanguard at 5 (same).
    \29\ For example, the Final Margin Rule raised the material 
swaps exposure level from $3 billion to the BCBS-IOSCO standard of 
$8 billion, which reduces the number of entities that must collect 
and post initial margin. See Final Margin Rule, 81 FR at 644. In 
addition, the definition of uncleared swaps was broadened to include 
DCOs that are not registered with the Commission but pursuant to 
Commission orders are permitted to clear for U.S. persons. See id. 
at 638.
    \30\ See Guidance, 78 FR at 45297. See also United States v. 
Edge Broadcasting Co., 509 U.S. 418, 434 (1993) (``[A]n agency does 
not have to make progress on every front before it can make progress 
on any front.''). See also Personal Watercraft Indus. Ass'n v. Dep't 
of Commerce, 48 F.3d 540, 544 (D.C. Cir. 1995).
---------------------------------------------------------------------------

    Commenters also requested that the Commission delay the cross-
border application of its margin rules until after it has made 
comparability determinations.\31\ Although the Commission declines to 
establish an open-ended delay in applying its margin rules, it remains 
committed to coordinating with foreign regulators to implement its 
cross-border margin framework in a workable manner.
---------------------------------------------------------------------------

    \31\ See, e.g., ABA/ABASA at 3 (``sufficient time'' for foreign 
jurisdictions to adopt margin rules); AIMA/IA at 3 (``sufficient 
time'' to reach agreement with foreign counterparts); ISDA at 16-17 
(12 months after margin rules are finalized in U.S., EU, and Japan, 
or two-year ``transitional comparability determination,'' providing 
substituted compliance for all foreign jurisdictions that adopt 
rules based on BCBS-IOSCO framework, while Commission undertakes 
comparability analysis); JBA at 3, 4 (at least 18 months after 
margin rules are finalized in the U.S., EU, and Japan); 
PensionsEurope at 3 (12-18 months); SIFMA AMG at 4, 14-15 (at least 
18 months).
---------------------------------------------------------------------------

A. Key Definitions

    The extent to which substituted compliance and the Exclusion are 
available depends on whether the relevant swap involves a U.S. person, 
a guarantee by a U.S. person, or a ``Foreign Consolidated Subsidiary'' 
(or ``FCS''). The Final Rule adopts definitions of ``U.S. person,'' 
``guarantee,'' and ``Foreign Consolidated Subsidiary'' solely for 
purposes of the margin rules. These definitions are discussed below.
1. U.S. Person
    Under the Final Rule, the term ``U.S. person'' is defined to 
include individuals or entities whose activities have a significant 
nexus to the U.S. market as a result of their being domiciled or 
organized in the United States or by virtue of the strength of their 
connection to the U.S. markets, even if they are domiciled or organized 
outside the United States. As discussed in section II.B.2.b.i. below, 
U.S. CSEs \32\ are generally subject to the margin rules with only 
partial substituted compliance and are not eligible for the Exclusion.
---------------------------------------------------------------------------

    \32\ See 17 CFR 23.160(a)(8) (defining ``U.S. CSE'' as a CSE 
that is a ``U.S. person,'' as defined in the Final Rule). See also 
17 CFR 23.160(a)(4) (defining ``non-U.S. CSE'' as a CSE that is not 
a U.S. person).
---------------------------------------------------------------------------

a. Proposed Rule
    In the proposed rule, the term ``U.S. person'' was defined to mean 
the following:
     Any natural person who is a resident of the United States 
(proposed Sec.  23.160(a)(10)(i));
     Any estate of a decedent who was a resident of the United 
States at the time of death (proposed Sec.  23.160(a)(10)(ii));
     Any corporation, partnership, limited liability company, 
business or other trust, association, joint-stock company, fund or any 
form of entity similar to any of the foregoing (other than an entity as 
described in paragraph (a)(10)(iv) or (v) of proposed Sec.  23.160) (a 
legal entity), in each case that is organized or incorporated under the 
laws of the United States or that has its principal place of business 
in the United States, including any branch of

[[Page 34822]]

the legal entity (proposed Sec.  23.160(a)(10)(iii));
     Any pension plan for the employees, officers or principals 
of a legal entity as described in paragraph (a)(10)(iii) of proposed 
Sec.  23.160, unless the pension plan is primarily for foreign 
employees of such an entity (proposed Sec.  23.160(a)(10)(iv));
     Any trust governed by the laws of a state or other 
jurisdiction in the United States, if a court within the United States 
is able to exercise primary supervision over the administration of the 
trust (proposed Sec.  23.160(a)(10)(v));
     Any legal entity (other than a limited liability company, 
limited liability partnership or similar entity where all of the owners 
of the entity have limited liability) owned by one or more persons 
described in paragraphs (a)(10)(i) through (v) of proposed Sec.  23.160 
who bear(s) unlimited responsibility for the obligations and 
liabilities of the legal entity, including any branch of the legal 
entity (proposed Sec.  23.160(a)(10)(vi)); and
     Any individual account or joint account (discretionary or 
not) where the beneficial owner (or one of the beneficial owners in the 
case of a joint account) is a person described in paragraphs (a)(10)(i) 
through (vi) of proposed Sec.  23.160 (proposed Sec.  
23.160(a)(10)(vii)).\33\
---------------------------------------------------------------------------

    \33\ See proposed 17 CFR 23.160(a)(10). See also proposed 17 CFR 
23.160(a)(5) (defining ``non-U.S. person'' as any person that is not 
a ``U.S. person'').
---------------------------------------------------------------------------

    The Commission explained that, as indicated in paragraphs (iii) and 
(vi) of the proposed rule, a legal entity's status as a U.S. person 
would be determined at the entity level and would therefore include a 
foreign branch of a U.S. person.\34\ An affiliate or subsidiary of a 
U.S. person that is organized or incorporated outside the United 
States, however, would not be deemed a ``U.S. person'' solely by virtue 
of its affiliation with the U.S. person.\35\ The Commission also stated 
that a swap counterparty should generally be permitted to reasonably 
rely on its counterparty's written representation with regard to its 
status as a U.S. person.\36\
---------------------------------------------------------------------------

    \34\ See Proposal, 80 FR at 41383 (stating that the definition 
includes any foreign operations that are part of the U.S. legal 
person, regardless of their location); proposed 17 CFR 23.160 
(a)(10)(iii), (vi) (defining such U.S. persons to include ``any 
branch of the legal entity'').
    \35\ See Proposal, 80 FR at 41383 (explaining that the status of 
a legal person as a U.S. person would not affect whether a 
separately incorporated or organized legal person in the affiliated 
corporate group is a U.S. person).
    \36\ See id. (recognizing that the information necessary to 
accurately assess a counterparty's U.S. person status may be 
available only through overly burdensome due diligence).
---------------------------------------------------------------------------

    The proposed rule was generally consistent with the U.S. person 
interpretation set forth in the Guidance, with certain exceptions.\37\ 
Notably, the proposed rule did not define ``U.S. person'' to include a 
commodity pool, pooled account, investment fund, or other collective 
investment vehicle that is majority-owned by one or more U.S. persons 
(the ``U.S. majority-owned fund prong'').\38\ The proposed rule also 
did not include a catchall provision, thereby limiting the definition 
of ``U.S. person'' for purposes of the margin rule to persons 
enumerated in the rule.\39\ Finally, paragraph (vi) of the proposed 
rule (the ``unlimited U.S. responsibility prong'') represented a 
modified version of a similar concept from the Guidance, which 
interprets ``U.S. person'' to include a legal entity ``directly or 
indirectly majority-owned'' by one or more U.S. person(s) that bear 
unlimited responsibility for the legal entity's liabilities and 
obligations.\40\
---------------------------------------------------------------------------

    \37\ See Proposal, 80 FR at 41382-84. See also Guidance, 78 FR 
at 45308-17 (setting forth the interpretation of ``U.S. person'' for 
purposes of the Guidance).
    \38\ See Proposal, 80 FR at 41383. See also Guidance, 78 FR 
45313-14 (discussing the U.S. majority-ownership prong for purposes 
of the Guidance). The Guidance interpreted ``majority-owned'' in 
this context to mean the beneficial ownership of more than 50 
percent of the equity or voting interests in the collective 
investment vehicle. See id. at 45314.
    \39\ See Proposal, 80 FR at 41383. See also Guidance, 78 FR at 
45316 (discussing the inclusion of the prefatory phrase ``include, 
but not be limited to'' in the interpretation of ``U.S. person'' in 
the Guidance).
    \40\ See Proposal, 80 FR at 41383. See also Guidance, 78 FR at 
45312-13 (discussing the unlimited U.S. responsibility prong for 
purposes of the Guidance).
---------------------------------------------------------------------------

    The Commission requested comment on all aspects of the proposed 
definition of ``U.S person,'' including whether the definition should 
include a U.S. majority-owned fund prong or an unlimited U.S. 
responsibility prong and whether it should be identical to the U.S. 
person definition adopted by the SEC.\41\
---------------------------------------------------------------------------

    \41\ See Proposal, 80 FR at 41384. See also 17 CFR 240.3a71-
3(a)(4) (setting forth the definition of ``U.S. person'' adopted by 
the SEC for purposes of security-based swap regulation).
---------------------------------------------------------------------------

b. Comments
    In general, commenters raised few objections to the proposed ``U.S. 
person'' definition. Nearly all commenters supported the absence of a 
U.S. majority-owned fund prong,\42\ and several expressly supported the 
absence of a catchall provision.\43\ With respect to the U.S. majority-
owned funds prong, commenters argued that U.S. ownership alone is not 
indicative of whether a fund's activities have a direct and significant 
effect on the U.S. financial system \44\ and that identifying and 
tracking a fund's beneficial ownership may pose a significant challenge 
in certain circumstances.\45\ Commenters added that characterizing such 
U.S. majority-owned funds as U.S. persons may lead to duplicative 
margin requirements because such funds will likely also be subject to 
foreign regulation.\46\
---------------------------------------------------------------------------

    \42\ See e.g., AIMA/IA at 3-4; FSR at 2, 8; IATP at 4; IIB/SIFMA 
at 18; ISDA at 12; JBA at 11; MFA at 3, 5-6; SIFMA AMG at 10, 
Vanguard at 5.
    \43\ See e.g., IIB/SIFMA at 17; ISDA at 12 (the absence the 
prefatory phrase ``includes, but is not limited to'' would 
``increase legal certainty''); SIFMA AMG at 10-11.
    \44\ See e.g., AIMA/IA at 3; FSR at 8; IATP at 4; IIB/SIFMA at 
18 (fund owners are not direct counterparties to swap and their risk 
of loss is limited to extent of their investment in the fund); MFA 
at 6.
    \45\ See e.g., AIMA/IA at 3-4 (highlighting challenges presented 
by nominee accounts); IATP at 4 (ownership can be complex and 
variable over the life of a fund); IIB/SIFMA at 18 (highlighting 
challenges associated with funds formed before adoption of 
Guidance); SIFMA AMG at 10. But see MFA at 5-6 (funds organized or 
having a principal place of business in the United States are 
properly included in the U.S. person definition).
    \46\ See AIMA/IA at 4 (``comparable foreign rules'' will apply 
to limit the likelihood and impact of a counterparty default); FSR 
at 8 (neither SEC nor EU regulators have proposed exercising 
jurisdiction over an entity on the basis of majority control); ISDA 
at 12 (neither BCBS-IOSCO framework nor proposed EU rules impose 
rules on funds based on jurisdiction of its owners).
---------------------------------------------------------------------------

    A few commenters, however, requested changes regarding the 
unlimited U.S. responsibility prong. ISDA and JBA recommended that, 
consistent with the Guidance, the Commission require that the U.S. 
person(s) bearing unlimited responsibility for the obligations and 
liabilities of the legal entity have a majority ownership stake in the 
entity. ISDA argued broadly that, to avoid confusion and regulatory 
overlap, legal entities that have multiple owners with unlimited 
liability for the obligations and liabilities of the legal entity 
should only be subject to the jurisdiction of the majority owner.\47\ 
JBA argued that the definition should be consistent with the Guidance 
in order to avoid the possibility that the Commission's margin 
requirements would apply to a ``broader scope of U.S. persons relative 
to other swap regulations.'' \48\ IIB/SIFMA requested that the 
unlimited U.S. responsibility prong be removed altogether, arguing that 
unlimited responsibility is ``largely equivalent'' to a guarantee and 
should therefore be afforded the same treatment.\49\
---------------------------------------------------------------------------

    \47\ See ISDA at 12.
    \48\ See JBA at 11-12.
    \49\ See IIB/SIFMA at 17-18 (while guarantor may have legal 
defenses to enforcement of guarantee, both U.S. guarantee and 
unlimited U.S. responsibility prong create risk to U.S. persons only 
to the extent that legal entity incurs losses and fails to perform 
obligations).

---------------------------------------------------------------------------

[[Page 34823]]

    Commenters also made certain other recommendations to further 
conform the U.S. person definition to the interpretation of ``U.S. 
person'' in the Guidance.\50\ ICI Global, SIFMA AMG, and Vanguard 
requested that the Commission confirm that, as indicated in the 
Guidance, a pool, fund or other collective investment vehicle that is 
publicly offered only to non-U.S. persons and not offered to U.S. 
persons would not fall within the scope of the U.S. person 
definition.\51\ SIFMA AMG also added that language in paragraphs (iii) 
and (vi) specifying that a legal entity deemed a U.S. person would 
include ``any branch of the legal entity'' was unnecessarily 
confusing.\52\
---------------------------------------------------------------------------

    \50\ As indicated above, several commenters recommended 
generally that the Commission establish a uniform definition of 
``U.S. person'' that would apply both in the context of the cross-
border application of the margin rules and with respect to the other 
swaps regulatory topics covered by the Guidance. See supra note 28.
    \51\ See ICI Global at 5-7 (clarification is necessary to avoid 
imposing Dodd-Frank Act swap provisions on entities that only have 
``nominal nexus'' to United States); SIFMA AMG at 10-12 
(reclassifying such funds as U.S. persons solely for purposes of 
margin rule would be extremely complicated and burdensome for asset 
managers and their clients); Vanguard at 5. See also Guidance, 78 FR 
at 45314 (providing that a collective investment vehicle that is 
publicly offered only to non-U.S. persons and not offered to U.S. 
persons generally would not fall within any of the prongs of the 
``U.S. person'' interpretation in the Guidance).
    \52\ SIFMA AMG at 12 (such language, which is not present in 
corresponding prongs of U.S. person interpretation in Guidance, 
could ``cause confusion in terms of whether a person having any 
branches in the United States needs to take into account its U.S. 
person status, including in assessing the entity's principal place 
of business'').
---------------------------------------------------------------------------

    Finally, FSR and JBA requested that, in the interest of harmonizing 
margin requirements and reducing compliance costs, the Commission 
should, consistent with the SEC's cross-border rules, exclude from the 
U.S. person definition certain designated international 
organizations.\53\ IATP argued, however, that such exclusion would be 
either unnecessary or inappropriate.\54\
---------------------------------------------------------------------------

    \53\ See FSR at 8; JBA at 12 (while international financial 
institutions ``are invested by the U.S. government, financial 
institutions generally separate them from the U.S. country risk in 
evaluating their credit risk in practice''). See also 17 CFR 
240.3a71-3(a)(4)(iii) (defining ``U.S. person'' for purposes of the 
SEC's regulation of security-based swaps to exclude the 
International Monetary Fund, the International Bank for 
Reconstruction and Development, the Inter-American Development Bank, 
the Asian Development Bank, the African Development Bank, the United 
Nations, and their agencies and pension plans, and any other similar 
international organizations, their agencies and pension plans).
    \54\ See IATP at 4 (intergovernmental organizations should 
``voluntarily practice'' the margin requirements in order to 
``realize the objectives of the [sic] intergovernmental investment 
charters'').
---------------------------------------------------------------------------

c. Final Rule
    The Final Rule defines ``U.S. person'' as proposed, but the 
Commission is providing some additional clarifications in response to 
commenters. As stated in the Proposal, the definition generally follows 
a traditional, territorial approach to defining a U.S. person, and the 
Commission believes that this definition offers a clear, objective 
basis for determining those individuals or entities that should be 
identified as U.S. persons.
    Under the Final Rule, a legal person's status as a U.S. person is 
determined at the entity level and therefore includes any foreign 
operations that are part of the legal person, regardless of their 
location. Consistent with this approach, the definition includes any 
foreign branch of a U.S. person.\55\ The status of a legal entity as a 
U.S. person would not generally affect whether a separately 
incorporated or organized legal entity in the affiliated corporate 
group is a U.S. person. Therefore, an affiliate or a subsidiary of a 
U.S. person that is organized or incorporated in a non-U.S. 
jurisdiction would not be deemed a U.S. person solely by virtue of 
being affiliated with a U.S. person.\56\
---------------------------------------------------------------------------

    \55\ The Commission clarifies that the inclusion of ``any branch 
of the legal entity'' in sections 23.160(a)(10)(iii) and (vi) of the 
Final Rule is intended to make clear that the definition includes 
both foreign and U.S. branches of an entity and does not introduce 
any additional criteria for determining an entity's U.S. person 
status.
    \56\ See also 17 CFR 23.160(a)(5) (defining ``non-U.S. person'' 
as any person that is not a U.S. person).
---------------------------------------------------------------------------

    Sections 23.160(a)(10)(i) through (v) and (vii) of the Final Rule 
identify certain persons as U.S. persons by virtue of being domiciled 
or organized in the United States. The Commission has traditionally 
looked to where a legal entity is organized or incorporated (or, in the 
case of a natural person, where he or she resides) to determine whether 
it is a U.S. person.\57\ Persons domiciled or organized in the United 
States are likely to have significant financial and legal relationships 
in the United States and are therefore appropriately included within 
the definition of ``U.S. person.''
---------------------------------------------------------------------------

    \57\ See, e.g., 17 CFR 4.7(a)(1)(iv) (defining ``Non-United 
States person'' for purposes of part 4 of the Commission 
regulations, which applies to commodity pool operators).
---------------------------------------------------------------------------

    Consistent with this traditional approach, section 
23.160(a)(10)(iii) of the Final Rule includes persons that are 
organized or incorporated outside the United States but have their 
principal place of business in the United States. For purposes of this 
section, the Commission interprets ``principal place of business'' to 
mean the location from which the officers, partners, or managers of the 
legal person primarily direct, control, and coordinate the activities 
of the legal person. This interpretation is consistent with the Supreme 
Court's decision in Hertz Corp. v. Friend, which described a 
corporation's principal place of business, for purposes of diversity 
jurisdiction, as the ``place where the corporation's high level 
officers direct, control, and coordinate the corporation's 
activities.'' \58\
---------------------------------------------------------------------------

    \58\ 559 U.S. 77, 80 (2010).
---------------------------------------------------------------------------

    The Commission is of the view that determining the principal place 
of business of an investment fund may require consideration of 
additional factors beyond those applicable to operating companies. In 
the case of a fund, the senior personnel that direct, control, and 
coordinate a fund's activities are generally not the named directors or 
officers of the fund but rather persons employed by the fund's 
investment adviser or the fund's promoter. Therefore, consistent with 
the Guidance, the Commission would generally consider the principal 
place of business of a fund to be in the United States if the senior 
personnel responsible for either (1) the formation and promotion of the 
fund or (2) the implementation of the fund's investment strategy are 
located in the United States, depending on the facts and circumstances 
that are relevant to determining the center of direction, control and 
coordination of the fund.\59\
---------------------------------------------------------------------------

    \59\ See Guidance, 78 FR at 45309-12 (providing guidance on 
application of the principal place of business test to funds and 
other collective investment vehicles in the context of cross-border 
swaps, including examples of how the Commission's approach could 
apply to a consideration of whether the ``principal place of 
business'' of a fund is in the United States in particular 
hypothetical situations). Note that the examples included in the 
Guidance are for illustrative purposes only and do not purport to 
address all potential variations in the structure of collective 
investment vehicles or all factors relevant to determining whether a 
collective investment vehicle's principal place of business is in 
the United States.
---------------------------------------------------------------------------

    Section 23.160(a)(10)(vi) of the Final Rule defines ``U.S. person'' 
to include certain legal entities owned by one or more U.S. person(s) 
and for which such person(s) bear unlimited responsibility for the 
obligations and liabilities of the legal entity.\60\ In such cases, the 
U.S.

[[Page 34824]]

person owner(s) serve as a financial backstop for all of the legal 
entity's obligations and liabilities. Creditors and counterparties 
accordingly look to the U.S. person owner(s) when assessing the risk of 
dealing with the entity.\61\ Because the U.S. person owner(s)' 
responsibility is unlimited, the amount of equity the U.S. owner(s) 
have in the legal entity would not be relevant.
---------------------------------------------------------------------------

    \60\ The Commission does not view the unlimited U.S. 
responsibility prong as equivalent to a U.S. guarantee (as 
``guarantee'' is defined in the Final Rule). As stated in the 
Guidance, a guarantee does not necessarily provide for ``unlimited 
responsibility for the obligations and liabilities of the guaranteed 
entity'' in the same sense that the owner of an unlimited liability 
corporation bears such unlimited liability. See 78 FR at 45312.
    \61\ By extension, by virtue of their unlimited responsibility 
for the legal entity's swap obligations, the U.S. person owner(s) 
have an interest in the swap activities of the legal entity to the 
same extent as if the swap activities were conducted by the U.S. 
person directly.
---------------------------------------------------------------------------

    In line with the proposed rule, the Final Rule does not include a 
U.S. majority-owned funds prong. Although the U.S. owners of such funds 
may be adversely impacted in the event of a counterparty default, the 
Commission believes that, on balance, the majority-ownership test 
should not be included in the definition of U.S. person for purposes of 
the margin rules. Non-U.S. funds with U.S. majority-ownership, even if 
treated as a non-U.S. person, are excluded from the Commission's margin 
rules only in limited circumstances (namely, when these funds transact 
with a non-U.S. CSE that is not a consolidated subsidiary of a U.S. 
entity or a U.S. branch of a non-U.S. CSE). This result, coupled with 
the implementation issues raised by commenters, persuade the Commission 
that including a U.S. majority-owned funds prong in the scope of the 
``U.S. person'' definition would not be appropriate for purposes of the 
margin rules.\62\ The Final Rule's U.S. person definition also does not 
include the prefatory phrase ``includes, but is not limited to'' that 
was included in the Guidance. As stated in the proposed rule, the 
Commission believes that this catchall should not be included in order 
to provide legal certainty regarding the application of U.S. margin 
requirements to cross-border swaps.
---------------------------------------------------------------------------

    \62\ Such a fund may nevertheless be a U.S. person by virtue of 
fitting within the scope of Sec.  23.160(a)(10)(iii) (entities 
organized or having a principal place of business in the United 
States). In response to commenters, the Commission further clarifies 
that whether a pool, fund or other collective investment vehicle is 
publicly offered only to non-U.S. persons and not offered to U.S. 
persons would not be relevant in applying Sec.  23.160(a)(10)(iii).
---------------------------------------------------------------------------

    The Commission notes that, as discussed in the proposed rule, the 
Final Rule defines ``U.S. person'' in a manner that is substantially 
similar to the definition used by the SEC in the context of cross-
border regulation of security-based swaps.\63\ The Commission further 
believes that any differences, such as the inclusion of an unlimited 
U.S. responsibility prong, are necessary and appropriate in the context 
of the cross-border application of margin requirements for uncleared 
swaps, for the reasons discussed above.\64\ With respect to the 
designated international organizations excluded from the SEC's U.S. 
person definition, the Commission notes that a similar exclusion is 
unnecessary in the context of the cross-border application of the 
Commission's margin rules, given that such entities are generally 
considered non-financial end users under the Final Margin Rule and are 
therefore unaffected by application of the margin requirements for 
uncleared swaps.\65\
---------------------------------------------------------------------------

    \63\ See Proposal, 80 FR at 41382 n.46 (discussing the SEC's 
``U.S. person'' definition for purposes of security-based swap 
regulation).
    \64\ The SEC does not include the U.S. responsibility prong in 
its U.S. person definition, but instead treats a legal entity where 
one or more U.S. person(s) bears unlimited responsibility for the 
obligations and liabilities of the legal entity as a non-U.S. person 
with a guarantee. The Commission believes that, for the reasons 
stated above, these entities should be included as a U.S. person 
rather than being treated as a non-U.S. person with a guarantee for 
purposes of the margin requirements for uncleared swaps.
    \65\ Under the Final Margin Rule, the following international 
organizations are expressly considered non-financial end users: (1) 
The International Bank for Reconstruction and Development; (2) The 
Multilateral Investment Guarantee Agency; (3) The International 
Finance Corporation; (4) The Inter-American Development Bank; (5) 
The Asian Development Bank; (6) The African Development Bank; (7) 
The European Bank for Reconstruction and Development; (8) The 
European Investment Bank; (9) The European Investment Fund; (10) The 
Nordic Investment Bank; (11) The Caribbean Development Bank; (12) 
The Islamic Development Bank; (13) The Council of Europe Development 
Bank; and (14) Any other entity that provides financing for national 
or regional development in which the U.S. government is a 
shareholder or contributing member or which the Commission 
determines poses comparable credit risk). See 17 CFR 23.151 
(defining ``financial end user,'' ``non-financial end user,'' and 
``multilateral development bank''). Under the Final Margin Rule, 
CSEs are not required to exchange margin with non-financial end 
users.
---------------------------------------------------------------------------

2. Guarantees
    Under the Final Rule, the term ``guarantee'' is defined to include 
arrangements, pursuant to which one party to an uncleared swap has 
rights of recourse against a guarantor, with respect to its 
counterparty's obligations under the uncleared swap. As discussed in 
section II.B.2.b.i. below, non-U.S. CSEs whose obligations under the 
relevant swap are guaranteed by a U.S. person (``U.S. Guaranteed 
CSEs'') \66\ are eligible for substituted compliance to the same extent 
as U.S. CSEs and are similarly ineligible for the Exclusion.
---------------------------------------------------------------------------

    \66\ This release uses the term ``U.S. Guaranteed CSE'' for 
convenience only. Whether a non-U.S. CSE falls within the meaning of 
the term ``U.S. Guaranteed CSE'' varies on a swap-by-swap basis, 
such that a non-U.S. CSE may be considered a U.S. Guaranteed CSE for 
one swap and not another, depending on whether the non-U.S. CSE's 
obligations under such swap are guaranteed by a U.S. person.
---------------------------------------------------------------------------

a. Proposed Rule
    The proposed rule defined the term ``guarantee'' as an arrangement 
pursuant to which one party to a swap with a non-U.S. counterparty has 
rights of recourse against a U.S. person, with respect to the non-U.S. 
counterparty's obligations under the swap. The proposed rule defined 
``rights of recourse'' as a conditional or unconditional legally 
enforceable right to receive or otherwise collect payment, in whole or 
in part. An arrangement would constitute a ``guarantee'' regardless of 
whether the rights of recourse were conditioned upon the non-U.S. 
counterparty's insolvency or failure to meet its obligations under the 
relevant swap or whether the counterparty seeking to enforce the 
guarantee is required to make a demand for payment or performance from 
the non-U.S. counterparty before proceeding against the U.S. guarantor. 
The Commission requested comment on all aspects of its proposed 
definition of ``guarantee,'' including whether it would be appropriate 
to distinguish guarantee arrangements with a legally enforceable right 
of recourse from those without direct recourse.\67\
---------------------------------------------------------------------------

    \67\ See Proposal, 80 FR at 41385.
---------------------------------------------------------------------------

b. Comments
    Most commenters supported the proposed definition of ``guarantee.'' 
\68\ Commenters generally preferred it to the broader interpretation of 
``guarantee'' in the Guidance, which includes other types of financial 
arrangements and support (e.g., keepwell agreements and liquidity 
puts),\69\ and agreed that it would promote legal certainty and lower 
compliance costs as a result.\70\ IIB/SIFMA further argued the proposed 
definition is appropriate in the margin context and consistent with CEA 
section 2(i) because, absent such a legal relationship to a U.S. 
person, a non-U.S. person would not have a sufficient connection with 
activities in U.S. commerce to warrant the application of

[[Page 34825]]

U.S. margin rules.\71\ Commenters expressed concern, however, that 
multiple ``guarantee'' definitions could lead to confusion and 
recommended that the Commission apply the proposed ``guarantee'' 
definition throughout its cross-border policy.\72\
---------------------------------------------------------------------------

    \68\ See FSR at 2, 9; IATP at 5; IIB/SIFMA at 18-19; ISDA at 12; 
JBA at 12; SIFMA AMG at 4, 13.
    \69\ See IIB/SIFMA at 18-19; ISDA at 12; JBA at 12; SIFMA AMG at 
13.
    \70\ See IIB/SIFMA at 18-19; ISDA at 12 (interpretation of 
``guarantee'' in Guidance requires facts-and-circumstances analysis 
to determine whether arrangement supports a party's ability to pay 
or perform under swap); JBA at 12; SIFMA AMG at 13 (expressing 
approval that the proposed definition aligns with guarantee 
definition adopted by SEC).
    \71\ See IIB/SIFMA at 18-19. See also FSR at 9 (``transaction-
level'' swap risk would not transfer back to United States absent 
right of recourse against a U.S. person and ``entity-level'' risk 
would be captured by other regulatory requirements, such as capital 
rules).
    \72\ See ISDA at 12; JBA at 12; SIFMA AMG at 13.
---------------------------------------------------------------------------

    AFR and Better Markets opposed the proposed ``guarantee'' 
definition.\73\ Both expressed a preference for the broader 
interpretation of ``guarantee'' in the Guidance and, like other 
commenters, recommended that the term have one consistent meaning.\74\ 
AFR argued that both implicit guarantees, such as when a parent entity 
faces reputational incentives to provide financial support for a 
subsidiary, and other formal agreements that obligate a U.S. person to 
provide financial support, create a direct and significant nexus to the 
U.S. financial system and should be included within the scope of the 
term ``guarantee.'' \75\ Accordingly, the proposed definition of 
``guarantee'' may not fully capture the risk to the U.S. financial 
markets.\76\ AFR suggested that the policy objective of increasing the 
availability of substituted compliance in the margin context would be 
better achieved by adopting the broad interpretation of ``guarantee'' 
in the Guidance and instead limiting the availability of substituted 
compliance with respect to swaps involving an ``explicit recourse 
guarantee.'' \77\
---------------------------------------------------------------------------

    \73\ AFR at 3, 5-7; Better Markets at 4.
    \74\ See AFR at 3 (adopting different definition solely for 
purposes of margin rules would not only complicate overall set of 
cross-border rules, but establish an ``extremely poor precedent'' 
for narrowing guarantee concept in applying rest of Guidance); 
Better Markets at 4 (proposed definition is ``less robust'' than 
interpretation of guarantee in Guidance and should not be different 
in margin context).
    \75\ See AFR at 6.
    \76\ See id.
    \77\ See id. at 5-6.
---------------------------------------------------------------------------

c. Final Rule
    The Final Rule defines ``guarantee'' for purposes of the cross-
border application of the Commission's margin rules to mean an 
arrangement pursuant to which one party to an uncleared swap has rights 
of recourse against a guarantor, with respect to its counterparty's 
obligations under the uncleared swap.\78\ For these purposes, a party 
to an uncleared swap has rights of recourse against a guarantor if the 
party has a conditional or unconditional legally enforceable right to 
receive or otherwise collect, in whole or in part, payments from the 
guarantor with respect to its counterparty's obligations under the 
uncleared swap. A counterparty has a right of recourse against a 
guarantor even if the right of recourse is conditioned upon its 
counterparty's insolvency or failure to meet its obligations under the 
swap, and regardless of whether the counterparty seeking to enforce the 
guarantee is first required to make a demand for payment or performance 
from its counterparty before proceeding against the guarantor. Further, 
the term ``guarantee'' applies equally regardless of whether the U.S. 
guarantor is affiliated with either counterparty or is an unaffiliated 
third party. In addition, the terms of the guarantee need not 
necessarily be included within the swap documentation or even otherwise 
reduced to writing, so long as a party to the swap has legally 
enforceable rights of recourse under the laws of the relevant 
jurisdiction.
---------------------------------------------------------------------------

    \78\ See 17 CFR 23.160(a)(2).
---------------------------------------------------------------------------

    The Final Rule's definition of guarantee is generally consistent 
with the proposed rule's definition of guarantee, but reflects certain 
changes that are intended to more closely align it with the definition 
included in the Prudential Regulators' Final Margin Rule.\79\ Language 
has been added to the Final Rule to address the concerns of the 
Commission and Prudential Regulators that swaps could be structured in 
a manner that would avoid application of the margin requirements to 
swaps that are guaranteed by a U.S. person.\80\ Under this additional 
language, the term ``guarantee'' also encompasses any arrangement 
pursuant to which the guarantor itself has a conditional or 
unconditional legally enforceable right to receive or otherwise 
collect, in whole or in part, payments from any other guarantor with 
respect to the counterparty's obligations under the uncleared swap. 
Under the Final Rule, such arrangement will be deemed a guarantee of 
the counterparty's obligations under the uncleared swap by the other 
guarantor.
---------------------------------------------------------------------------

    \79\ The Final Rule also includes certain technical edits that 
would not affect the substance of the rule as compared to the 
proposed rule.
    \80\ Based on this change to the definition of ``guarantee,'' 
the Final Rule differs from the proposed rule in that it treats 
certain non-U.S. persons as if they were U.S. persons.
---------------------------------------------------------------------------

    To illustrate, consider a swap between a non-U.S. CSE (``Party A'') 
and a non-U.S. person (``Party B''). Party B's obligations under the 
swap are guaranteed by a non-U.S. affiliate (``Party C''), who in turn 
has a guarantee from its U.S. CSE parent entity on Party C's swap 
obligations (``Parent D''). The Final Rule would deem a guarantee to 
exist between Party B and Parent D with respect to Party B's 
obligations under the swap with Party A.\81\
---------------------------------------------------------------------------

    \81\ This example is included for illustrative purposes only, 
and is not intended to cover all examples of swaps that could be 
affected by changes in the Final Rules.
---------------------------------------------------------------------------

    The Commission is cognizant that many other financial arrangements 
or support, other than a recourse guarantee as defined in the Final 
Rule, may be provided by a U.S. person to a non-U.S. CSE. The 
Commission acknowledges that these other financial arrangements or 
support may transfer risk directly back to the U.S. financial system, 
with possible significant adverse effects, in a manner similar to an 
arrangement that is covered by the definition of a ``guarantee'' in the 
Final Rule. However, the Commission believes that, in the context of 
the Final Rule, non-U.S. CSEs benefitting from such other forms of U.S. 
financial support will likely meet the definition of an FCS, a concept 
included in the final margin rules adopted by the Prudential 
Regulators, and thereby be adequately covered by the Commission's 
margin requirements. In this way, the Commission believes that the 
Final Rule achieves the dual goals of protecting the U.S. markets while 
promoting a workable cross-border margin framework that closely tracks 
the cross-border application of the Prudential Regulators' Final Margin 
Rule.\82\
---------------------------------------------------------------------------

    \82\ The Commission has determined that using the term 
``explicit recourse guarantee'' in lieu of the broader ``guarantee'' 
would, in light of the Prudential Regulators' use of the comparable 
term ``guarantee,'' likely only cause confusion without making any 
substantive difference with respect to the cross-border application 
of the Commission's margin requirements.
---------------------------------------------------------------------------

3. Foreign Consolidated Subsidiary (``FCS'')
    Under the Final Rule, the term ``Foreign Consolidated Subsidiary'' 
identifies non-U.S. CSEs that are consolidated for accounting purposes 
with an ultimate parent entity that is a U.S. person (a ``U.S. ultimate 
parent entity''). As further discussed in section II.B.2.b.ii. below, 
substituted compliance would be broadly available to an FCS to the same 
extent as any other non-U.S. CSE, but such an FCS would not be eligible 
for the Exclusion.
a. Proposed Rule
    The proposed rule defined a ``Foreign Consolidated Subsidiary'' as 
a non-U.S. CSE in which an ``ultimate parent entity'' \83\ that is a 
U.S. person has a

[[Page 34826]]

controlling interest, in accordance with U.S. generally accepted 
accounting principles (``U.S. GAAP'') such that the U.S. ultimate 
parent entity includes the non-U.S. CSE's operating results, financial 
position and statement of cash flows in its consolidated financial 
statements, in accordance with U.S. GAAP.\84\ The Commission explained 
that the fact that an entity is included in the consolidated financial 
statements of another entity is an indication of potential risk to the 
other entity that offers a clear and objective standard for the 
application of margin requirements. The Commission further explained 
that, as a result of the FCS' direct connection to, and the possible 
negative impact of its swap activities on, its U.S. ultimate parent 
entity and the U.S. financial system, an FCS raises a more substantial 
supervisory concern in the United States relative to other non-U.S. 
CSEs.
---------------------------------------------------------------------------

    \83\ See proposed 17 CFR 23.160(a)(6) (defining ``ultimate 
parent entity'' as the parent entity in a consolidated group in 
which none of the other entities in the consolidated group has a 
controlling interest, in accordance with U.S. GAAP).
    \84\ Under U.S. GAAP, consolidated financial statements report 
the financial position, results of operations and statement of cash 
flows of a parent entity together with subsidiaries in which the 
parent entity has a controlling financial interest (which are 
required to be consolidated under U.S. GAAP).
---------------------------------------------------------------------------

    The Commission requested comment on all aspects of its proposed FCS 
definition, including whether the Commission should instead adopt the 
``control test'' proposed by the Prudential Regulators, which focused 
solely on the level of ownership and control a U.S. person would have 
over a non-U.S. subsidiary.\85\
---------------------------------------------------------------------------

    \85\ See Proposal, 80 FR at 41386. See also Prudential 
Regulators' Proposed Margin Rule, 79 FR at 57379.
---------------------------------------------------------------------------

b. Comments
    A few commenters expressed strong support for the FCS concept.\86\ 
AFR and Better Markets characterized it as an improvement to the cross-
border approach to margin taken in the Guidance, calling it a ``logical 
and reasonable approach'' to capturing non-U.S. subsidiaries of U.S. 
swap entities that may expect an implicit guarantee from a U.S. parent 
and an ``effective remedy to evasion.'' \87\ AFR stated that, by virtue 
of being included in the same consolidated financial statement, an FCS 
has a direct financial impact on its U.S. ultimate parent entity, even 
absent a direct recourse guarantee.\88\
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    \86\ See AFR at 4-5; Better Markets at 5; IATP at 3, 5-6.
    \87\ See AFR at 4 (FCS concept ``economizes'' Commission 
resources by tying regulatory coverage to ``easily available'' 
accounting information). See also Better Markets at 5 (Guidance 
should be amended to apply FCS concept to all Title VII 
requirements).
    \88\ See AFR at 4. See also IATP at 3 (inclusion in another's 
consolidated financial statement indicates a potential risk to that 
entity).
---------------------------------------------------------------------------

    Nevertheless, AFR and IATP expressed some concern over the reliance 
on U.S. GAAP, particularly with respect to its ability to capture off-
balance sheet entities.\89\ IATP suggested that the Commission consider 
including in the FCS definition an option to carry out the consolidated 
financial reporting according to International Financial Reporting 
Standards (``IFRS'').\90\ AFR also expressed concern that reliance on 
U.S. GAAP may not capture all entities that could expect an implicit 
guarantee from a U.S. parent, including privately held entities that 
are not required to prepare consolidated financial statements under 
U.S. GAAP, and certain variable interest entities or owned funds.\91\
---------------------------------------------------------------------------

    \89\ See AFR at 5 (prior to the passage of U.S. Financial 
Accounting Standards Board (``U.S. FASB'') Statements Nos. 166 and 
167, U.S. GAAP accounting failed to properly require the 
consolidation of many securitization entities and such gaps could 
appear in the future).
    \90\ See IATP at 6 (reliance on IFRS should be predicated on the 
IFRS agreeing with U.S. FASB participation and offering improved 
handling of off-balance sheet entities compared to U.S. GAAP).
    \91\ See AFR at 4-5.
---------------------------------------------------------------------------

    AFR and IATP therefore urged the Commission to expand the FCS 
definition in a few ways. Both recommended that the FCS definition 
include entities whose U.S. parent entity is not required to prepare 
consolidated financial statements (e.g., a private partnership) but 
that would otherwise meet the standard for consolidation.\92\ AFR 
argued that failing to include such entities within the meaning of 
``FCS'' could result in entities with a similar nexus to the U.S. 
financial system being treated differently based on factors such as 
whether the ultimate parent is publicly traded.\93\ AFR also urged the 
Commission to incorporate a facts-and-circumstances test for 
determining when a foreign subsidiary's relationship with its U.S. 
parent may create a sufficient nexus to require compliance with U.S. 
margin rules.\94\
---------------------------------------------------------------------------

    \92\ See AFR at 4-5; IATP at 6 (it would not be 
``inconceivable'' for U.S. CSE to spin off swaps trading activities 
as private partnerships).
    \93\ See AFR at 5.
    \94\ See id.
---------------------------------------------------------------------------

    A few commenters opposed the FCS concept altogether.\95\ IIB/SIFMA 
argued that, absent a legal obligation to provide support, an FCS's 
potential effect on its U.S. ultimate parent entity is not sufficiently 
``direct'' to create a nexus to the U.S. financial system within the 
meaning of CEA section 2(i).\96\ Nevertheless, most commenters, 
including IIB/SIFMA, preferred the proposed FCS definition to the 
control test proposed by the Prudential Regulators.\97\ IIB/SIFMA also 
appreciated that the proposed FCS definition would foreclose the 
possibility of such a non-U.S. CSE having multiple parent entities.\98\
---------------------------------------------------------------------------

    \95\ See, e.g., AIMA/IA at 3 (touting potential operational 
costs involved with obtaining counterparty representations regarding 
FCS status); FSR at 10 (FCS concept is ``not necessary'' because 
FCSs will be subject to foreign regulation); IIB/SIFMA at 19-20 
(Commission should not distinguish FCSs from other non-U.S. CSEs).
    \96\ See IIB/SIFMA at 14 (``chain of intervening factors and 
events,'' including ``materiality'' of FCS to parent entity, that 
could affect a U.S. parent's decision to provide support is too long 
and uncertain).
    \97\ See FSR at 10 (a control test may not clearly identify the 
non-U.S. covered swap entities that are likely to raise greater 
supervisory concerns); IATP at 6; IIB/SIFMA at 19-20 (reliance on 
the familiar standards of U.S. GAAP would promote legal certainty); 
ISDA at 13 (a control test is not appropriate for the application of 
margin rules).
    \98\ See IIB/SIFMA at 19-20.
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c. Final Rule
    The Final Rule defines ``Foreign Consolidated Subsidiary'' as 
proposed.\99\ Specifically, ``Foreign Consolidated Subsidiary'' means a 
non-U.S. CSE in which an ultimate parent entity that is a U.S. person 
has a controlling financial interest, in accordance with U.S. GAAP, 
such that the U.S. ultimate parent entity includes the non-U.S. CSE's 
operating results, financial position and statement of cash flows in 
the U.S. ultimate parent entity's consolidated financial statements, in 
accordance with U.S. GAAP. The term ``ultimate parent entity'' means 
the parent entity in a consolidated group in which none of the other 
entities in the consolidated group has a controlling interest, in 
accordance with U.S. GAAP.\100\
---------------------------------------------------------------------------

    \99\ See 17 CFR 23.160(a)(1).
    \100\ See 17 CFR 23.160(a)(6). The definition of ``Foreign 
Consolidated Subsidiary'' refers only to the U.S ultimate parent 
entity. The Commission believes that this is appropriate because 
consolidated financial statements are the financial statements of a 
group under the control of the ultimate parent entity. Where the 
ultimate parent entity is a non-U.S. person, the non-U.S. CSE is not 
categorized as an FCS and therefore would be eligible for the 
Exclusion (assuming that the other conditions of the Exclusion are 
satisfied), for the reasons discussed in section II.B.3.
---------------------------------------------------------------------------

    The Commission believes that the FCS concept offers a clear, 
bright-line test for identifying those non-U.S. CSEs whose uncleared 
swap activities present a greater supervisory interest relative to 
other non-U.S. CSEs. Under U.S. GAAP, an FCS' financial statements are 
consolidated with its U.S. ultimate parent entity by virtue of the 
parent's

[[Page 34827]]

controlling financial interest in the FCS. By virtue of having its 
financial statements consolidated with those of its U.S. ultimate 
parent, the financial position, operating results and statement of cash 
flows of an FCS are included in the financial statements of its U.S. 
ultimate parent entity and therefore affect the financial position, 
risk profile and market value of the U.S. ultimate parent. Because of 
the FCS' direct relationship with, and the possible negative impact of 
its swap activities on, its U.S. ultimate parent entity and the U.S. 
financial system, an FCS raises greater supervisory concern in the 
United States relative to other non-U.S. CSEs (in each case provided 
that the obligations under the relevant swap are not guaranteed by a 
U.S. person).\101\
---------------------------------------------------------------------------

    \101\ The Commission notes that it has a relatively greater 
supervisory interest in FCSs than other non-U.S. CSEs, even if they 
have a U.S. subsidiary or affiliate, because an FCS's ultimate 
parent entity is a U.S. person.
---------------------------------------------------------------------------

    Further, the Commission continues to believe that, in the absence 
of a direct recourse guarantee from a U.S. person, an FCS should not be 
treated in the same manner as a U.S. CSE or U.S. Guaranteed CSE. In 
contrast with a U.S. Guaranteed CSE, in the event of the FCS's default, 
the U.S. ultimate parent entity does not have a legal obligation to 
fulfill the obligations of the FCS. Rather that decision would depend 
on the business judgment of its parent.
    By relying on a consolidation test, the FCS concept is intended to 
provide a clear, bright-line test for identifying those non-U.S. CSEs 
whose uncleared swaps are likely to raise greater supervisory concerns 
relative to other non-guaranteed non-U.S. CSEs. The Commission further 
believes that, as some commenters noted, reliance on familiar U.S. GAAP 
accounting standards will promote legal certainty. In particular, the 
Commission notes that consolidation accounting is a longstanding part 
of U.S. GAAP and that all non-U.S. CSEs with a U.S. ultimate parent 
entity currently prepare consolidated financial statements.
    With respect to the definition's reliance on U.S. GAAP, the 
Commission notes that since the 2008 financial crisis, the U.S. FASB 
made significant changes to the consolidation model for variable 
interest entities (``VIEs'') and that as a result of these changes, 
more VIEs (including special purpose vehicles) are being consolidated 
with other entities (i.e., their parent entities) under U.S. GAAP. 
Furthermore, because the U.S. GAAP consolidation requirement adequately 
addresses these VIEs, the Commission believes that the addition of IFRS 
as an option is likely to inject unnecessary complexity and costs in 
many circumstances.\102\ Accordingly, the Commission believes that the 
U.S. GAAP consolidation test in the FCS definition is sufficiently 
similar to the IFRS consolidation standard with respect to VIEs so that 
additional reliance on the IFRS standard would be neither necessary nor 
beneficial.\103\
---------------------------------------------------------------------------

    \102\ The Commission notes that the standards for consolidation 
under U.S. GAAP's VIE model are similar to the consolidation 
standards that would apply under IFRS, as both consider control over 
one entity by the other. The Commission further notes that it does 
not believe that special purpose vehicles are likely to be used to 
conduct swaps business. Even if such vehicles transact in swaps and, 
consequently, register as CSEs, the ultimate parent entity would 
likely exercise control over them because these vehicles typically 
rely on parental support or guarantees to maintain their credit 
standards. Such control would lead to consolidation under U.S. GAAP.
    \103\ The Commission notes that although privately held 
companies are not under a regulatory obligation to prepare and file 
consolidated financial statements pursuant to U.S. GAAP, they 
nevertheless are likely to prepare consolidated financial statements 
for other purposes (e.g., to provide to creditors as a condition to 
loan or to private investors), in which case their foreign 
subsidiaries may fall within the parameters of the FCS definition.
---------------------------------------------------------------------------

4. Counterparty Representations
    The proposed rule provided that market participants should 
generally be permitted to reasonably rely on counterparty 
representations with regard to their status as a U.S. person. The 
Commission received comments regarding its proposed reliance standard 
\104\ and a request that the Commission also permit reliance on 
counterparty representations with respect to the guarantee and FCS 
definitions.\105\
---------------------------------------------------------------------------

    \104\ See, e.g., SIFMA AMG at 12 (standard for reliance on 
counterparty representations with respect to U.S. person status is 
consistent with that articulated in Guidance and Commission's 
external business conduct rules; proposed rule could be read to 
require ``further, unnecessary diligence'').
    \105\ See, e.g., id.
---------------------------------------------------------------------------

    The Commission acknowledges that the information necessary for a 
swap counterparty to accurately assess the status of its counterparties 
as U.S. persons or FCSs, or to determine whether a non-U.S. 
counterparty's obligations under a swap are guaranteed by a U.S. 
person, may be unavailable, or available only through overly burdensome 
due diligence. For this reason, the Commission believes that a market 
participant should generally be permitted to reasonably rely on written 
counterparty representations in each of these respects. The Commission 
clarifies that, consistent with the reliance standard articulated in 
the Commission's external business conduct rules,\106\ market 
participants may reasonably rely on such a counterparty representation 
unless it has information that would cause a reasonable person to 
question the accuracy of the representation.
---------------------------------------------------------------------------

    \106\ See 17 CFR 23.402(d).
---------------------------------------------------------------------------

B. Applicability of Margin Requirements to Cross-Border Uncleared Swaps

    The following sections discuss the cross-border application of the 
margin requirements to swaps between CSEs and their counterparties, 
including when substituted compliance and the Exclusion are applicable. 
Section 1 provides a brief overview of the proposed rule; section 2 
addresses the availability of substituted compliance; section 3 
addresses the availability of the Exclusion; section 4 discusses a 
special provision in the Final Rule for non-segregation jurisdictions; 
and section 5 discusses a special provision in the Final Rule for non-
netting jurisdictions.
1. Proposed Rule
    Under the proposed rule, the application of substituted compliance 
and the scope of the Exclusion closely tracked the Prudential 
Regulators' Proposed Margin Rule.\107\ Specifically:
---------------------------------------------------------------------------

    \107\ See 79 FR at 57379-81.
---------------------------------------------------------------------------

     A U.S. CSE would be required to comply with the 
Commission's margin rules for all uncleared swaps but would be eligible 
for substituted compliance with respect to the requirement to post (but 
not the requirement to collect) initial margin for swaps with certain 
non-U.S. counterparties (referred to herein as ``partial substituted 
compliance'').\108\
---------------------------------------------------------------------------

    \108\ U.S. CSEs would not be eligible for substituted compliance 
with respect to the requirement that they collect initial margin or 
the requirement to post or collect variation margin.
---------------------------------------------------------------------------

     A U.S. Guaranteed CSE would receive the same treatment as 
a U.S. CSE.
     A non-U.S. CSE whose obligations under the relevant swap 
are not guaranteed by a U.S. person would be eligible for substituted 
compliance unless the counterparty to the swap is a U.S. CSE or U.S. 
Guaranteed CSE, in which case substituted compliance would be available 
with respect to the requirement to collect (but not the requirement to 
post) initial margin (also referred to as ``partial substituted 
compliance'').
     A non-U.S. CSE would be eligible for an exclusion from the 
Final Margin Rule when trading with a non-U.S. person counterparty 
provided that (a) neither party's obligations under the relevant swap 
are guaranteed by a U.S.

[[Page 34828]]

person; (b) neither party is an FCS; and (c) the swap is not conducted 
by or through a U.S. branch of a non-U.S. CSE.
    The Commission requested comment on all aspects of the proposed 
rule, including how the rule should treat FCSs (e.g., whether they 
should be offered the same treatment as U.S. Guaranteed CSEs or 
conversely be offered the Exclusion), whether U.S. branches should be 
eligible for the Exclusion, and whether the Commission should provide 
exceptions related to certain ``emerging markets'' or non-netting 
jurisdictions.\109\
---------------------------------------------------------------------------

    \109\ See Proposal, 80 FR at 41387, 88-91.
---------------------------------------------------------------------------

2. Substituted Compliance
a. Comments
    Most commenters argued for the greater availability of substituted 
compliance. Some requested that all CSEs, whether a U.S. persons or a 
non-U.S. person, be eligible for full substituted compliance with 
respect to all comparable foreign margin requirements, including any 
swap dealer in a BCBS-IOSCO framework-compliant jurisdiction.\110\ 
Others phrased their requests in narrower terms, arguing for the 
broader availability of substituted compliance for U.S. CSEs and/or 
U.S. Guaranteed CSEs when trading with non-U.S. persons.\111\ 
Commenters generally argued that requiring CSEs to comply with the 
Commission's margin requirements in the face of comparable foreign 
margin requirements would undermine international efforts to develop a 
consistent global swaps regime and impose unnecessary and costly 
compliance burdens, resulting in competitive disparities and market 
inefficiencies.\112\ Several commenters also argued that the proposed 
rule would involve substantial operational costs, including 
categorizing market participants and developing appropriate 
documentation.\113\
---------------------------------------------------------------------------

    \110\ See, e.g., AIMA/IA at 4-5 (substituted compliance should 
be ``all encompassing, and applicable to all parties to a 
transaction''); ICI Global at 2, 9 (substituted compliance should be 
made available ``without qualification'' wherever foreign 
jurisdiction's margin requirements are comparable); ISDA at 2, 7-8 
(substituted compliance should be available for any transaction 
subject to foreign requirements comparable to BCBS-IOSCO framework); 
SIFMA AMG 4, 6-8 (market participants should be allowed ``to comply 
with a single set of substantive margin requirements for all 
uncleared swaps''). See also ABA/ABASA at 3 (market participants 
should be allowed to rely on substituted compliance ``to the 
greatest possible degree across the markets in and structures 
through which they operate'').
    \111\ See, e.g., FSR at 7 (U.S. CSEs should be able to rely on 
substituted compliance for both posting and collecting of initial 
margin when trading with non-U.S. CSEs and their foreign branches be 
extended full substituted compliance); IIB/SIFMA at 4-9 (substituted 
compliance should be available for U.S. CSEs and U.S. Guaranteed 
CSEs with respect to all margin requirements, including posting and 
collecting both initial and variation margin); JBA at 8-9 
(availability of substituted compliance for U.S. Guaranteed CSEs is 
too limited); PensionsEurope at 2 (``full substituted compliance,'' 
including collection of initial margin and variation margin, should 
be available for transactions between U.S. Guaranteed CSEs and 
``financial institutions without a U.S. nexus'').
    \112\ See, e.g., AIMA/IA at 1; FSR at 3-7; ICI Global at 8-9. 
See also Vanguard at 2 (applying substituted compliance on a 
``transaction-by-transaction basis'' would undermine ``the 
fundamental risk mitigation tool of cross-transactional close-out 
netting'').
    \113\ See, e.g., AIMA/IA at 1 (proposed rule would require a 
``significant amount of replacement and additional documentation to 
account for different counterparty combinations''); ISDA at 5 
(operational complexity of proposed substituted compliance regime 
would further increase operating costs); IIB/SIFMA at 7 (CSEs would 
not know sufficient information about businesses of their 
counterparties to categorize them, and non-U.S. counterparties would 
not be familiar with, and would be reluctant to hire counsel to 
determine, all U.S. laws relevant to making the determination); 
SIFMA AMG at 6 (highlighting complications in determining 
availability of substituted compliance on basis of counterparty 
status in context of block trades).
---------------------------------------------------------------------------

    With respect to U.S. CSEs and U.S. Guaranteed CSEs, IIB/SIFMA and 
ISDA argued that compliance with the Commission's margin requirements 
was not necessary to prevent the transmission of risk to the U.S. 
financial system because the risk would be adequately addressed by 
comparable foreign margin requirements.\114\ IIB/SIFMA argued that the 
proposed substituted compliance regime could actually increase 
liquidity risk by discouraging non-U.S. counterparties from trading 
with U.S. CSEs and U.S. Guaranteed CSEs in order to avoid costs 
associated with understanding and complying with the Commission's 
margin requirements, and that the resulting increased concentration of 
bilateral credit exposures among U.S. CSEs and U.S. Guaranteed CSEs 
would increase the risk of contagion in U.S. markets.\115\ ISDA further 
argued that ``[c]omity and respect for the supervisory interests of 
non-U.S. regulators'' argue in favor of full substituted compliance or 
exclusion for swaps involving non-U.S. person counterparties.\116\ FSR 
argued that substituted compliance is at least necessary for foreign 
branches because they are likely to be subject to foreign margin 
requirements and pose the same concerns to foreign regulators as the 
U.S. branches of non-U.S. CSEs pose to U.S. regulators.\117\
---------------------------------------------------------------------------

    \114\ See IIB/SIFMA at 5; ISDA at 6-7. See also ICI Global at 9 
(by not permitting substituted compliance in certain instances, 
Commission would effectively be determining that foreign margin 
requirements are not ``good enough'' despite being found 
comparable).
    \115\ See IIB/SIFMA at 6-7.
    \116\ See ISDA at 6.
    \117\ See FSR at 7-8. See also AIMA/IA at 3 (absence of 
substituted compliance for foreign branches of U.S. CSEs is an 
``apparent gap[ ]'').
---------------------------------------------------------------------------

    Several commenters raised concerns with regard to the proposal to 
allow partial substituted compliance.\118\ SIMFA AMG argued that 
partial substituted compliance would be ``inconsistent with the 
importance of bilateral margining,'' add unnecessary costs and 
complexity, and increase the potential for margin disputes.\119\ AIMA/
IA argued that developing a legal agreement allowing for the transfer 
of margin amounts according to more than one margin regime would be 
``commercially and legally problematic.'' \120\ As a result, market 
participants would default to complying with the Commission's margin 
requirements, negating the value of substituted compliance.\121\ ISDA 
similarly argued that developing a standardized model for initial 
margin that could account for different margin rules in one netting set 
would be ``impractical'' in the available timeframe for 
compliance.\122\ FSR argued that partial substituted compliance was not 
``in the spirit of the International Standards'' \123\ and pointed out 
that its usefulness may be questionable, given that no other foreign 
jurisdiction has proposed a similar approach.\124\
---------------------------------------------------------------------------

    \118\ See, e.g., AIMA/IA at 4; FSR at 7; ISDA at 3, 5; SIFMA AMG 
at 10.
    \119\ See SIFMA AMG at 10 (highlighting additional complexities 
in calculating margin for clients using multiple asset managers).
    \120\ See AIMA/IA at 4.
    \121\ See id.
    \122\ See ISDA at 9 (counterparties wanting to use a single 
custodian could face additional challenges, as the custodial 
arrangement would have to be drafted to accommodate overlapping and 
potentially inconsistent requirements for segregation).
    \123\ See proposed 17 CFR 23.160(a)(3) (defining ``International 
Standards'' as based on the BCBS-IOSCO framework).
    \124\ See FSR at 7.
---------------------------------------------------------------------------

    IATP, on the other hand, supported the proposed substituted 
compliance regime.\125\ IATP agreed that FCSs should be granted 
substituted compliance but not U.S. Guaranteed Affiliates because 
losses from the swaps of an FCS may have a negative impact on the 
foreign jurisdiction's economy.\126\ IATP also agreed that U.S. 
Guaranteed Affiliates should not be eligible for substituted compliance 
with respect to the requirement to collect

[[Page 34829]]

initial margin from a non-U.S. counterparty.\127\ AFR described the 
proposed rule as creating a ``very significant scope for substituted 
compliance'' with respect to non-U.S. CSEs, but suggested that the 
scope would not be a concern provided the substituted compliance were 
limited to foreign rules that are ``very similar'' to U.S. margin 
requirements.\128\
---------------------------------------------------------------------------

    \125\ See IATP at 3-4 (proposed rule would provide ``the 
greatest opportunity for effective risk mitigation against swaps 
counterparty default'' and would be a ``critical step'' to ensuring 
that ``de-guaranteed'' swaps ``will not continue to elude effective 
regulation'').
    \126\ See IATP at 7.
    \127\ See id.
    \128\ See AFR at 7. See also id. at 4 (scope of substituted 
compliance could become ``overbroad'' given that proposed rule 
included narrow definition of ``guarantee'' and limited Foreign 
Consolidated Subsidiaries to subsidiaries of registered CSEs).
---------------------------------------------------------------------------

b. Final Rule
    The Commission has determined to adopt a cross-border framework 
largely as proposed, but with certain modifications to address concerns 
raised by commenters and to further align the rule with the cross-
border approach adopted by the Prudential Regulators. Generally 
speaking, the cross-border margin framework in the Final Rule reflects 
the Commission's efforts to carefully tailor the application of the 
Commission's margin requirements to address comity considerations and 
mitigate potential adverse impact on market efficiency and competition 
without compromising the safety and soundness of CSEs. The availability 
of substituted compliance under the Final Rule therefore depends on the 
degree of nexus the CSEs and their counterparties have to the U.S. 
financial system, as indicated by their status (e.g., whether they are 
U.S. persons or non-U.S. persons whose obligations under the relevant 
swap are guaranteed by a U.S. person).
i. Uncleared Swaps of U.S. CSEs and U.S. Guaranteed CSEs
    As a general rule, the Commission believes that, in light of their 
position in the U.S. financial system, U.S. persons and U.S. Guaranteed 
CSEs should be required to comply with the Commission's margin 
requirements. Under the Final Rule, however, U.S. CSEs and U.S. 
Guaranteed CSEs would be eligible for substituted compliance with 
respect to the requirement to post (but not the requirement to collect) 
initial margin provided that the counterparty is a non-U.S. person 
whose obligations under the relevant swap are not guaranteed by a U.S. 
person. By virtue of their being domiciled or organized in the United 
States, U.S. CSEs give rise to greater supervisory interests relative 
to other CSEs. U.S. Guaranteed CSEs create a similar supervisory 
interest because, as discussed in the proposed rule, the swap of a non-
U.S. CSE whose obligations under the swap are guaranteed by a U.S. 
person is identical, in relevant aspects, to a swap entered into 
directly by a U.S. person.
    Nevertheless, the Commission believes that, in the interest of 
comity, permitting substituted compliance for the limited requirement 
of posting initial margin would be reasonable. While requiring a CSE to 
post initial margin protects the counterparty in the event of default 
by the CSE, it also serves as a risk management tool because it limits 
the amount of leverage a CSE can incur by requiring that it have 
adequate eligible collateral to enter into an uncleared swap. 
Accordingly, when the counterparty is a non-U.S. person (whose 
obligations under the swap are not guaranteed by a U.S. person), the 
Commission believes that substituting the foreign margin requirements 
with regard to the initial margin posted would be reasonable. The 
Commission further believes that allowing substituted compliance in 
this limited instance may reduce transaction costs for U.S. CSEs when 
trading with non-U.S. counterparties \129\ and thereby mitigate 
potential competitive disparities (relative to other CSEs and non-CFTC 
registered dealers operating in the foreign jurisdiction), while 
ensuring that the U.S. CSE is adequately protected in the event of 
default of the non-U.S. counterparty. The availability of substituted 
compliance is limited to circumstances where the non-U.S. 
counterparty's obligations under the relevant swap are not guaranteed 
by a U.S. person in order to avoid incentivizing market participants to 
structure their swaps solely for purposes of avoiding application of 
the Commission's margin requirements.\130\
---------------------------------------------------------------------------

    \129\ That is, if the initial margin amount required to be 
posted under the foreign rule is lower than the amount required 
under the Commission's Final Margin Rule, and the parties elect for 
the CSE to post margin pursuant to the foreign margin requirements, 
the lower margin may reduce the U.S. CSE's funding costs.
    \130\ For example, if partial substituted compliance were 
available for non-U.S. counterparties that are guaranteed by a U.S. 
person, a swap between a U.S. CSE and a U.S. counterparty could be 
restructured as a swap between a U.S. CSE and a non-U.S. 
counterparty that is guaranteed by a U.S. person in order to avoid 
application of the Commission's margin requirements.
---------------------------------------------------------------------------

    The Commission does not believe that partial substituted compliance 
would prohibit the use of a single netting set for calculating initial 
margin. Under the Final Rule, a U.S. CSE can comply with the 
Commission's initial margin requirements by posting pursuant to 
comparable foreign margin requirements. Accordingly, from the 
Commission's perspective, one netting set could encompass swaps that 
comply with both foreign and CFTC initial margin requirements.\131\
---------------------------------------------------------------------------

    \131\ The Commission similarly does not expect that reliance on 
partial substituted compliance will hinder the development or use of 
a standardized model for initial margin, as the Commission believes 
that a single model could be developed to satisfy the initial margin 
requirements of multiple jurisdictions.
---------------------------------------------------------------------------

    The Commission understands that CSEs relying on partial substituted 
compliance may face certain costs or challenges not experienced by non-
U.S. CSEs that are eligible for full substituted compliance. 
Nevertheless, as discussed above, the Commission believes that granting 
substituted compliance more broadly (e.g., permitting both collection 
and posting of initial margin pursuant to the foreign requirements) 
would not be appropriate for a swap transaction involving a U.S. CSE or 
a U.S. Guaranteed CSE. Moreover, U.S. CSEs and U.S. Guaranteed CSEs 
that elect to rely on partial substituted compliance may realize 
savings in the form of reduced funding costs (to the extent that 
foreign jurisdiction requires less initial margin to be posted), and 
their non-U.S. counterparties may experience lower operational costs as 
a result of only having to comply with their home jurisdiction's 
requirements.
    Finally, the Commission does not believe it would be appropriate to 
broaden the scope of substituted compliance available to swaps 
conducted through foreign branches of U.S. CSEs. A foreign branch is 
legally indistinguishable from the U.S. CSE itself, such that the whole 
U.S. CSE, and not merely the foreign branch, holds itself out to the 
market and assumes the risks of any uncleared swap transactions 
conducted by or through the foreign branch. Accordingly, swaps 
conducted through a foreign branch of a U.S. CSE are appropriately 
treated the same as swaps of the U.S. CSE as a whole. Moreover, if the 
Commission were to allow broader substituted compliance for swaps 
conducted through foreign branches than swaps conducted domestically, 
U.S. CSEs could be incentivized to conduct swap activity through 
foreign branches to avoid direct compliance with Commission's margin 
requirements.
ii. Uncleared Swaps of Non-U.S. CSEs (Including FCSs) Whose Obligations 
Under the Relevant Swap Are Not Guaranteed by a U.S. Person
    Under the Final Rule, consistent with the Proposed Rule, non-U.S. 
CSEs (including FCSs) whose obligations under the relevant uncleared 
swap are

[[Page 34830]]

not guaranteed by a U.S. person may avail themselves of substituted 
compliance to a greater extent than U.S. CSEs and U.S. Guaranteed CSEs. 
Specifically, where the obligations of a non-U.S. CSE (including an 
FCS) under the relevant swap are not guaranteed by a U.S. person, 
substituted compliance is available with respect to its uncleared swaps 
with any counterparty, other than a U.S. CSE or a U.S. Guaranteed 
CSE.\132\
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    \132\ With respect to uncleared swaps of a non-U.S. CSE whose 
obligations under the swap are not guaranteed by a U.S. person, on 
the one hand, with a U.S. CSE or a U.S. Guaranteed CSE, on the other 
hand, substituted compliance would only be available for initial 
margin collected by the non-U.S. CSE whose obligations under the 
relevant swap are not guaranteed by a U.S. person, as discussed 
above.
---------------------------------------------------------------------------

    The broad substituted compliance framework available to this 
category of non-U.S. CSEs reflects the Commission's recognition of 
foreign jurisdictions' supervisory interest in CSEs that are domiciled 
and operating in their jurisdictions. In addition, the Commission 
understands that compliance with two sets of margin regulations may 
lead to costs and burdens for non-U.S. CSEs not faced by their 
competitors in the local jurisdiction and may provide disincentives for 
foreign clients to transact with a non-U.S. CSE. The Commission 
believes that making substituted compliance broadly available to non-
U.S. CSEs that are not guaranteed by a U.S. person may help to reduce 
the potential adverse impact on market efficiency and competition, 
without compromising the protections for the non-U.S. CSE and the U.S. 
financial markets.
    As discussed in the next section, a non-U.S. CSE that is not an FCS 
will be eligible for the Exclusion from the Commission's margin rules 
under certain circumstances. However, uncleared swaps entered into by 
an FCS will not be eligible for any exclusion because of its 
relationship with its U.S. ultimate parent entity, and because of the 
possible negative impact of its swap activities on its U.S. ultimate 
parent entity and the U.S. financial system. As explained in section 
II.A.3.c. above, the financial position, operating results, and 
statement of cash flows of an FCS are included in the financial 
statements of the U.S. ultimate parent entity and therefore have a 
direct impact on the consolidated entity's financial position, risk 
profile, and market value. The Commission is also concerned that 
extending the Exclusion to FCSs would incentivize U.S. entities to 
conduct their swap activities with non-U.S. counterparties through non-
U.S. subsidiaries solely in order to avoid application of the Dodd-
Frank Act margin requirements, leading to further bifurcation between 
U.S. and non-U.S. swap business.
    The Commission recognizes that its decision not to extend the 
Exclusion to FCSs could put them at a disadvantage relative to other 
non-U.S. market participants/swap dealers (including those that are 
CSEs).\133\ However, given the supervisory concerns raised by the nexus 
between FCSs and their U.S. ultimate parent entity, the Commission 
believes that extending the Exclusion to an FCS would not further the 
paramount statutory objective of ensuring the safety and soundness of a 
CSE and the stability of U.S. financial markets. The Commission notes 
that potential competitive disparities may be mitigated to the extent 
that the relevant foreign jurisdiction implements comparable margin 
requirements.
---------------------------------------------------------------------------

    \133\ For example, a non-U.S. CSE relying on the Exclusion or 
non-CFTC registered swap dealers may be able to realize cost savings 
and offer better pricing terms to foreign clients.
---------------------------------------------------------------------------

3. Exclusion
a. Comments
    Several commenters supported the Exclusion because they believed 
that it recognized the absence of a U.S. jurisdictional nexus.\134\ 
Nevertheless, these commenters requested that the Exclusion be expanded 
to include U.S. branches of non-U.S. CSEs and FCSs.\135\
---------------------------------------------------------------------------

    \134\ See ICI Global at 2, 5; IIB/SIFMA at 10.
    \135\ See id. See also ISDA at 3 (Exclusion should be expanded 
to include any swap between a non-U.S. CSE, whether or not 
guaranteed, and any non-U.S. person counterparty that is not 
guaranteed by a U.S. person).
---------------------------------------------------------------------------

    With respect to U.S. branches, IIB/SIFMA argued that distinguishing 
them would not be necessary from a risk-mitigation perspective because 
the risk remains with the non-U.S. CSE outside the United States 
regardless of whether the non-U.S. CSE involves U.S. personnel.\136\ 
ISDA and ICI Global further argued that treating U.S. branches 
differently from the rest of the CSE could create ``significant 
operational issues and credit risks.'' \137\ ICI Global stated that the 
same ISDA Master Agreement typically governs all transactions involving 
both the U.S. and non-U.S. branches of a non-U.S. CSE, and that not 
granting the Exclusion to swaps between a non-U.S. person and a U.S. 
branch of a non-U.S. CSE (whose obligations are not guaranteed by a 
U.S. person) may require parties to document transactions with the U.S. 
branch under a separate master agreement, which could create 
operational difficulties.\138\ ICI Global also expressed concern that 
disparate treatment of U.S. branches could lead to additional credit 
risk because counterparties might lose netting benefits under 
bankruptcy laws.\139\
---------------------------------------------------------------------------

    \136\ See IIB/SIFMA at 16.
    \137\ See IIB/SIFMA at 16; ICI Global at 10-11.
    \138\ See ICI Global at 10-11.
    \139\ See also ISDA at 11 (fragmenting netting sets could 
increase risk and discourage use and employment of U.S. personnel).
---------------------------------------------------------------------------

    With respect to FCSs, ICI Global argued that consolidation is 
insufficient to create a ``direct'' U.S. nexus because the U.S. 
ultimate parent is not under a legal obligation to support the 
FCS.\140\ IIB/SIFMA added that foreign jurisdictions have not proposed 
to apply margin rules to foreign, non-guaranteed subsidiaries and that 
the Commission should extend the Exclusion to avoid overlapping 
requirements that could lead market participants to avoid trading with 
an FCS.\141\ Although substituted compliance would potentially be 
available in place of the Exclusion, ISDA asserted that the difference 
between the Exclusion and substituted compliance is not costless, as 
affected swap dealers would incur costs of complying with any 
conditions imposed with respect to substituted compliance and with the 
Commission's exercise of its related examination authority, in addition 
to lost business that could result if substituted compliance is not 
``seamless'' and counterparties are ``inconvenienced'' by its 
application.\142\
---------------------------------------------------------------------------

    \140\ See ICI Global at 11. See also IIB/SIFMA at 14 (CEA 
section 2(i) does not authorize the Commission to regulate a foreign 
subsidiary solely due to potential for support from and risk to a 
U.S. parent entity because, absent a legal obligation to provide 
support, the ``chain of intervening factors and events'' that might 
lead to such support would not satisfy ``direct'' requirement in CEA 
section 2(i)).
    \141\ See IIB/SIFMA at 15.
    \142\ See id. at 7.
---------------------------------------------------------------------------

    As an alternative to extending the Exclusion to FCSs, IIB/SIFMA 
suggested that the Commission grant an exclusion to FCSs operating 
without a U.S. guarantee when transacting with non-U.S. persons 
operating without a U.S. guarantee, up to an aggregate 5 percent limit 
on the notional trading volume in uncleared swaps entered into by 
commonly controlled FCSs under the exclusion relative to the total 
notional swap trading volume of entities within the common U.S. 
ultimate parent entity's consolidated group.\143\ IIB/SIFMA argued that 
such a limited exclusion would achieve the Commission's risk mitigation 
objectives

[[Page 34831]]

without directly regulating wholly non-U.S. counterparties.\144\
---------------------------------------------------------------------------

    \143\ See IIB/SIFMA at 16.
    \144\ See id.
---------------------------------------------------------------------------

    Both AFR and Better Markets expressed support for the proposal not 
to extend the Exclusion to FCSs, describing it as a means of addressing 
the issue of de-guaranteeing.\145\ AFR nevertheless expressed concern 
that the Exclusion would apply to a non-U.S. CSE when entering into a 
swap with a foreign subsidiary that is a financial end user that has a 
U.S. ultimate parent, and suggested that the Commission also deny the 
Exclusion in this case.\146\ AFR also suggested that the Commission 
``supplement'' its approach by further denying the Exclusion to a non-
consolidated, non-U.S. subsidiary that could, based on the facts and 
circumstances, have a ``major impact on the financial well-being of the 
parent,'' including circumstances where the parent does not use U.S. 
GAAP accounting.\147\
---------------------------------------------------------------------------

    \145\ See AFR at 2 (proposed rule would go ``some distance'' 
toward limiting evasion of Commission's margin requirements); Better 
Markets at 5 (proposed rule ``adequately captures'' many foreign 
affiliates that may have escaped U.S. margin requirements through 
de-guaranteeing).
    \146\ See AFR at 8 (foreign subsidiary of a U.S. financial end 
user that is not a CSE would not be defined as an FCS even if 
consolidated).
    \147\ See AFR at 3. See also Better Markets at 2 (Exclusion is 
needlessly complicated and indirect and Commission should address 
issue more completely by reverting to and updating approach in 
Guidance).
---------------------------------------------------------------------------

b. Final Rule
    The Commission has determined to adopt the Exclusion largely as 
proposed, with a modification that preserves the Commission's intent 
with respect to the treatment of inter-affiliate swaps under the Final 
Margin Rule. Under the Final Rule, an uncleared swap entered into by a 
non-U.S. CSE with a non-U.S. counterparty (including a non-U.S. CSE) is 
excluded from the Commission's margin rules, provided that neither 
counterparty's obligations under the relevant swap are guaranteed by a 
U.S. person and neither counterparty is an FCS.\148\ This approach 
reflects the Commission's recognition of foreign jurisdictions' strong 
supervisory interest in the uncleared swaps of non-U.S. CSEs and their 
non-U.S. counterparties, both of which are domiciled and operate 
abroad. Under these circumstances, the Commission believes that it is 
appropriate to make a limited exception to the principle of firm-wide 
application of margin requirements, consistent with comity principles, 
so as to exclude a narrow class of uncleared swaps involving a non-U.S. 
CSE and a non-U.S. counterparty.\149\
---------------------------------------------------------------------------

    \148\ The Exclusion also does not apply if the counterparty is a 
U.S. branch of a non-U.S. CSE. See 17 CFR 23.160(b)(2)(ii).
    \149\ The Commission disagrees that the Commission lacks a 
jurisdictional nexus with respect to swaps subject to the Exclusion. 
To the contrary, as discussed above, by the terms of the relevant 
statutory provision, CEA section 4s(e), and the underlying purpose 
of that provision, the Commission's authority to adopt margin rules 
applies to all CSEs, U.S. and non-U.S., and extends to all of their 
uncleared swaps, regardless of the counterparties' domicile or the 
location of the swaps transaction.
---------------------------------------------------------------------------

    The Commission notes that a non-U.S. CSE that can avail itself of 
the Exclusion is still subject to the Commission's margin rules with 
respect to all other uncleared swaps (i.e., those that do not qualify 
for the Exclusion), with the possibility of substituted compliance. And 
any excluded swaps may be covered by the margin requirements of another 
jurisdiction that adheres to the BCBS-IOSCO framework.\150\ 
Additionally, the non-U.S. CSE would be subject to the Commission's 
capital requirements, which, as proposed, would impose a capital charge 
for uncollateralized exposures.\151\
---------------------------------------------------------------------------

    \150\ In this regard, the Commission notes that, as indicated in 
supra note 23, representatives of 26 regulatory authorities 
(comprising 17 nations) participated in the WGMR that developed the 
BCBS-IOSCO framework. As of today, 24 of these 26 regulatory 
authorities that participated in the WGMR have proposed a regulatory 
framework for margin for uncleared swaps, all of which are 
consistent with the BCBS-IOSCO framework. In addition, these 24 
regulatory authorities have jurisdiction over more than 90% of the 
swaps activities in the world by any measure.
    \151\ See Proposed Capital Rule, 76 FR 27802.
---------------------------------------------------------------------------

    The Commission considered comments urging a broader scope of the 
Exclusion to include, for example, any FCSs so long as their swaps are 
not guaranteed by a U.S. person or alternatively, do not exceed a ``de 
minimis'' level of swap activity. However, the Commission does not 
believe that extending the Exclusion to uncleared swaps of FCSs is 
appropriate given the nature of their relationship to their U.S. 
ultimate parent entity. The limited scope of the Exclusion reflects 
that the benefits of the margin requirement are achieved when it is 
applied to all CSEs and on a firm-wide basis and therefore, any 
exception needs to be carefully tailored to avoid creating a 
significant supervisory gap and inappropriate levels of risk to the CSE 
and the U.S. financial system.
    The Commission also disagrees with comments that the Exclusion is 
overly broad because it would extend to a swap between a non-U.S. CSE 
and a foreign subsidiary of a U.S. financial end user.\152\ The 
Commission notes that such a foreign subsidiary would not be an FCS 
even if it is consolidated with its U.S. parent because it is not a 
CSE. The Commission believes that a swap between such a foreign 
subsidiary and a non-U.S. CSE should be eligible for the Exclusion 
because financial end users are not covered swap entities and are 
likely to include many entities that do not conduct a significant level 
of swap activities; as such, their swap activities would not have the 
same effect on the U.S. ultimate parent entity as would a covered swap 
entity's. Therefore, the Exclusion applies to qualifying non-U.S. CSEs 
when transacting with foreign subsidiaries that are financial end users 
that have a U.S. ultimate parent entity.
---------------------------------------------------------------------------

    \152\ The term ``financial end user'' is defined in section 
23.150 of the Final Margin Rule.
---------------------------------------------------------------------------

    Under the Final Margin Rule, a CSE is not required to collect 
initial margin from its affiliate, provided, among other things, that 
affiliate collects initial margin on its market-facing swaps or is 
subject to comparable initial margin collection requirements (in the 
case of non-U.S. affiliates that are financial end users) on its own 
market-facing swaps. In order to preserve the Commission's intent with 
respect to the treatment of inter-affiliate swaps under the Final 
Margin Rule, the Exclusion is not available if the market-facing swap 
of the non-U.S. CSE (that is otherwise eligible for the Exclusion) is 
not subject to comparable initial margin collection requirements in the 
home jurisdiction and any of the risk associated with the uncleared 
swap is transferred, directly or indirectly, through inter-affiliate 
transactions, to a U.S. CSE or a U.S. Guaranteed CSE. This condition is 
intended to ensure that inter-affiliate swaps are not used to avoid the 
requirement to collect initial margin from third-parties.\153\ The 
limitation on the Exclusion is consistent with that rationale.
---------------------------------------------------------------------------

    \153\ See 17 CFR 23.159.
---------------------------------------------------------------------------

    Under the Final Rule, uncleared swaps of a U.S. branch of a non-
U.S. CSE are not eligible for the Exclusion. The Commission does not 
believe extending the Exclusion to U.S. Branches would be appropriate. 
Generally speaking, U.S. branches of foreign banks \154\ have a 
Prudential Regulator and must therefore comply with the Prudential 
Regulators' margin rules. The Prudential Regulators' Final Margin Rule 
does not grant an exclusion for the uncleared swaps of such U.S. 
branches on the basis that U.S. branches of foreign banks clearly 
operate within the United States and could pose risk to

[[Page 34832]]

the U.S. financial system.\155\ To the extent that a U.S. branch of a 
non-U.S. CSE is subject to the Commission's requirements rather than a 
Prudential Regulator, the Final Rule appropriately harmonizes with the 
Prudential Regulators.\156\ Additionally, given that U.S. branches 
operate within the United States, allowing their swaps to be excluded 
from application of the Commission's margin requirements could 
disadvantage U.S. CSEs when competing with U.S. branches for U.S. 
clients \157\ and create incentives for CSEs to operate through U.S. 
branches solely for purposes of avoiding the Dodd-Frank Act margin 
requirements. Accordingly, the Commission believes that a non-U.S. CSE 
should be subject to the Commission's margin requirements when 
conducting swap activities from within the United States by or through 
a U.S. branch.\158\
---------------------------------------------------------------------------

    \154\ See Prudential Regulators' Final Margin Rule, 80 FR at 
74901 (setting forth the definition of ``foreign bank'' for purposes 
of the Prudential Regulators' Final Margin Rule).
    \155\ See Prudential Regulators' Final Margin Rule, 80 FR at 
74883.
    \156\ Under the International Banking Act of 1978, 12 U.S.C. 
3101 et seq., U.S. branches are generally treated the same as 
national banks operating in that same location and are subject to 
the same laws, regulations, policies, and procedures that apply to 
national banks.
    \157\ That is, a U.S. branch of a non-U.S. CSE that is permitted 
to operate outside of the Commission's margin requirements may, by 
virtue of being subject to reduced or even no margin requirements, 
be able to offer a more competitive price to U.S. clients than a 
U.S. CSE.
    \158\ As noted above in section II.B.3.a., some commenters 
suggested that not extending the Exclusion to U.S. branches of non-
U.S. CSEs could require non-U.S. CSEs to document transactions with 
the U.S. branch under a separate ISDA Master Agreement, creating 
operational challenges. However, because such U.S. branches are 
eligible for substituted compliance, use of a separate credit 
support agreement to document transactions with a non-U.S. CSE's 
U.S. branch should only be necessary where foreign margin 
requirements are not comparable. Although the Commission 
acknowledges that the non-U.S. CSE may need to use a separate credit 
support agreement for U.S. branch transactions in this limited case, 
the Commission nevertheless believes that it would not be 
appropriate to extend the Exclusion to U.S. branches of non-U.S. 
CSEs for the reasons discussed above.
---------------------------------------------------------------------------

4. Special Provision for Non-Segregation Jurisdictions \159\
---------------------------------------------------------------------------

    \159\ The term ``emerging market'' is not used in the Final Rule 
because some jurisdictions covered by this provision of the Final 
Rule are not aptly described by that term.
---------------------------------------------------------------------------

a. Comments
    Several commenters supported the creation of a de minimis exception 
similar to the emerging markets exemption set out in the Guidance.\160\ 
Specifically, commenters recommended that U.S. CSEs be exempt from the 
margin requirements when trading with ``emerging market 
counterparties'' provided that the aggregate notional volume of its 
uncleared swaps with emerging market counterparties does not exceed 5 
percent of the CSEs' total notional swap trading volume, both cleared 
and uncleared.\161\ They further recommended defining ``emerging market 
counterparty'' as a non-U.S. person that is (a) not a registered CSE, 
(b) not guaranteed by a U.S. person, and (c) not located in a 
jurisdiction covered by a comparability determination for uncleared 
swaps margin rules issued by the Commission.\162\ Commenters generally 
agreed that the exception should apply to foreign branches of U.S. 
CSEs,\163\ but some commenters also recommended that it be extended to 
U.S. Guaranteed CSEs \164\ and FCSs.\165\ For swaps between U.S. 
Guaranteed CSEs and emerging market counterparties, ABA/ABASA and IIB/
SIFMA recommended that the de minimis threshold apply to the aggregate 
volume of uncleared swaps guaranteed by a particular U.S. person, 
rather than to the trading volume of the U.S. Guaranteed CSE 
itself.\166\
---------------------------------------------------------------------------

    \160\ See, e.g., ABA/ABASA at 3-5; IIB/SIFMA at 3, 11-13; ISDA 
at 2, 9-10; JBA at 10.
    \161\ See ABA/ABASA at 5. See also ISDA at 9-10 (further 
recommending that Commission impose recordkeeping requirement as 
condition to exemption, as was included in Guidance).
    \162\ See ABA/ABASA at 4-5; IIB/SIFMA at 13. See also ISDA at 9 
(``emerging market counterparty'' should be defined as any non-U.S. 
person that is not guaranteed by a U.S. person and that is not 
located in one of six jurisdictions identified in Guidance as having 
submitted requests for comparability determinations).
    \163\ See ABA/ABASA at 1 n.5 (exemption should apply to ``U.S.-
based banking organizations, however they are operating in emerging 
markets, including, but not limited to, through a foreign branch of 
a prudentially-regulated CSE''); IIB/SIFMA; ISDA.
    \164\ See ABA/ABASA at 1 n.5, 3; IIB/SIFMA at 12; ISDA at 9.
    \165\ See ISDA at 10 (availability of the exemption should be 
extended to FCSs if Commission does not otherwise make Exclusion 
available to them).
    \166\ See ABA/ABASA at 5; IIB/SIFMA at 13 (approach would be 
appropriate given that risk to U.S. guarantor provides basis for 
extraterritorial application of margin rules to U.S. Guaranteed 
CSEs).
---------------------------------------------------------------------------

    In support of such an exception, commenters argued that legal and 
operational constraints in emerging market jurisdictions could make 
compliance with margin rules difficult, if not impossible.\167\ As a 
result, broad application of the margin requirements to these swaps 
could negatively impact the competitiveness of registered CSEs.\168\ 
Commenters argued that by limiting the exception to CSEs with a de 
minimis level of swaps activity, the Commission could accomplish the 
goal of ensuring a CSE's safety and soundness but with less disruption 
to existing business relationships than the exchange of initial and 
variation margin would impose.\169\ IIB/SIFMA also argued that the 
exception would be consistent with CEA section 2(i), and encouraged the 
Commission to coordinate with foreign regulators to develop a 
consistent global approach to swaps with emerging market 
counterparties.\170\
---------------------------------------------------------------------------

    \167\ See, e.g., ABA/ABASA at 4 (local banking sector may lack 
operational infrastructure to support daily exchange of margin or 
third-party custodial arrangements); IIB/SIFMA (local legal regime 
may not recognize concept of netting); ISDA at 4 (emerging market 
counterparties may be unable to comply with U.S. margin 
requirements).
    \168\ See ABA/ABASA at 4 (absent an exemption, U.S. CSEs could 
lose not only derivatives business but associated commercial and 
investment banking relationships); IIB/SIFMA at 12 (emerging market 
counterparties are likely to move business away from U.S. CSEs and 
U.S. Guaranteed CSEs in order to avoid being subject to margin 
requirements); ISDA at 10 (dealing activities that would fall within 
exemption may be an ``integral element'' of CSEs' global business).
    \169\ See ABA/ABASA at 3; IIB/SIFMA at 12-13; ISDA at 10.
    \170\ See IIB/SIFMA at 12 (arguing that de minimis nature of 
exemption ensures that nexus of swap activity to the United States 
is not ``significant'').
---------------------------------------------------------------------------

b. Final Rule
    The Commission is adopting a special provision for swaps with 
counterparties in foreign jurisdictions where limitations in the legal 
or operational infrastructure of the jurisdiction make it impracticable 
for the CSE and its counterparty to comply with the custodial 
arrangement requirements in the Final Margin Rule (``non-segregation 
jurisdictions'').\171\ The Commission understands that CSEs may 
transact swaps with counterparties located in foreign jurisdictions 
that do not have legal or operational infrastructures to support 
custodial arrangements required under the Final Margin Rule.\172\ In 
the face of these legal and operational impediments, FCSs and foreign 
branches of U.S. CSEs would be forced to discontinue their swaps 
business with clients located in these jurisdictions. Taking these 
factors into consideration, the Commission has determined to include a 
special provision to accommodate this unique circumstance. The 
Commission notes that the Prudential Regulators adopted a similar 
provision in their final margin rules.
---------------------------------------------------------------------------

    \171\ For convenience, the term ``non-segregation jurisdiction'' 
is used in the preamble of this release.
    \172\ The Final Margin Rule addresses the manner in which the 
margin collected or posted by a CSE must be held and requires, among 
other things, that the CSE must have a custodial agreement 
prohibiting rehypothecation or otherwise transfer the initial margin 
held by the custodian. See 17 CFR 23.157. The custodial requirements 
are critical to ensuring the proper segregation and protection of 
CSE funds.
---------------------------------------------------------------------------

    Under section 23.160(e) of the Final Rule, an FCS or a foreign 
branch of a U.S. CSE would be eligible to engage in

[[Page 34833]]

uncleared swaps with certain non-U.S. counterparties in non-segregation 
jurisdictions, without complying with either the requirement to post 
initial margin \173\ or the custodial arrangement requirements that 
pertain to initial margin collected by a CSE under the Final Margin 
Rule,\174\ subject to certain conditions.\175\ This special provision 
reflects the Commission's recognition that CSEs would otherwise be 
precluded from engaging in any uncleared swaps in these foreign 
jurisdictions as they cannot satisfy the custodial requirements of the 
Final Margin Rule. The Commission clarifies that the special provision 
for non-segregation jurisdictions only provides relief from the 
specified requirements; all other margin rules in part 23 of the 
Commission's regulations (with the exception of the special provision 
for non-netting jurisdictions) would continue to apply.\176\
---------------------------------------------------------------------------

    \173\ See 17 CFR 23.152(b).
    \174\ See 17 CFR 23.157(b). The Commission notes that with 
respect to initial margin collected by a qualifying CSE in a non-
segregation jurisdiction in reliance on Sec.  23.160(e), Sec.  
23.157(c) also would not apply to initial margin that is collected 
by the CSE. Section 23.157(c) requires a CSE to enter a custodial 
agreement meeting specified requirements with respect to any funds 
that the CSE holds (i.e., initial margin posted or collected by the 
CSE). Because CSEs that rely on Sec.  23.160(e) are not required to 
hold collateral in accordance with Sec.  23.157(b) for initial 
margin that they collect, they also would not be required to comply 
with Sec.  23.157(c) with respect to initial margin that they 
collect.
    \175\ This provision only provides relief from the custodial 
requirement for collection of initial margin in Sec.  23.157(b). 
Accordingly, FCSs and foreign branches of U.S. CSEs remain subject 
to the requirements of Sec.  23.157(a) and (c) of the Final Margin 
Rule with respect to initial margin that is posted in a non-
segregation jurisdiction (which the CSE would be unable to comply 
with in a non-segregation jurisdiction).
    \176\ If the special provision for non-segregation jurisdictions 
is available, then the special provision for non-netting 
jurisdictions (discussed in the next section) would not be available 
even if the relevant foreign jurisdiction is also a ``non-netting 
jurisdiction.'' As explained in supra note 174, because CSEs that 
rely on Sec.  23.160(e) are not required to hold collateral in 
accordance with Sec.  23.157(b) for initial margin that they 
collect, they would not be required to comply with Sec.  23.157(c) 
with respect to initial margin that they collect.
---------------------------------------------------------------------------

    This provision is narrowly tailored to limit its availability to 
FCSs (and foreign branches of U.S. CSEs) in foreign jurisdictions where 
compliance with the Final Margin Rule's custodial requirements is 
effectively precluded due to impediments inherent in the relevant 
foreign jurisdiction.\177\ In addition, this provision is only 
available in such jurisdictions if the following conditions are 
satisfied. First, the CSE's counterparty must be a non-U.S. person that 
is not a CSE, and the counterparty's obligations under the swap must 
not be guaranteed by a U.S. person.\178\ Second, the CSE must collect 
initial margin in cash on a gross basis, and post and collect variation 
margin in cash, in accordance with the Final Margin Rule.\179\ The 
collection of margin on a gross basis ensures that the CSE has adequate 
collateral in the event of a counterparty or custodial default; 
similarly, not requiring the CSE to post initial margin minimizes the 
amount of collateral that may not be recovered if the CSE's 
counterparty defaults. Third, for each broad risk category set out in 
section 23.154(b)(2)(v) of the Final Margin Rule,\180\ the total 
outstanding notional value of all uncleared swaps in that broad risk 
category, as to which the CSE is relying on section 23.160(e), may not 
exceed 5 percent of the CSE's total outstanding notional value for all 
uncleared swaps in the same broad risk category. Accordingly, a 5 
percent limit applies to each of the four broad risk categories set 
forth in section 23.154(b)(2)(v): Credit, equity, foreign exchange and 
interest rates (considered together as a single asset class), and 
commodities. Fourth, the CSE must have policies and procedures ensuring 
that it is in compliance with all of the requirements of this 
exception. Fifth, the CSE must maintain books and records properly 
documenting that all of the requirements of this exception are 
satisfied.\181\
---------------------------------------------------------------------------

    \177\ The special provision applies where inherent limitations 
in the legal or operational infrastructure in the applicable foreign 
jurisdiction make it impracticable for the FCS (or foreign branch of 
a U.S. CSE) and its counterparty to post initial margin in 
compliance with the custodial requirements of Sec.  23.157 of the 
Final Margin Rule. The special provision does not apply if the CSE 
that is subject to the foreign regulatory restrictions is permitted 
to post collateral for the uncleared swap in compliance with the 
custodial arrangements of Sec.  23.157 in the United States or a 
jurisdiction for which the Commission has issued a comparability 
determination with respect to Sec.  23.157. See 17 CFR 23.160(e)(1) 
and (2).
    \178\ The Commission would expect the CSE's counterparty to be a 
local financial end user that is required to comply with the foreign 
jurisdiction's laws and that is prevented by regulatory restrictions 
in the foreign jurisdiction from posting collateral for the 
uncleared swap in compliance with the custodial arrangements of 
Sec.  23.157 in the United States or a jurisdiction for which the 
Commission has issued a comparability determination under the Final 
Rule, even using an affiliate.
    \179\ The CSE must collect initial margin in accordance with 
Sec.  23.152(a) on a gross basis, in the form of cash pursuant to 
Sec.  23.156(a)(1)(i) and post and collect variation margin in 
accordance with Sec.  23.153(a) in the form of cash pursuant to 
Sec.  23.156(a)(1)(i). See Sec.  23.160(e)(4) of the Final Rule.
    \180\ Section 23.154(b)(2)(v) of the Final Margin Rule permits a 
CSE to use an internal initial margin model that reflects offsetting 
exposures, diversification, and other hedging benefits within four 
broad risk categories: Credit, equity, foreign exchange and interest 
rates (considered together as a single asset class), and commodities 
when calculating initial margin for a particular counterparty if the 
uncleared swaps are executed under the same ``eligible master 
netting agreement.'' See 17 CFR 23.154(b)(2)(v).
    \181\ See 17 CFR 23.160(e).
---------------------------------------------------------------------------

    In adopting this provision, the Commission considered the various 
alternatives endorsed by commenters, including the adoption of a 
blanket exclusion, subject to a transactional volume limit (e.g., using 
a 5 percent limit patterned after a limited exclusion for certain 
jurisdictions in the Guidance, as discussed in section II.B.4.a. 
above). However, given the importance of the Final Margin Rule's 
requirements to the protection of CSEs and the broader financial 
system, and the potential for a blanket exclusion to incentivize market 
participants to structure their swap business solely to avoid 
application of the Commission's margin requirements, the Commission 
believes that a more targeted approach that provides relief from only 
from the requirement to post initial margin and the custodial 
arrangement requirements that pertain to initial margin collected by a 
CSE, as described above, is appropriate. While the Commission believes 
that the relief provided by the special provision is appropriate 
because FCSs and foreign branches of U.S. CSEs would otherwise be 
effectively precluded from entering swaps in non-segregation 
jurisdictions, the Commission also believes that, in order to protect 
the safety and soundness of FCSs and foreign branches of U.S. CSEs 
relying on the special provision, the exception from the specified 
requirements is appropriately limited, as these CSEs are integral to 
the stability of the U.S. financial system.
    Therefore, rather than provide an exception from all of the 
Commission's margin requirements to CSEs that engage in swaps 
activities in non-segregation jurisdictions up to a 5% limit, as 
suggested by some commenters, the special provision only excepts 
qualifying FCSs and foreign branches of U.S. CSEs from certain 
specified requirements, subject to specified conditions (including a 5 
percent limit in each of four broad risk categories set forth in Sec.  
23.154(b)(2)(v)), as described above. The Commission believes that 
imposing a 5 percent limit in each of the four broad risk categories 
set out in Sec.  23.154(b)(2)(v) is necessary because the FCS (or 
foreign branch of a U.S. CSE) may have a large notional amount 
outstanding in the foreign exchange and interest rate category (which 
is considered together as a single class) which would effectively 
eviscerate any limit in other lower notional risk categories.
    The Commission believes that the total outstanding notional value 
of all

[[Page 34834]]

uncleared swaps as to which an FCS relies on Sec.  23.160(e) should not 
exceed 5 percent of the FCS's total outstanding notional amount of 
uncleared swaps (in each of the four broad risk categories), rather 
than the total notional outstanding amount of uncleared swaps of its 
ultimate parent entity. Using the ultimate parent entity's swap 
activity as the basis for the formula could allow the FCS to engage in 
significant levels of swap activity in non-segregation jurisdictions 
based on swap activities of its affiliates, rendering the 5 percent 
limit meaningless. In addition, as an FCS is a registered CSE, its swap 
activities with U.S. persons were sufficient to require its 
registration in the United States, and therefore its swap activity in 
the non-segregation jurisdiction would never account for all of the 
CSE's swap dealing activity.
5. Special Provision for Non-Netting Jurisdictions
a. Comments
    Commenters generally agreed that, at a minimum, the Commission 
should provide an exception for swaps with counterparties located in 
jurisdictions in which netting, collateral or third party custodial 
arrangements may not be legally effective, including in a 
counterparty's insolvency.\182\ ISDA and JBA proposed that an exception 
for non-netting jurisdictions should apply up to 5 percent of the 
aggregate notional amount of a CSE's uncleared swaps.\183\ They argued 
that, without enforceable netting and collateral arrangements, a 
bankruptcy administrator could ``cherry pick'' when determining the 
return of posted collateral in the event of insolvency.\184\ ISDA 
further argued that imposing margin in such cases could severely limit 
swaps activity in non-netting jurisdictions and cause significant 
disruptions in financial markets.\185\
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    \182\ See ABA/ABASA at 5 n.14; IIB/SIFMA at 13 n.44; ISDA at 10 
(requesting an exemption for jurisdictions where getting a ``clean'' 
netting or collateral opinion is ``not possible''); JBA at 10.
    \183\ See ISDA at 10; JBA at 10.
    \184\ See ISDA at 10 (further arguing that a CSE may not be able 
to effectively foreclose on margin in event of a counterparty 
default); JBA at 10.
    \185\ See ISDA at 10.
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    ISDA and JBA further recommended that, absent an exception for non-
netting jurisdictions, CSEs should have at least some exception from 
the requirement to collect or post margin.\186\ According to ISDA, 
without such an exception, a CSE could be prevented from applying 
collateral to the obligations of the counterparty and face difficulties 
in recovering it.\187\ ISDA argued that posting margin could therefore 
increase risk to the CSE, while an exception could bypass segregation 
problems in the non-netting jurisdiction.\188\
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    \186\ See ISDA at 10-11 (requesting exemption from requirement 
to post initial margin); JBA at 10 (requesting exemption from both 
initial and variation margin requirements because, under such 
conditions, amount of variation margin to be posted or collected 
cannot be fixed).
    \187\ See ISDA at 11.
    \188\ See id.
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b. Final Rule
    The Commission is adopting a special provision, also included in 
the Prudential Regulators' Final Margin Rule, for non-netting 
jurisdictions.\189\ Under the Final Rule, a CSE that cannot conclude, 
with a well-founded basis, that the netting agreement with a 
counterparty in a foreign jurisdiction meets the definition of an 
``eligible master netting agreement'' set forth in the Final Margin 
Rule may nevertheless net uncleared swaps in determining the amount of 
margin that it posts, provided that certain conditions are met.\190\ In 
order to avail itself of this special provision, the CSE must treat the 
uncleared swaps covered by the agreement on a gross basis in 
determining the amount of initial and variation margin that it must 
collect, but may net those uncleared swaps in determining the amount of 
initial and variation margin it must post to the counterparty, in 
accordance with the netting provisions of the Final Margin Rule.\191\ 
Requiring CSEs to calculate and collect initial margin on a gross basis 
is intended to ensure that the CSE can obtain the collateral posted 
with the counterparty in the event of counterparty default. As with the 
special provision for non-segregation jurisdictions in section 
23.160(e) of the Final Rule, this provision is carefully tailored to 
allow CSEs to enter into uncleared swaps in ``non-netting'' 
jurisdictions but without abandoning the key protections behind the 
netting requirement under the Final Margin Rule. A CSE that enters into 
uncleared swaps in ``non-netting'' jurisdictions in reliance on this 
provision must have policies and procedures ensuring that it is in 
compliance with the special provision's requirements, and maintain 
books and records properly documenting that all of the requirements of 
this exception are satisfied.\192\
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    \189\ As used in this release, a ``non-netting jurisdiction'' is 
a jurisdiction in which a CSE cannot conclude, with a well-founded 
basis, that the netting agreement with a counterparty in that 
foreign jurisdiction meets the definition of an ``eligible master 
netting agreement'' set forth in the Final Margin Rule. See 17 CFR 
23.151.
    \190\ The Final Margin Rule permits offsets in relation to 
either initial margin or variation margin calculation when (among 
other things), the offsets related to swaps are subject to the same 
eligible master netting agreement. This ensures that CSEs can 
effectively foreclose on the margin in the event of a counterparty 
default, and avoids the risk that the administrator of an insolvent 
counterparty will ``cherry-pick'' from posted collateral to be 
returned.
    \191\ As noted above, in the event that the special provision 
for non-segregation jurisdictions applies to a CSE, then the special 
provision for non-netting jurisdictions would not apply to the CSE 
even if the relevant jurisdiction is also a ``non-netting 
jurisdiction.'' In this circumstance, the CSE must collect the gross 
amount of initial margin in cash (but would not be required to post 
initial margin), and post and collect variation margin in cash in 
accordance with the requirements of the special provision for non-
segregation jurisdictions, as discussed in section II.B.4.b.
    \192\ See Sec.  23.160(d) of the Final Rule.
---------------------------------------------------------------------------

    The Commission considered ISDA's request that it adopt a blanket 
exclusion, subject to a percentage limitation based on the level of 
swap activity. However, the Commission believes that a blanket 
exclusion, even with a transactional limit, presents a significant risk 
that the safety and soundness of a CSE engaged in swaps in non-netting 
jurisdictions would be insufficiently protected because, without the 
collection of sufficient margin, the CSE could be unduly exposed to 
counterparty default. The Commission also considered, but determined to 
not adopt, ISDA's request that posting to counterparties in non-netting 
jurisdictions not be required.\193\ Because the posting requirement 
serves to limit the ability of a CSE to assume excessive risk, the 
Commission believes that CSEs should be required to post margin in 
order to advance the objectives of the margin mandate.
---------------------------------------------------------------------------

    \193\ The Commission agrees with commenters that without 
enforceable netting and collateral arrangements, there is a risk 
that the administrator of an insolvent counterparty will ``cherry-
pick'' from posted collateral to be returned in the event of 
insolvency. This would result in an increase in the risk in posting 
collateral, because a CSE may not be able to effectively foreclose 
on the margin in the event its counterparty defaults.
---------------------------------------------------------------------------

C. Comparability Determinations

    As discussed above, consistent with CEA section 2(i) and comity 
principles, the Final Rule permits eligible CSEs to rely on substituted 
compliance to the extent that the Commission determines the relevant 
foreign jurisdiction's margin requirements are comparable to the 
Commission's. Specifically, the Final Rule outlines a framework for the 
Commission's comparability determinations, including eligibility and 
submission requirements for requesters and the Commission's standard of 
review for making comparability determinations.\194\
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    \194\ See 17 CFR 23.160(c).

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[[Page 34835]]

1. Proposed Rule
    As proposed, section 23.160(c) established a process for requesting 
comparability determinations. Specifically, the proposed rule 
identified persons eligible to request a comparability determination 
(CSEs eligible to rely on substituted compliance and any relevant 
foreign regulatory authorities) and the information and documentation 
they should provide the Commission, including how the relevant foreign 
jurisdiction's margin requirements address the various elements of the 
Commission's margin regime (e.g., the products and entities subject to 
margin requirements).
    The proposed rule also identified several factors the Commission 
would consider in making a comparability determination, such as how the 
relevant foreign margin requirements compare to International Standards 
\195\ and whether they achieve comparable outcomes to the Commission's 
requirements. The Commission explained that its analysis would follow 
an outcome-based approach, one that would focus on evaluating the 
outcomes and objectives of the foreign margin requirements and not 
require them to be identical to the Commission's margin 
requirements.\196\ The Commission further explained that it would 
review a foreign margin regime's comparability on an element-by-element 
basis, such that a foreign jurisdiction's margin requirements could be 
deemed comparable with respect to some elements of the Commission's 
margin requirements and not others.\197\ The Commission made clear, 
however, that consistent with its outcome-based approach, a 
comparability determination could be appropriate even if the foreign 
jurisdiction approaches an element differently.\198\
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    \195\ See proposed 17 CFR 23.160(a)(3) (defining ``International 
Standards'' as based on the BCBS-IOSCO framework).
    \196\ See Proposal, 80 FR at 41389.
    \197\ See id.
    \198\ See id. (``[T]he Commission would evaluate whether a 
foreign jurisdiction has rules and regulations that achieve 
comparable outcomes. If it does, the Commission believes that a 
comparability determination may be appropriate, even if there may be 
differences in the specific elements of a particular regulatory 
provision.'').
---------------------------------------------------------------------------

    The proposed rule concluded by explaining the regulatory effect of 
complying with a foreign jurisdiction's margin requirements in reliance 
on a comparability determination, such that a violation of a foreign 
margin requirement could constitute a violation of the Commission's 
corresponding requirement. It also codified the Commission's authority 
to condition or otherwise modify any comparability determination it 
issues.
    The Commission requested comment on all aspects of proposed Sec.  
23.160(c).\199\
---------------------------------------------------------------------------

    \199\ The Commission also requested comment on the scope of the 
Commission's proposed substituted compliance regime, whether the 
Commission should develop an interim process for comparability 
determinations that would take into account differing implementation 
timeliness for margin rules by other foreign jurisdictions, and the 
need for an emerging markets exception. Comments received in 
response to these questions were addressed above.
---------------------------------------------------------------------------

2. Comments
    Commenters generally focused on the Commission's proposed approach 
to evaluating the comparability of a foreign jurisdiction's margin 
regime.\200\ Commenters supported an approach that would focus on the 
regulatory objectives and outcomes of the relevant margin regimes and 
not require uniformity with the Commission's rule provisions.\201\ JBA, 
for instance, urged the Commission not to deny a comparability 
determination because a Commission rule is ``stricter,'' but to focus 
on whether the substance of the foreign jurisdiction's rules 
effectively achieves the objective of mitigating risk.\202\
---------------------------------------------------------------------------

    \200\ See proposed 17 CFR 23.160(c)(2)-(3); Proposal, 80 FR at 
41389-90.
    \201\ See, e.g., AIMA/IA at 3-4 (absent ``automatic substituted 
compliance'' for any transaction involving an entity from a 
jurisdiction that participated in the WGMR, Commission should make 
comparability determinations based ``on broad comparability of 
requirements rather than detailed correspondence of rules''); ICI 
Global at 9-10; IIB/SIFMA at 3; ISDA at 7; JBA at 9; Vanguard at 3.
    \202\ See JBA at 9 (for example, while Commission's proposed 
margin rule with respect to eligible collateral for variation margin 
was narrower in scope than rule proposed by European or Japanese 
authorities, foreign regulations are not necessarily less effective 
from a risk mitigation perspective).
---------------------------------------------------------------------------

    Commenters expressed concern, however, that the Commission's 
proposed approach was overly complicated and would undermine an 
outcome-based approach.\203\ IIB/SIFMA described the Commission's 
proposed approach as too ``granular,'' requiring ``consistency at a 
level of detail that ignores the overall risk mitigating impact'' of a 
foreign jurisdiction's margin regime.\204\ IIB/SIFMA suggested that the 
``test for comparability'' should be ``whether differences between the 
regimes would, in the aggregate, create a significant and unacceptable 
level of risk to CSEs or the U.S. financial system.'' \205\
---------------------------------------------------------------------------

    \203\ See, e.g., ICI Global at 10 (proposed approach to 
determining comparability is ``unnecessarily complicated'' and 
effectively requires comparability with respect to ``each particular 
aspect'' of the foreign jurisdiction's margin regime); ISDA at 7 
(``complexity and specificity'' of Commission's proposed approach is 
``not consistent with a general outcome-based approach'').
    \204\ See IIB/SIFMA at 9 (element-by-element approach would 
result in ``stricter-rule-applies'' approach).
    \205\ See id. at 10 (margin regimes that comply with 
International Standards would likely satisfy such a test).
---------------------------------------------------------------------------

    Commenters also expressed concern that issuing comparability 
determinations with respect to some but not all of a foreign 
jurisdiction's margin requirements would be challenging and costly to 
implement.\206\ As a result, market participants would either default 
to the Commission's margin requirements, undercutting the benefits of 
substituted compliance,\207\ or modify their cross-border activities to 
avoid Commission regulation, increasing market fragmentation.\208\ ISDA 
further argued that an element-by-element approach would be 
inconsistent with the goals of the BCBS-IOSCO framework to avoid 
``duplicative or conflicting margin requirements'' and ensuring 
``substantial certainty'' as to which country's margin rules 
apply.\209\ Commenters urged the Commission to evaluate and issue a 
comparability determination for a foreign jurisdiction's margin regime 
as a whole.\210\
---------------------------------------------------------------------------

    \206\ See, e.g., PensionsEurope at 2 (there are ``some 
benefits'' to an element-by-element approach but, by creating 
potential for partial comparability determinations, proposed rule 
would add ``a significant amount of complexity'' and ``likely create 
more problems than it solves''); SIFMA AMG at 8 (``the potential for 
piecemeal comparability determinations'' would lead to 
``uncertainty, compliance difficulties and the potential for margin 
disputes''); Vanguard at 4-5 (market participants would be required 
to develop and implement a new system designed to apply the 
Commission's comparability determinations and ensure simultaneous 
compliance with two sets of rules).
    \207\ See, e.g., ICI Global at 10; IIB/SIFMA at 9; SIFMA at 8 
(Commission's prior issuance of partial comparability determinations 
with respect to swap trading relationship documentation led to 
confusion and disagreements regarding which rule sections may be 
complied with via substituted compliance).
    \208\ See IIB/SIFMA at 9; SIFMA AMG at 7.
    \209\ See ISDA at 8 (highlighting background discussion of 
element 7 of the BCBS-IOSCO framework (interaction of national 
regimes in cross-border transactions), which encourages cooperation 
among regulatory regimes to produce ``sufficiently consistent and 
non-duplicative'' margin requirements).
    \210\ See, e.g., ICI Global at 2, 10 (Commission should 
``consider [] the margin rules of a jurisdiction in their entirety'' 
and not ``mak[e] determinations for each element of the margin 
rules''); IIB/SIFMA at 9-10; SIFMA AMG at 8; Vanguard at 4-5.
---------------------------------------------------------------------------

    A majority of commenters also encouraged the Commission to make 
consistency with the BCBS-IOSCO framework the primary focus of its 
comparability determinations.\211\ FSR

[[Page 34836]]

suggested that the Commission ignore whether the foreign margin 
requirements achieve comparable outcomes to the Commission's margin 
requirements \212\ and make consistency with International Standards 
the sole basis of its analysis.\213\ FSR argued that the ``purpose and 
driving force'' of the BCBS-IOSCO framework was to create a ``uniform 
global standard'' and that the Commission would undermine that goal if 
it were to deny a comparability determination when the foreign margin 
regime conforms to International Standards.\214\ Thus, FSR recommended 
that the Commission issue a comparability determination to any regime 
that complies with the International Standards despite any divergence 
from the Commission's rules.\215\ IIB/SIFMA argued that margin regimes 
that adhere to the BCBS-IOSCO framework are ``highly unlikely'' to 
demonstrate ``material differences'' in the degree to which they reduce 
aggregate risk,\216\ adding that issuing comparability determinations 
based on consistency with the BCBS-IOSCO framework would further the 
goal of international harmonization promoted by BCBS-IOSCO and 
Congress.\217\
---------------------------------------------------------------------------

    \211\ See, e.g., AIMA/IA at 3; FSR at 2-5; ISDA at 7; SIFMA AMG 
at 8; Vanguard at 5.
    \212\ See proposed 17 CFR 23.160(c)(3)(iii).
    \213\ See FSR at 5-6.
    \214\ See id. at 3-4 (pointing to differences in the approaches 
proposed by the European Market Infrastructure Regulation and the 
Commission with regard to certain topics (e.g., eligible collateral 
for variation margin) and expressing concern that, under the 
Proposal, the Commission would reject comparability even though both 
proposed approaches are consistent with BCBS-IOSCO framework).
    \215\ See id. at 3. See also Vanguard at 5 (``unique local legal 
or market structure issues'' may render certain individual elements 
of a foreign jurisdiction's margin regime not comparable to 
Commission's margin rules but foreign regime's ``overall outcome'' 
may nevertheless be consistent with BCBS-IOSCO framework).
    \216\ See id. at 2 (BCBS-IOSCO framework-compliant regimes would 
impose ``full, daily variation margin requirements and stringent 
initial margin requirements'').
    \217\ See id. at 3 (citing Dodd-Frank section 752(a)). See also 
SIFMA AMG 7.
---------------------------------------------------------------------------

    AFR, on the other hand, argued that foreign margin rules should not 
qualify for substituted compliance on the basis that they follow 
International Standards alone.\218\ AFR stated that the Commission's 
proposed margin rules evidenced ``a number of important differences'' 
from the BCBS-IOSCO framework and that, given the broad availability of 
substituted compliance in the proposed rule, issuing comparability 
determinations solely on the basis of consistency with International 
Standards could lead to ``excessive opportunities for substituted 
compliance.'' \219\
---------------------------------------------------------------------------

    \218\ See AFR at 7.
    \219\ See id. See also IATP at 4 (provide appendix illustrating 
``comparable and quantitative outcomes of swaps margining in other 
jurisdictions with those under Commission authority, once margining 
requirements and margin calculation methodology are agreed in those 
jurisdictions'').
---------------------------------------------------------------------------

3. Final Rule
    After a careful review of the comments, the Commission is adopting 
Sec.  23.160(c) as proposed, but is providing some additional 
clarifications in response to commenters. The rule begins by 
identifying persons eligible to request a comparability determination 
with respect to the Commission's margin requirements, including any CSE 
that is eligible for substituted compliance under rule Sec.  23.160 
\220\ and any foreign regulatory authority that has direct supervisory 
authority over one or more CSEs and that is responsible for 
administering the relevant foreign jurisdiction's margin 
requirements.\221\ Eligible persons may request a comparability 
determination individually or collectively and with respect to some or 
all of the Commission's margin requirements. Eligible CSEs may wish to 
coordinate with their home regulators and other CSEs in order to 
simplify and streamline the process. The Commission will make 
comparability determinations on a jurisdiction-by-jurisdiction basis.
---------------------------------------------------------------------------

    \220\ See 17 CFR 23.160(c)(1)(i).
    \221\ See 17 CFR 23.160(c)(1)(ii).
---------------------------------------------------------------------------

    Persons requesting comparability determinations should provide the 
Commission with certain documents and information in support of their 
request. Notably, the Final Rule provides that requesters should 
provide copies of the relevant foreign jurisdiction's margin 
requirements \222\ and descriptions of their objectives,\223\ how they 
differ from the International Standards,\224\ and how they address the 
elements of the Commission's margin requirements.\225\ With regard to 
how the foreign margin requirements address the elements of the 
Commission's margin requirements, the description should identify the 
specific legal and regulatory provisions that correspond to each 
element and, if necessary, whether the relevant foreign jurisdiction's 
margin requirements do not address a particular element.\226\ 
Requesters should also provide a description of the ability of the 
relevant foreign regulatory authority or authorities to supervise and 
enforce compliance with the relevant foreign jurisdiction's margin 
requirements \227\ and any other information and documentation the 
Commission deems appropriate.\228\
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    \222\ See 17 CFR 23.160(c)(2)(v).
    \223\ See 17 CFR 23.160(c)(2)(i).
    \224\ See 17 CFR 23.160(c)(2)(iii). See also 17 CFR 23.160(a)(3) 
(defining ``International Standards'' as based on the BCBS-IOSCO 
framework).
    \225\ See 17 CFR 23.160(c)(2)(ii) (identifying the elements as: 
(A) The products subject to the foreign jurisdiction's margin 
requirements; (B) the entities subject to the foreign jurisdiction's 
margin requirements; (C) the treatment of inter-affiliate derivative 
transactions; (D) the methodologies for calculating the amounts of 
initial and variation margin; (E) the process and standards for 
approving models for calculating initial and variation margin 
models; (F) the timing and manner in which initial and variation 
margin must be collected and/or paid; (G) any threshold levels or 
amounts; (H) risk management controls for the calculation of initial 
and variation margin; (I) eligible collateral for initial and 
variation margin; (J) the requirements of custodial arrangements, 
including segregation of margin and rehypothecation; (K) margin 
documentation requirements; and (L) the cross-border application of 
the foreign jurisdiction's margin regime). Section 23.160(c)(2)(ii) 
largely tracks the elements of the BCBS-IOSCO framework, but breaks 
them down into their components as appropriate to ensure ease of 
application.
    \226\ See id.
    \227\ See 17 CFR 23.160(c)(2)(iv) (requesting that such 
description discuss the powers of the foreign regulatory authority 
or authorities to supervise, investigate, and discipline entities 
for compliance with the margin requirements and the ongoing efforts 
of the regulatory authority or authorities to detect and deter 
violations of the margin requirements).
    \228\ See 17 CFR 23.160(c)(2)(vi). See also 17 CFR 23.160(c)(7) 
(delegating authority to request additional information and/or 
documentation to the Director of the Division of Swap Dealer and 
Intermediary Oversight, or such other employee or employees as the 
Director may designate from time to time).
---------------------------------------------------------------------------

    The Final Rule identifies certain key factors that the Commission 
will consider in making a comparability determination. Specifically, 
the Commission will consider the scope and objectives of the relevant 
foreign jurisdiction's margin requirements; \229\ whether the relevant 
foreign jurisdiction's margin requirements achieve comparable outcomes 
to the Commission's corresponding margin requirements; \230\ and the 
ability of the relevant regulatory authority or authorities to 
supervise and enforce compliance with the relevant foreign 
jurisdiction's margin requirements.\231\
---------------------------------------------------------------------------

    \229\ See 17 CFR 23.160(c)(3)(i). See also 17 CFR 23.160(a)(3) 
(defining ``International Standards'' as based on the BCBS-IOSCO 
framework).
    \230\ See proposed 17 CFR 23.160(c)(3)(ii). As discussed above, 
the Commission's Final Margin Rule is based on the International 
Standards; therefore, the Commission expects that the relevant 
foreign margin requirements would conform to the International 
Standards at minimum in order to be deemed comparable to the 
Commission's corresponding margin requirements.
    \231\ See 17 CFR 23.160(c)(3)(iii). See also supra note 227; 17 
CFR 23.160(c)(3)(iv) (indicating the Commission would also consider 
any other relevant facts and circumstances).
---------------------------------------------------------------------------

    As indicated in the proposed rule, the Final Rule reflects an 
outcome-based approach to assessing the comparability of a foreign 
jurisdiction's margin

[[Page 34837]]

requirements. Instead of demanding strict uniformity with the 
Commission's margin requirements, the Commission will evaluate the 
objectives and outcomes of the foreign margin requirements in light of 
foreign regulator(s)' supervisory and enforcement authority. 
Recognizing that jurisdictions may adopt different approaches to 
achieving the same outcome, the Commission will focus on whether the 
foreign jurisdiction's margin requirements are comparable to the 
Commission's in purpose and effect, not whether they are comparable in 
every aspect or contain identical elements.
    As commenters noted, the Commission was actively involved in 
developing the BCBS-IOSCO framework, and the Commission believes that 
the minimum standards it establishes are consistent with the objectives 
of the Commission's own margin requirements. However, while the BCBS-
IOSCO framework establishes minimum standards that are consistent with 
the objectives of the Commission's own margin requirements, the 
Commission notes that just because a foreign jurisdiction's margin 
requirements are consistent with International Standards does not 
necessarily mean that they will be comparable to the Commission's 
requirements.\232\ Consequently, in the Commission's view, consistency 
with International Standards is necessary but may not be sufficient to 
finding comparability.\233\
---------------------------------------------------------------------------

    \232\ The BCBS-IOSCO framework leaves certain elements open to 
interpretation (e.g., the definition of ``derivative'') and 
expressly invites regulators to build on certain principles as 
appropriate. See, e.g., Element 4 (eligible collateral) (national 
regulators should ``develop their own list of eligible collateral 
assets based on the key principle, taking into account the 
conditions of their own markets''); Element 5 (initial margin) (the 
degree to which margin should be protected would be affected by 
``the local bankruptcy regime, and would vary across 
jurisdictions''); Element 6 (transactions with affiliates) 
(``Transactions between a firm and its affiliates should be subject 
to appropriate regulation in a manner consistent with each 
jurisdiction's legal and regulatory framework.'').
    \233\ As the Commission noted above, the Final Margin Rule 
included substantial modifications from the Proposed Margin Rule 
that further aligned the Commission's margin requirements with 
International Standards and, as a result, the potential for conflict 
with foreign margin requirements should be reduced. See supra note 
29. The Commission further notes that whether a particular margin 
requirement in a foreign jurisdiction is comparable to the 
Commission's corresponding requirement entails a fact-specific 
analysis.
---------------------------------------------------------------------------

    As stated in the proposed rule, the Commission will review the 
foreign margin requirements on an element-by-element basis.\234\ Margin 
regimes are complex structures made up of a number of interrelated 
components, and differences in how jurisdictions approach and assemble 
those components are inevitable, even among jurisdictions that base 
their margin requirements on the principles and requirements set forth 
in the BCBS-IOSCO framework. In order to arrive at a meaningful and 
complete comparability determination, the Commission must therefore 
engage in a fact-specific analysis to develop a clear understanding of 
the elements of the foreign margin regime and how they interact. The 
Commission believes this level of review will support its outcome-based 
approach by aiding its assessment of whether such differences affect 
comparability.
---------------------------------------------------------------------------

    \234\ See 17 CFR 23.160(c)(2) (specifying that persons 
requesting comparability determinations should provide the 
Commission with documentation and information relating to each 
element of the Commission's margin requirements).
---------------------------------------------------------------------------

    As indicated in the proposed rule, the Commission is allowing for 
the possibility that a comparability determination may not include all 
elements of a foreign jurisdiction's margin regime.\235\ The Commission 
believes that this position is preferable to an all-or-nothing 
approach, in which the Commission would be unable to make a 
comparability determination for an entire jurisdiction if one or more 
aspects of the foreign jurisdiction's margin regime results in an 
outcome that is critically different from that of the Commission's.
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    \235\ For example, the Commission may determine that a foreign 
jurisdiction's margin regime is comparable with respect to its 
variation margin requirements but not with respect to custodial 
arrangements, including segregation and rehypothecation 
requirements.
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    The Final Rule provides that any CSE that, in accordance with a 
comparability determination, complies with a foreign jurisdiction's 
margin requirements will be deemed in compliance with the Commission's 
corresponding margin requirements.\236\ Accordingly, if the Commission 
determines that a CSE has failed to comply with the relevant foreign 
margin requirements, it could initiate an action for a violation of the 
Commission's margin requirements. In addition, all CSEs remain subject 
to the Commission's examination and enforcement authority regardless of 
whether they rely on a comparability determination. Although the Final 
Rule does not obligate the Commission to consult with or rely on the 
advice of the foreign regulatory authority in making its determination 
regarding whether a violation of foreign margin requirements has 
occurred, the Commission notes that Commission staff may consult with 
the relevant foreign regulatory authority to assist the Commission in 
making its determination.
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    \236\ See 17 CFR 23.160(c)(4).
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    The Final Rule concludes by codifying the Commission's authority to 
impose any terms and conditions it deems appropriate in issuing a 
comparability determination,\237\ and to further condition, modify, 
suspend, terminate or otherwise restrict any comparability 
determination it has issued in its discretion.\238\
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    \237\ See 17 CFR 23.160(c)(5).
    \238\ See 17 CFR 23.160(c)(6). For instance, a comparability 
determination may require modification or termination if a key basis 
for the determination ceases to be true.
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    Comparability determinations issued by the Commission will require 
that the Commission be notified of any material changes to information 
submitted in support of a comparability determination, including, but 
not limited to, changes in the relevant foreign jurisdiction's 
supervisory or regulatory regime. The Commission also expects that the 
relevant foreign regulator will enter into, or will have entered into, 
an appropriate memorandum of understanding (``MOU'') or similar 
arrangement with the Commission in connection with a comparability 
determination.\239\
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    \239\ Under Commission regulations 23.203 and 23.606, registered 
swap dealers and major swap participants must maintain all records 
required by the CEA and the Commission's regulations in accordance 
with Commission regulation 1.31 and keep them open for inspection by 
representatives of the Commission, the United States Department of 
Justice, or any applicable prudential regulator. See 17 CFR 23.203, 
23.606. The Commission further expects that prompt access to books 
and records and the ability to inspect and examine a non-U.S. CSE 
will be a condition to any comparability determination.
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    As stated above, the Commission recognizes that systemic risks 
arising from the global and interconnected swap market must be 
addressed through coordinated regulatory requirements for margin across 
international jurisdictions. Accordingly, the Commission will continue 
its practice of actively engaging market participants and consulting 
closely with foreign regulators to encourage the international 
harmonization and coordination of margin requirements for uncleared 
swaps and to minimize market disruptions.

III. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') requires that agencies 
consider whether the regulations they propose will have a significant 
economic impact on a substantial number of small

[[Page 34838]]

entities.\240\ The Commission previously has established certain 
definitions of ``small entities'' to be used in evaluating the impact 
of its regulations on small entities in accordance with the RFA.\241\ 
The final regulation establishes a mechanism for CSEs \242\ to satisfy 
margin requirements by complying with comparable margin requirements in 
the relevant foreign jurisdiction as described in paragraph (c) of the 
Final Rule,\243\ but only to the extent that the Commission makes a 
determination that complying with the laws of such foreign jurisdiction 
is comparable to complying with the corresponding margin requirement(s) 
for which the determination is sought.
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    \240\ 5 U.S.C. 601 et seq.
    \241\ See 47 FR 18618 (Apr. 30, 1982) (finding that designated 
contract markets, future commission merchants, commodity pool 
operators and large traders are not small entities for RFA 
purposes).
    \242\ See 17 CFR 23.151 (defining ``CSE'' as a swap dealer or 
major swap participant for which there is no Prudential Regulator).
    \243\ See 17 CFR 23.160(c).
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    The Commission previously has determined that swap dealers and 
major swap participants are not small entities for purposes of the 
RFA.\244\ Thus, the Commission is of the view that there will not be 
any small entities directly impacted by this rule.
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    \244\ See 77 FR 30596, 30701 (May 23, 2012); 77 FR 2613, 2620 
(Jan. 19, 2012) (noting that like future commission merchants, swap 
dealers will be subject to minimum capital requirements, and are 
expected to be comprised of large firms, and that major swap 
participants should not be considered to be small entities for 
essentially the same reasons that it previously had determined large 
traders not to be small entities).
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    The Commission notes that under the Final Margin Rule, swap dealers 
and major swap participants would only be required to collect and post 
margin on uncleared swaps when the counterparties to the uncleared 
swaps are either other swap dealers and major swap participants or 
financial end users. As noted above, swap dealers and major swap 
participants are not small entities for RFA purposes. Furthermore, any 
financial end users that may be indirectly \245\ impacted by the Final 
Rule would be similar to eligible contract participants (``ECPs''), 
and, as such, they would not be small entities.\246\ Further, to the 
extent that there are any foreign financial entities that would not be 
considered ECPs, the Commission expects that there would not be a 
substantial number of these entities significantly impacted by the 
Final Rule. As noted above, most foreign financial entities would 
likely be ECPs to the extent they would transact in uncleared swaps. 
The Commission expects that only a small number of foreign financial 
entities that are not ECPs, if any, would transact in uncleared swaps. 
In addition, the material swaps exposure threshold for financial end 
users in the Final Margin Rule reinforces the Commission's expectation 
that only a small number of entities would be affected by the Final 
Rule.
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    \245\ The RFA focuses on direct impact to small entities and not 
on indirect impacts on these businesses, which may be tenuous and 
difficult to discern. See Mid-Tex Elec. Coop., Inc. v. FERC, 773 
F.2d 327, 340 (D.C. Cir. 1985); Am. Trucking Assns. v. EPA, 175 F.3d 
1027, 1043 (D.C. Cir. 1985).
    \246\ As noted in paragraph (1)(xii) of the definition of 
``financial end user'' in Sec.  23.151 of the Final Margin Rule, a 
financial end user includes a person that would be a financial 
entity described in paragraphs (1)(i)-(xi) of that definition, if it 
were organized under the laws of the United States or any State 
thereof. See 17 CFR 23.151. The Commission believes that this prong 
of the definition of financial end user captures the same type of 
U.S. financial end users that are ECPs, but for them being foreign 
financial entities. Therefore, for purposes of the Commission's RFA 
analysis, these foreign financial end users will be considered ECPs 
and therefore, like ECPs in the U.S., not small entities.
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    Accordingly, the Commission finds that there will not be a 
substantial number of small entities impacted by the Final Rule. 
Therefore, the Chairman, on behalf of the Commission, hereby certifies 
pursuant to 5 U.S.C. 605(b) that the proposed regulations will not have 
a significant economic impact on a substantial number of small 
entities.

B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \247\ imposes certain 
requirements on Federal agencies, including the Commission, in 
connection with their conducting or sponsoring any collection of 
information, as defined by the PRA. This final rulemaking will result 
in the collection of information requirements within the meaning of the 
PRA, as discussed below. Responses to these collections of information 
will be required to obtain or retain benefits. An agency may not 
conduct or sponsor, and a person is not required to respond to, a 
collection of information unless it displays a currently valid control 
number. One of the collections of information required by this final 
rulemaking, which is described below under the heading ``Information 
Collection--Comparability Determinations,'' was previously included in 
the proposed rule and discussed in the Proposal. Accordingly, the 
Commission requested from the Office of Management and Budget (``OMB'') 
a control number for that information collection. OMB assigned OMB 
control number 3038-0111. The title for this collection of information 
is ``Margin Requirements for Uncleared Swaps for Swap Dealers and Major 
Swap Participants; Comparability Determinations with Margin 
Requirements.'' No comments were received on the paperwork burden 
associated with this information collection request. In addition, this 
final rulemaking includes two additional collections of information 
that were not previously proposed, which are described below under the 
headings ``Information Collection--Non-Segregation Jurisdictions'' and 
``Information Collection--Non-Netting Jurisdictions,'' respectively. 
Accordingly, the Commission, by separate notice published in the 
Federal Register concurrently with this Final Rule, will request 
approval by OMB of this new information collection under OMB Control 
Number 3038-0111.
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    \247\ 44 U.S.C. 3501 et seq.
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1. Information Collection--Comparability Determinations
    Section 731 of the Dodd-Frank Act amended the CEA to add, as 
section 4s(e) thereof, provisions concerning the setting of initial and 
variation margin requirements for swap dealers and major swap 
participants. Each swap dealer and major swap participant for which 
there is a Prudential Regulator, as defined in section 1a(39) of the 
CEA, must meet margin requirements established by the applicable 
Prudential Regulator, and each CSE must comply with the Commission's 
regulations governing margin. With regard to the cross-border 
application of the swap provisions enacted by Title VII of the Dodd-
Frank Act, section 2(i) of the CEA provides the Commission with express 
authority over activities outside the United States relating to swaps 
when certain conditions are met. Section 2(i) of the CEA provides that 
the CEA's provisions relating to swaps enacted by Title VII of the 
Dodd-Frank Act (including Commission rules and regulations promulgated 
thereunder) shall not apply to activities outside the United States 
unless those activities (1) have a direct and significant connection 
with activities in, or effect on, commerce of the United States or (2) 
contravene such rules or regulations as the Commission may prescribe or 
promulgate as are necessary or appropriate to prevent the evasion of 
any provision of Title VII.\248\ Because margin requirements are 
critical to ensuring the safety and soundness of a CSE and supporting 
the stability of the U.S. financial markets, the Commission believes 
that its margin rules should

[[Page 34839]]

apply on a cross-border basis in a manner that effectively addresses 
risks to the registered CSE and the U.S. financial system.
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    \248\ 7 U.S.C. 2(i).
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    As noted above, the Final Rule establishes margin requirements for 
uncleared swaps of CSEs, with substituted compliance available in 
certain circumstances, except as to a narrow class of uncleared swaps 
between a non-U.S. CSE and a non-U.S. counterparty that fall within the 
Exclusion. The Final Rule also establishes a procedural framework in 
which the Commission will consider permitting compliance with 
comparable margin requirements in a foreign jurisdiction to substitute 
for compliance with the Commission's margin requirements in certain 
circumstances. The Commission will consider whether the requirements of 
such foreign jurisdiction with respect to margin of uncleared swaps are 
comparable to the Commission's margin requirements.
    Specifically, the Final Rule provides that a CSE that is eligible 
for substituted compliance may submit a request, individually or 
collectively, for a comparability determination.\249\ Persons 
requesting a comparability determination may coordinate their 
application with other market participants and their home regulators to 
simplify and streamline the process. Once a comparability determination 
is made for a jurisdiction, it will apply for all entities or 
transactions in that jurisdiction to the extent provided in the 
determination, as approved by the Commission. In providing information 
to the Commission for a comparability determination, applicants must 
include, at a minimum, information describing any differences between 
the relevant foreign jurisdiction's margin requirements and 
International Standards,\250\ and the specific provisions of the 
foreign jurisdiction that govern: (A) The products subject to the 
foreign jurisdiction's margin requirements; (B) the entities subject to 
the foreign jurisdiction's margin requirements; (C) the treatment of 
inter-affiliate derivative transactions; (D) the methodologies for 
calculating the amounts of initial and variation margin; (E) the 
process and standards for approving models for calculating initial and 
variation margin models; (F) the timing and manner in which initial and 
variation margin must be collected and/or paid; (G) any threshold 
levels or amounts; (H) risk management controls for the calculation of 
initial and variation margin; (I) eligible collateral for initial and 
variation margin; (J) the requirements of custodial arrangements, 
including segregation of margin and rehypothecation; (K) margin 
documentation requirements; and (L) the cross-border application of the 
foreign jurisdiction's margin regime.\251\
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    \249\ A CSE may apply for a comparability determination only if 
the uncleared swap activities of the CSE are directly supervised by 
the authorities administering the foreign regulatory framework for 
uncleared swaps. Also, a foreign regulatory agency may make a 
request for a comparability determination only if that agency has 
direct supervisory authority to administer the foreign regulatory 
framework for uncleared swaps in the requested foreign jurisdiction.
    \250\ See 17 CFR 23.160(a)(3) (defining ``International 
Standards'' as based on the BCBS-IOSCO framework).
    \251\ See 17 CFR 23.160(c)(2)(ii).
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    In addition, the Commission expects the applicant, at a minimum, to 
describe how the foreign jurisdiction's margin requirements address 
each of the above-referenced elements, and identify the specific legal 
and regulatory provisions that correspond to each element (and, if 
necessary, whether the relevant foreign jurisdiction's margin 
requirements do not address a particular element). Further, the 
applicant must describe the objectives of the foreign jurisdiction's 
margin requirements, the ability of the relevant regulatory authority 
or authorities to supervise and enforce compliance with the foreign 
jurisdiction's margin requirements, including the powers of the foreign 
regulatory authority or authorities to supervise, investigate, and 
discipline entities for noncompliance with the margin requirements and 
the ongoing efforts of the regulatory authority or authorities to 
detect and deter violations of the margin requirements. Finally, the 
applicant must furnish copies of the foreign jurisdiction's margin 
requirements (including an English translation of any foreign language 
document) and any other information and documentation that the 
Commission deems appropriate.\252\
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    \252\ See 17 CFR 23.160(c)(2)(v) and (vi).
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    In issuing a comparability determination, the Commission may impose 
any terms and conditions it deems appropriate. In addition, the Final 
Rule will provide that the Commission may, on its own initiative, 
further condition, modify, suspend, terminate, or otherwise restrict a 
comparability determination in the Commission's discretion. This could 
result, for example, from a situation where, after the Commission 
issues a comparability determination, the basis of that determination 
ceases to be true. In this regard, the Commission will require an 
applicant to notify the Commission of any material changes to 
information submitted in support of a comparability determination 
(including, but not limited to, changes in the foreign jurisdiction's 
supervisory or regulatory regime) as the Commission's comparability 
determination may no longer be valid.\253\
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    \253\ The Commission expects to impose this obligation as one of 
the conditions to the issuance of a comparability determination.
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    The collection of information that is proposed by this rulemaking 
is necessary to implement section 4s(e) of the CEA, which mandates that 
the Commission adopt rules establishing minimum initial and variation 
margin requirements for CSEs on all swaps that are not cleared by a 
registered derivatives clearing organization, and section 2(i) of the 
CEA, which provides that the provisions of the CEA relating to swaps 
that were enacted by Title VII of the Dodd-Frank Act (including any 
rule prescribed or regulation promulgated thereunder) apply to 
activities outside the United States that have a direct and significant 
connection with activities in, or effect on, commerce of the United 
States. Further, the information collection is necessary for the 
Commission to determine whether the requirements of the foreign rules 
are comparable to the Commission's rules.
    As noted above, any CSE who is eligible for substituted compliance 
may make a request for a comparability determination. Currently, there 
are approximately 106 swap entities provisionally registered with the 
Commission. The Commission further estimates that of the approximately 
106 swap entities that are provisionally registered, approximately 54 
are CSEs that are subject to the Commission's margin rules as they are 
not subject to a Prudential Regulator. The Commission notes that any 
foreign regulatory agency that has direct supervisory authority over 
one or more CSEs and that is responsible to administer the relevant 
foreign jurisdiction's margin requirements may also apply for a 
comparability determination. Further, once a comparability 
determination is made for a jurisdiction, it will apply for all 
entities or transactions in that jurisdiction to the extent provided in 
the determination, as approved by the Commission. The Commission 
estimates that it will receive requests for a comparability 
determination from 17 jurisdictions, consisting of the 16 jurisdictions 
within the G20, plus Switzerland, and that each request will impose an 
average of 10 burden hours.
    Based upon the above, the estimated hour burden for collection is 
calculated as follows:

[[Page 34840]]

    Number of respondents: 17.
    Frequency of collection: Once.
    Estimated annual responses per registrant: 1.
    Estimated aggregate number of annual responses: 17.
    Estimated annual hour burden per registrant: 10 hours.
    Estimated aggregate annual hour burden: 170 hours (17 registrants x 
10 hours per registrant).
2. Information Collection--Non-Segregation Jurisdictions
    Section 23.160(e) of the Final Rule provides that, in certain 
foreign jurisdictions where inherent limitations in the legal or 
operational infrastructure of the jurisdiction make it impracticable 
for the CSE and its counterparty to post initial margin for the 
uncleared swap pursuant to custodial arrangements that comply with the 
Commission's margin rules, an FCS or a foreign branch of a U.S. CSE may 
be eligible to engage in uncleared swaps with certain non-U.S. 
counterparties without complying with the requirement to post initial 
margin, and without complying with the requirement to hold initial 
margin collected by the CSE with one or more custodians that are not 
the CSE, its counterparty, or an affiliate of the CSE or its 
counterparty, pursuant to section 23.157(b) of the Final Margin 
Rule,\254\ but only if certain conditions are satisfied.\255\ In order 
to rely on this provision, an FCS or foreign branch of a U.S. CSE will 
need to satisfy all of the conditions of the rule, including that (1) 
inherent limitations in the legal or operational infrastructure of the 
foreign jurisdiction make it impracticable for the CSE and its 
counterparty to post any form of eligible initial margin collateral for 
the uncleared swap pursuant to custodial arrangements that comply with 
the Commission's margin rules; (2) foreign regulatory restrictions 
require the CSE to transact in uncleared swaps with the counterparty 
through an establishment within the foreign jurisdiction and do not 
permit the posting of collateral for the swap in compliance with the 
custodial arrangements of section 23.157 of the Final Margin Rule in 
the United States or a jurisdiction for which the Commission has issued 
a comparability determination under the Final Rule with respect to 
section 23.157; (3) the CSE's counterparty is not a U.S. person and is 
not a CSE, and the counterparty's obligations under the uncleared swap 
are not guaranteed by a U.S. person; \256\ (4) the CSE collects initial 
margin in cash on a gross basis, in cash, and posts and collects 
variation margin in cash, for the uncleared swap in accordance with the 
Final Margin Rule; \257\ (5) for each broad risk category, as set out 
in section 23.154(b)(2)(v) of the Final Margin Rule, the total 
outstanding notional value of all uncleared swaps in that broad risk 
category, as to which the CSE is relying on section 23.160 (e), may not 
exceed 5 percent of the CSE's total outstanding notional value for all 
uncleared swaps in the same broad risk category; (6) the CSE has 
policies and procedures ensuring that it is in compliance with the 
requirements of this provision; and (7) the CSE maintains books and 
records properly documenting that all of the requirements of this 
provision are satisfied.\258\
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    \254\ As explained further in note 174, because CSEs that rely 
on section 23.160(e) are not required to hold collateral in 
accordance with section 23.157(b) for initial margin that they 
collect, they also would not be required to comply with 23.157(c) 
with respect to initial margin that they collect.
    \255\ CSEs that are not FCSs or foreign branches of U.S. CSEs 
and are not otherwise excluded from the Final Margin Rule could not 
engage in swap transactions in these jurisdictions.
    \256\ As noted above, the Commission would expect the CSE's 
counterparty to be a local financial end user that is required to 
comply with the foreign jurisdiction's laws and that is prevented by 
regulatory restrictions in the foreign jurisdiction from posting 
collateral for the uncleared swap in the United States or a 
jurisdiction for which the Commission has issued a comparability 
determination under the Final Rule, even using an affiliate.
    \257\ As noted above, the CSE must collect initial margin in 
accordance with Sec.  23.152(a) on a gross basis, in the form of 
cash pursuant to Sec.  23.156(a)(1)(i) and post and collect 
variation margin in accordance with section 23.153(a) in the form of 
cash pursuant to section 23.156(a)(1)(i). See Sec.  23.160(e)(4) of 
the Final Rule.
    \258\ See 17 CFR 23.160(e).
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3. Information Collection--Non-Netting Jurisdictions
    Section 23.160(d) of the Final Rule includes a special provision 
for non-netting jurisdictions. This provision allows CSEs that cannot 
conclude after sufficient legal review with a well-founded basis that 
the netting agreement with a counterparty in a foreign jurisdiction 
meets the definition of an ``eligible master netting agreement'' set 
forth in the Final Margin Rule to nevertheless net uncleared swaps in 
determining the amount of margin that they post, provided that certain 
conditions are met. In order to avail itself of this special provision, 
the CSE must treat the uncleared swaps covered by the agreement on a 
gross basis in determining the amount of initial and variation margin 
that it must collect, but may net those uncleared swaps in determining 
the amount of initial and variation margin it must post to the 
counterparty, in accordance with the netting provisions of the Final 
Margin Rule. A CSE that enters into uncleared swaps in ``non-netting'' 
jurisdictions in reliance on this provision must have policies and 
procedures ensuring that it is in compliance with the special 
provision's requirements, and maintain books and records properly 
documenting that all of the requirements of this exception are 
satisfied.\259\
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    \259\ See Sec.  23.160(d) of the Final Rule.
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    As noted above, the Commission is publishing a separate notice in 
the Federal Register concurrently with this final rule requesting 
comments on the burden estimates of both new information collections to 
amend OMB Control Number 3038-0111.

C. Cost-Benefit Considerations

1. Introduction
    As discussed above, the Final Rule addresses the cross-border 
application of the Commission's margin requirements. Specifically, the 
Final Rule establishes certain key definitions (``U.S. person,'' 
``guarantee,'' and ``Foreign Consolidated Subsidiary''); allows CSEs to 
rely on substituted compliance where appropriate; provides a limited 
Exclusion for certain transactions between non-U.S. persons; includes 
special provisions for ``non-segregation jurisdictions'' \260\ and 
``non-netting jurisdictions;'' \261\ and establishes a framework for 
making comparability determinations.
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    \260\ As used in this release, a ``non-segregation 
jurisdiction'' is a jurisdiction where inherent limitations in the 
legal or operational infrastructure of the foreign jurisdiction make 
it impracticable for the CSE and its counterparty to post initial 
margin pursuant to custodial arrangements that comply with the Final 
Margin Rule, as further described in section II.B.4.b.
    \261\ As used in this release, a ``non-netting jurisdiction'' is 
a jurisdiction in which a CSE cannot conclude, with a well-founded 
basis, that the netting agreement with a counterparty in that 
foreign jurisdiction meets the definition of an ``eligible master 
netting agreement'' set forth in the Final Margin Rule, as described 
in section II.B.5.b.
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    In the sections that follow, the Commission discusses the costs and 
benefits associated with the Final Rule on CSEs and affected market 
participants and any reasonable alternatives.\262\ Given a general lack 
of useful data regarding the costs and benefits of the Final Rule, from 
commenters or otherwise, and the considerable uncertainty given that 
foreign jurisdictions are at different

[[Page 34841]]

stages in implementing their regimes, the costs and benefits of the 
Final Rule are generally considered in qualitative terms.
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    \262\ As stated above, the Commission estimates that the Final 
Rule will affect approximately 54 registered swap dealers and major 
swap participants. The Commission further estimates that it will 
receive requests for a comparability determination from 17 
jurisdictions.
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    The baseline against which the costs and benefits of this Final 
Rule are being compared is the status quo, i.e., the swap market as it 
exists as if the Final Margin Rule is in full effect.\263\ The cost-
benefit considerations section of the Final Margin Rule made clear that 
CEA section 4s(e), read together with CEA section 2(i), applies the 
margin rules to a CSE's swap activities outside the United States, 
regardless of the domicile of the CSE or its counterparties.\264\ 
Accordingly, in considering the costs and benefits of this Final Rule, 
the Commission focused on the impact of permitting substituted 
compliance and certain exclusions from the Final Margin Rule.\265\
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    \263\ 81 FR 636 (Jan. 6, 2016) (codified at 17 CFR parts 23 and 
140). As the Commission noted above, the Final Margin Rule included 
substantial modifications from the Proposed Margin Rule that further 
aligned the Commission's margin requirements with International 
Standards and, as a result, the potential for conflict with foreign 
margin requirements should be reduced. See supra note 29.
    \264\ See Final Margin Rule, 81 FR at 682. The Commission notes 
that to the extent there may be differences in the particulars of 
costs to foreign CSEs or financial end users, the Commission had not 
been provided with information that would permit the evaluation of 
any such differences.
    \265\ As noted in the Final Margin Rule, as foreign 
jurisdictions adopt their own margin rules, the existence of those 
rules may affect the costs and benefits of the Final Margin Rule. 
See Final Margin Rule, 81 FR at 682, n.359. For example, if certain 
transactions become subject to duplicative foreign regulation, that 
could increase costs, or reduce benefits, of compliance with the 
Final Margin Rule. Because of the still developing state of foreign 
law in this area and the absence of specific information on the 
subject in the record, it was not possible to evaluate such effects 
in detail in the Final Margin Rule release. In this rulemaking, the 
same limitations do not permit a detailed evaluation of such 
possible effects in the present proceeding and therefore, the 
Commission discusses these possible effects in general qualitative 
terms.
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    The Commission is mindful of the potentially significant tradeoffs 
inherent in the Final Rule. As discussed above, given the highly-
interconnected, global swap market, overseas risk can quickly manifest 
in the United States. The cross-border application of the Commission's 
margin rules is therefore important to protecting the U.S. financial 
system from this risk. At the same time, competitive distortions and 
market inefficiencies can result--and the benefits of the Commission's 
cross-border framework could be reduced--if due consideration is not 
given to comity principles. The Commission considered these tradeoffs 
and worked to carefully tailor the cross-border approach in the Final 
Rule to address comity considerations, mitigate the potential for undue 
market distortions, and promote global coordination without 
compromising the safety and soundness of CSEs.
    Although commenters generally did not comment on the cost-benefit 
discussion in the proposed rule itself,\266\ they did discuss various 
costs and benefits associated with the Commission's proposal. These 
comments are further addressed in the context of the Commission's cost-
benefit considerations below.
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    \266\ But see IATP at 7 (Commission's assumptions about costs 
and benefits of the Proposal were accurate considering the current 
``stage of foreign jurisdiction rulemaking'' relating to margin 
requirements); ABA/ABASA at 3 (Proposal did not adequately take into 
account the costs of the proposed approach); ISDA at 5 (Proposal did 
not give ``due weight'' to its impact on price discovery, risk 
management, increased compliance and liquidity costs, market 
fragmentation, or comity).
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2. Key Definitions
    The extent to which the Commission's margin requirements apply--and 
the availability of substituted compliance and the Exclusion--depends 
on whether the relevant swap involves a U.S. person, a guarantee by a 
U.S. person, or a Foreign Consolidated subsidiary. As discussed above, 
the Final Rule adopts definitions of ``U.S. person,'' ``guarantee,'' 
and ``Foreign Consolidated Subsidiary'' solely for purposes of the 
margin rules. The costs and benefits associated with these definitions, 
and any reasonable alternatives, are discussed below. In general, the 
Commission believes that the clear, objective nature of these terms, 
along with the ability to rely on related written counterparty 
representations, will promote legal certainty and help minimize the 
costs associated with applying the Final Rule.
a. U.S. Person
    As discussed in section II.A.1., the term ``U.S. person'' 
identifies individuals or entities whose activities have a significant 
nexus to the U.S. market by virtue of being organized or domiciled in 
the United States or the depth of their connection to the U.S. market, 
even if they are domiciled or organized outside the United States. The 
Final Rule generally follows a traditional, territorial approach to 
defining a U.S. person, and the Commission believes that this 
definition provides an objective and clear basis for determining those 
individuals or entities that should be identified as a U.S. person. 
Accordingly, the Commission does not believe market participants will 
face significant costs in assessing their own U.S. person status, 
particularly given the broad similarities between how the Final Rule 
defines ``U.S. person'' and how the term is defined in the SEC's rules. 
The Final Rule also makes clear that market participants may reasonably 
rely on counterparty representations regarding their U.S. person status 
absent indications to the contrary, which should further reduce any 
operational costs associated with assessing U.S. person status.
    The Final Rule addresses many of the concerns commenters raised 
regarding the costs and benefits of its proposed approach to defining 
``U.S. person.'' As discussed above, the Final Rule does not include a 
U.S. majority-owned prong, which commenters argued would create 
operational burdens for assessing U.S. person status and result in 
regulatory overlap. Nor does it include a catchall provision, limiting 
the Rule's application to a list of enumerated persons.
    The Commission recognizes that, as commenters pointed out, legal 
entities that fall within the unlimited U.S. responsibility prong may 
also be subject to regulation under a foreign margin regime, creating 
the potential for overlapping requirements. However, as discussed in 
section II.A.1.c., the Commission believes that the unique nature of 
the relationship between the legal entity and its U.S. person owner(s) 
facilitates the legal entity's swap business and creates a significant 
nexus between the legal entity and U.S. financial markets. While the 
Commission understands that limiting application of the prong to 
circumstances where the U.S. persons are majority owners of the legal 
entity could mitigate the potential for overlapping requirements, as 
the Commission explained above, the U.S. person owner(s) responsibility 
for the legal entity's obligations and liabilities is unlimited 
regardless of the amount of equity it owns in the legal entity. 
Furthermore, excluding such legal entities from the scope of the U.S. 
person definition could create incentives for U.S. persons to establish 
such legal entities and use them as a pass-through for their own swap 
activities solely for purposes of avoiding the margin requirements of 
the Dodd-Frank Act.
    The Commission also recognizes that further narrowing the 
differences between the Final Rule's U.S. person definition and either 
the SEC's definition or the ``U.S. person'' interpretation in the 
Guidance could provide certain benefits. Namely, market participants 
could enjoy reduced operational costs by relying on existing systems 
and U.S. person status

[[Page 34842]]

determinations and not having to support multiple meanings of the term 
``U.S. person.'' As discussed above, however, the Commission believes 
that the Final Rule's ``U.S. person'' definition is appropriate in the 
context of the margin rule. The Commission further believes that the 
objective and clear definition set out in the Final Rule will result in 
a lower overall cost for assessing U.S. person status going forward.
b. Guarantees
    As explained in section II.A.2.c., under the Final Rule, the term 
``guarantee'' is defined to include arrangements, pursuant to which one 
party to an uncleared swap has rights of recourse against a guarantor, 
with respect to its counterparty's obligations under the uncleared 
swap. The Final Rule further defines what it means for a party to have 
rights of recourse, and further encompasses any arrangement pursuant to 
which the guarantor itself has a conditional or unconditional legally 
enforceable right to receive or otherwise collect, in whole or in part, 
payments from any other guarantor with respect to the counterparty's 
obligations under the uncleared swap.\267\ As further explained in 
section II.B.2.b.i, ``U.S. Guaranteed CSEs'' \268\ are eligible for 
substituted compliance, but are ineligible for the Exclusion and the 
special provision for non-segregation jurisdictions, to the same extent 
as U.S. CSEs (except that foreign branches of U.S. CSEs may be eligible 
for the special provision for non-segregation jurisdictions, as 
described in section II.B.4.b.).\269\
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    \267\ See 17 CFR 23.160(a)(2). As noted above, under the Final 
Rule, the term ``guarantee'' applies whenever a party to the swap 
has a legally enforceable right of recourse against a guarantor with 
respect to its counterparty's obligations under the swap, regardless 
of whether such right of recourse is conditioned upon the 
counterparty's insolvency or failure to meet its obligations under 
the relevant swap, or whether the counterparty seeking to enforce 
the guarantee is required to make a demand for payment or 
performance from its counterparty before proceeding against the U.S. 
guarantor.
    \268\ This release uses the term ``U.S. Guaranteed CSE'' for 
convenience only. Whether a non-U.S. CSE falls within the meaning of 
the term ``U.S. Guaranteed CSE'' varies on a swap-by-swap basis, 
such that a non-U.S. CSE may be considered a U.S. Guaranteed CSE for 
one swap and not another, depending on whether the non-U.S. CSE's 
obligations under such swap are guaranteed by a U.S. person.
    \269\ As further discussed above, the Final Rule generally 
treats uncleared swaps of non-U.S. CSEs, where the non-U.S. CSE's 
obligations under the uncleared swap are guaranteed by a U.S. 
person, the same as uncleared swaps of a U.S. CSE. In addition, 
guarantees may affect whether full or partial substituted compliance 
is available. Further, under the Final Rule, the Exclusion is not 
available if either party's obligations under the swap are 
guaranteed by a U.S. person. In addition, in order for an FCS or 
foreign branch of a U.S. CSE to engage in uncleared swaps in non-
segregation jurisdictions as provided in section 23.160(e) of the 
Final Rule, one of the conditions that must be satisfied is that the 
counterparty to the swap cannot be a U.S. person and its obligations 
under the uncleared swap cannot be guaranteed by a U.S. person.
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    As commenters noted, limiting the scope of guarantees in the 
context of the margin requirements to arrangements that include a right 
of recourse offers the benefit of legal certainty, making the 
definition relatively easy to apply and helping keep down the cost of 
determining whether a transaction involves a U.S. Guaranteed CSE. 
Allowing market participants to rely on counterparty representations 
with regard to the presence of guarantees should also help market 
participants keep costs down. Although the Final Rule adopts a 
definition of guarantee that is different than the existing 
interpretation in the Guidance, which may result in market participants 
incurring additional costs to update their current systems, those 
operational challenges may be mitigated given that the definition is 
straight-forward and similar to that previously adopted by the SEC. In 
addition, while the inclusion of language that addresses indirect 
guarantees may result in some added operational challenges or 
assessment costs, the Commission believes the provision is necessary to 
avoid creating incentives for market participants to structure 
guarantee arrangements in order to avoid application of the Dodd-Frank 
margin requirements. The Final Rule also achieves substantial benefits 
in harmonizing with the guarantee definitions adopted by the Prudential 
Regulators.
    The Commission recognizes that, as discussed in section II.B.2 and 
as pointed out by commenters, the definition of ``guarantee'' adopted 
in the Final Rule does not encompass all forms of financial 
arrangements or support that may result in a direct transfer of risk to 
the U.S. financial markets, such as keepwells and liquidity puts. Nor 
would it include instances in which a parent and a subsidiary entity 
are closely related and the parent faces strong reputational incentives 
to support the subsidiary. As discussed above, however, the Commission 
believes that, in the context of the Final Rule, non-U.S. CSEs 
benefitting from such other forms of U.S. financial support will likely 
meet the definition of an FCS and thus be adequately covered by the 
Commission's margin requirements. Given the further inclusion of 
language that addresses indirect guarantees and the mandate to 
coordinate with the Prudential Regulators, the Commission believes that 
a more limited ``guarantee'' definition is appropriate in the context 
of the cross-border application of the margin requirements and will not 
undermine the safety and soundness of CSEs or the U.S. financial 
markets.
c. Foreign Consolidated Subsidiary
    As explained in section II.B.3, the Final Rule uses the term 
``Foreign Consolidated Subsidiary'' to identify non-U.S. CSEs whose 
uncleared swaps raise substantial supervisory concern in the United 
States by virtue of their relationship with their U.S. ultimate parent 
entity and because their financial position, operating results, and 
statement of cash flows have a direct impact on the financial position, 
risk profile and market value of their U.S. ultimate parent entity. 
FCSs are not eligible for the Exclusion but are otherwise treated the 
same as any other non-U.S. CSEs whose obligations under the relevant 
swap are not guaranteed by a U.S. person.
    As commenters noted, the Final Rule's use of a consolidation test 
that relies on U.S. GAAP to define ``Foreign Consolidated Subsidiary'' 
promotes legal certainty by articulating a clear, familiar, bright-line 
test. The Commission also took into account that the consolidation test 
is already being used in preparing financial statements, and as a 
result, should not result in more costs to market participants.\270\ 
The Commission further believes that allowing market participants to 
rely on counterparty representations with respect to their status as an 
FCS will reduce any operational costs that may be associated with 
determining whether a counterparty is an FCS, especially given that the 
Prudential Regulators adopted a similar definition for purposes of 
their margin rules.
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    \270\ As discussed in greater detail in section II.A.3, although 
commenters suggested various modifications to the FCS definition, 
such as relying on IFRS instead of U.S. GAAP or including non-U.S. 
CSEs whose U.S. parent meets standards for consolidation, but is not 
required to prepare consolidated financial statements under U.S. 
GAAP, the Commission does not believe such modifications would offer 
substantial benefits.
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3. Application
    Section II.B describes the application of the Commission's margin 
rules to cross-border uncleared swaps between CSEs and their 
counterparties, including the availability of substituted compliance 
and the Exclusion. The Final Rule also includes special provisions for 
non-segregation

[[Page 34843]]

jurisdictions and non-netting jurisdictions.
a. Substituted Compliance
    As described in section II.B.2.b and as set out in Table A, the 
extent to which substituted compliance is available under the Final 
Rule depends on whether the relevant swap involves a U.S. person, a 
guarantee by a U.S. person, or an FCS. U.S. CSEs and U.S. Guaranteed 
CSEs are eligible for substituted compliance only with respect to the 
requirement to post (but not the requirement to collect) initial 
margin, provided that their counterparty is a non-U.S. person 
(including a non-U.S. CSE) whose obligations under the swap are not 
guaranteed by a U.S. person.\271\ On the other hand, non-U.S. CSEs 
whose obligations under the relevant swap are not guaranteed by a U.S. 
person are broadly eligible for substituted compliance (including for 
their swaps with U.S. persons that are not CSEs); however, only partial 
substituted compliance would be available for such non-U.S. CSE's swaps 
with U.S. CSEs or U.S. Guaranteed CSEs.\272\
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    \271\ Similarly, a non-U.S. CSE (including an FCS) is eligible 
for substituted compliance with respect to the requirement to 
collect initial margin if its counterparty is a U.S. CSE or a U.S. 
Guaranteed CSE.
    \272\ A subset of these non-U.S. CSEs may qualify for the 
Exclusion, as described in section II.B.3.b above.
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    The Commission recognizes that the decision to offer any 
substituted compliance in the first instance carries certain trade-
offs. Given the global and highly-interconnected nature of the swap 
market, where risk does not respect national borders, market 
participants are likely to be subject to the regulatory interest of 
more than one jurisdiction. As commenters have pointed out, allowing 
compliance with foreign margin requirements as an alternative to 
domestic requirements can therefore reduce the application of 
duplicative or conflicting requirements, resulting in lower compliance 
costs and facilitating a more level playing field. Substituted 
compliance also helps preserve the benefits of an integrated, global 
swap market by fostering and advancing efforts among U.S. and foreign 
regulators to collaborate in establishing robust regulatory standards, 
as envisioned by the BCBS-IOSCO framework. If not properly implemented, 
however, the Commission's margin regime could lose some of its 
effectiveness. Accordingly, as commenters have recognized, the ultimate 
costs and benefits of substituted compliance are affected by the 
standard under which it is granted and the extent to which it is 
applied. The Commission was mindful of this dynamic in structuring a 
substituted compliance regime for the margin requirements and believes 
the Final Rule strikes an appropriate balance, enhancing market 
efficiency and fostering global coordination of margin requirements 
without compromising the safety and soundness of CSEs and the U.S. 
financial system.
    The Commission also understands that, as commenters pointed out, by 
not offering substituted compliance equally to all CSEs, the Final Rule 
may lead to certain competitive disparities between CSEs and between 
CSEs and non-CFTC registered dealers. For example, to the extent that 
non-U.S. CSEs whose obligations are not guaranteed by a U.S. person can 
rely on substituted compliance that is not available to U.S. CSEs or 
U.S. Guaranteed CSEs, they may enjoy certain cost advantages (e.g., 
avoiding the costs of potentially duplicative or inconsistent 
regulation, which could allow them to develop one enterprise-wide set 
of compliance and operational infrastructures). The non-U.S. CSEs may 
then be able to pass on these cost savings to their counterparties in 
the form of better pricing or some other benefit. U.S. CSEs and U.S. 
Guaranteed CSEs, on the other hand, could, depending on the extent to 
which foreign margin requirements apply, be subject to both U.S. and 
foreign margin requirements, and therefore be at a competitive 
disadvantage. Counterparties may also be incentivized to transact with 
CSEs that are offered substituted compliance in order to avoid being 
subject to duplicative or conflicting margin requirements, which could 
lead to increased market inefficiencies.\273\
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    \273\ The Commission recognizes that its framework may impose 
certain initial operational costs, as CSEs will be required to 
determine the status of their counterparties in order to determine 
the extent to which substituted compliance is available. The 
Commission however believes the ability to obtain and rely on 
counterparty representations should help mitigate such costs.
---------------------------------------------------------------------------

    Nevertheless, the Commission does not believe it is appropriate to 
make substituted compliance broadly available to all CSEs. As discussed 
above, the Commission has a strong supervisory interest in the 
uncleared swaps activity of all CSEs, including non-U.S. CSEs, by 
virtue of their registration with the Commission. Furthermore, U.S. 
CSEs and U.S. Guaranteed CSEs are particularly key swap market 
participants and their safety and soundness is critical to a well-
functioning U.S. swap market and the stability of the U.S. financial 
system. Accordingly, in light of the Commission's supervisory interest 
in the activities of U.S. persons and its statutory obligation to 
ensure the safety and soundness of CSEs and the U.S. financial markets 
in the context of uncleared swaps, the Commission believes that 
substituted compliance is generally not appropriate for U.S. CSEs and 
U.S. Guaranteed CSEs given their importance to the U.S. financial 
markets.\274\ With respect to other non-U.S. CSEs (including FCSs) that 
are not subject to a U.S. guarantee, however, the Commission believes 
that, in the interest of international comity, making substituted 
compliance broadly available is appropriate.
---------------------------------------------------------------------------

    \274\ As discussed in section II.B.2.b.i above, because 
uncleared swaps of U.S. Guaranteed CSEs are identical in relevant 
respects to a swap entered directly by a U.S. person, the Final Rule 
treats these uncleared swaps the same as uncleared swaps of U.S. 
CSEs.
---------------------------------------------------------------------------

    As further discussed in section II.B.2.b.i., the Commission 
determined that partial substituted compliance is appropriate for U.S. 
CSEs and U.S. Guaranteed CSEs in the limited case of posting (but not 
collecting) initial margin. Contrary to commenters' assertions, the 
Commission does not believe that partial substituted compliance is 
impractical or will hinder the development of a standardized model for 
initial margin. As discussed above, the Commission does not expect a 
CSE to have two netting sets as a result of partial substituted 
compliance, given that the U.S. CSE is always required to collect 
initial margin according to the Commission's margin requirements while 
it has the option to post according to the Commission's or its 
counterparty's foreign margin requirements. If substituted compliance 
is elected, the U.S. CSE will be deemed to satisfy the Commission's 
margin requirements by meeting the foreign jurisdiction's margin 
requirements, which will result in one netting set. Furthermore, the 
Commission believes that permitting partial substituted compliance 
allows market participants to avoid some costs associated with 
complying with duplicative or conflicting requirements.
    The Commission acknowledges that foreign branches may, for the 
reasons raised by commenters and discussed above, be at a competitive 
disadvantage compared to non-U.S. CSEs, with whom they may compete in 
the countries in which they are established, by virtue of not being 
eligible for substituted compliance. However, as discussed in section 
II.B.2.b.i., the swap activities of a foreign branch of a U.S. CSE are

[[Page 34844]]

legally indistinguishable from the swap activities of the U.S. CSE. 
Permitting more favorable treatment to foreign branches of U.S. CSEs 
than the principal U.S. entity could create an easy way for U.S. CSEs 
to circumvent the Commission's margin requirements, which could 
undermine the safety and soundness of the U.S. CSE and the U.S. 
financial system.\275\
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    \275\ The Commission notes that the potential competitive 
disparities could be minimized to the degree foreign margin 
requirements are harmonized or otherwise comparable to the 
Commission's.
---------------------------------------------------------------------------

b. Exclusion
    Under the Final Rule, the Commission excludes from its margin 
requirements uncleared swaps entered into by a non-U.S. CSE with a non-
U.S. counterparty (including a non-U.S. CSE), provided that neither 
counterparty's obligations under the relevant swap are guaranteed by a 
U.S. person and neither counterparty is an FCS nor a U.S. branch of a 
non-U.S. CSE. As discussed in section II.B.3.b above, the Commission 
believes that it is appropriate to tailor the application of margin 
requirements in the cross-border context, consistent with section 4s(e) 
of the CEA and comity principles, so as to exclude this narrow class of 
uncleared swaps involving a non-U.S. CSE and a non-U.S. counterparty.
    The Commission believes that such non-U.S. CSEs may benefit from 
the Exclusion because it allows them to avoid duplicative or 
conflicting regulations where a transaction is subject to more than one 
uncleared swap margin regime. On the other hand, to the extent the 
Exclusion allows a non-U.S. CSE to rely on foreign margin requirements 
that are not comparable to the Commission's, the Exclusion could result 
in a less rigorous margin regime for such CSE or, in the extreme, the 
absence of any margin requirements. This would not only increase the 
risk posed by that CSE's swaps activities, but could create competitive 
disparities between non-U.S. CSEs relying on the Exclusion and other 
CSEs that are not eligible for the Exclusion. That is, the Exclusion 
could allow these non-U.S. CSEs to offer better pricing or other terms 
to their non-U.S. clients and put them in a better position (than CSEs 
ineligible for the Exclusion) to compete with non-CFTC registered 
dealers in the relevant foreign jurisdiction for foreign clients. The 
degree of competitive disparity will depend on the degree of disparity 
between the Commission's margin framework and that of the relevant 
foreign jurisdiction.
    The Commission does not generally expect that the Exclusion will 
result in a significant diminution in the safety and soundness of the 
non-U.S. CSE, as discussed in section II.B.3.b above. This is based on 
several considerations. First, the Commission understands that most 
swaps are currently transacted in jurisdictions that have agreed to 
adhere to the BCBS-IOSCO framework, which covers financial 
entities.\276\ Accordingly, the Commission anticipates that many 
excluded swaps will nevertheless be subject to margin requirements in a 
jurisdiction that adheres to the BCBS-IOSCO framework. Second, the 
potential adverse effect on a non-U.S. CSE would be mitigated by the 
Commission's capital requirements which, as proposed, would impose a 
capital charge for uncollateralized exposures.\277\
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    \276\ Element 2 of BCBS-IOSCO framework states: ``All covered 
entities (i.e. financial firms and systemically important non-
financial entities) that engage in non-centrally cleared derivatives 
must exchange initial and variation margin as appropriate to the 
counterparty risks posed by such transactions.''
    \277\ See Proposed Capital Rule, 76 FR 27802.
---------------------------------------------------------------------------

    Third, a non-U.S. CSE that can avail itself of the Exclusion will 
still be subject to the Commission's margin rules with respect to all 
uncleared swaps not meeting the criteria for the Exclusion, albeit with 
the possibility of substituted compliance. That the non-U.S. CSE will 
be subject to U.S. or comparable margin requirements when entering into 
a swap with U.S. counterparties reduces the possibility of a cascading 
event affecting U.S. counterparties and the U.S. financial markets more 
broadly as a result of a default by the non-U.S. CSE.
    The unavailability of the Exclusion to FCSs could disadvantage them 
relative to other non-U.S. CSEs that are eligible for the Exclusion or 
non-CFTC registered dealers within a foreign jurisdiction. As 
commenters noted, non-U.S. CSEs that rely on the Exclusion or non-CFTC 
registered dealers could realize a cost advantage over FCSs and thus 
have the potential to offer better pricing terms to foreign clients. 
The competitive disparity between non-U.S. CSEs that rely on the 
Exclusion and FCSs, however, may be somewhat mitigated to the extent 
that the relevant foreign jurisdiction implements the BCBS-IOSCO 
framework.\278\
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    \278\ As discussed above, a commenter's suggestion to exclude 
transactions between an FCS and another non-guaranteed non-U.S. 
person up to an aggregate 5 percent notional trading limit would be 
difficult to monitor and could create incentives to ``cherry-pick'' 
and exclude uncleared swaps presenting the highest margin 
requirement, which could thereby introduce undue risk into the 
system.
---------------------------------------------------------------------------

    As noted above in section II.B.3.a., some commenters suggested that 
treating U.S. branches of non-U.S. CSEs differently from the rest of 
the CSE with respect to eligibility for the Exclusion could present 
operational challenges, requiring non-U.S. CSEs to document 
transactions with the U.S. branch under a separate ISDA Master 
Agreement. However, as explained in section II.B.3.b., in most cases 
the Commission does not believe a separate credit support agreement 
will be necessary; \279\ furthermore, in those cases where it is 
required, the Commission nevertheless believes that extending the 
Exclusion to U.S. branches of non-U.S. CSEs would not be appropriate 
for the reasons discussed in section II.B.3.b above.\280\ In addition, 
allowing U.S. branches to rely on the Exclusion would enable them to 
offer more competitive terms to non-U.S. clients than U.S. CSEs, 
thereby gaining an advantage when dealing with non-U.S. clients 
relative to other CSEs operating within the United States (i.e., U.S. 
CSEs). On the other hand, for the same reason, the Final Rule could put 
non-U.S. CSEs that conduct swaps business through their U.S. branches 
at a disadvantage relative either to non-U.S. CSEs that are eligible 
for the Exclusion or non-CFTC registered dealers that conduct swaps 
business overseas. The Commission recognizes that while substituted 
compliance will be broadly available to such U.S. branches of non-U.S. 
CSEs, more compliance costs could be incurred by these entities than if 
the Exclusion were made available if a foreign jurisdiction's margin 
requirements are not comparable.\281\
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    \279\ See supra note 158.
    \280\ The Prudential Regulators' Final Margin Rule does not 
grant an exclusion for the uncleared swaps of such U.S. branches on 
the basis that U.S. branches of foreign banks clearly operate within 
the United States and could pose risk to the U.S. financial system, 
and the Commission believes that harmonization with the Prudential 
Regulators' Final Margin Rule is appropriate. For further discussion 
of the reasons that the Exclusion does not extend to U.S. branches 
of non-U.S. CSEs, see section II.B.3.b above.
    \281\ As noted above, U.S. branches of foreign banks (as 
``foreign bank'' is defined in section __.2 of the Prudential 
Regulators' Final Margin Rule (12 CFR part 237)) must comply with 
the Prudential Regulators' margin rules, as these U.S. branches have 
a Prudential Regulator, as defined in 1(a)(39) of the CEA.
---------------------------------------------------------------------------

    In order to effectuate the Commission's treatment of inter-
affiliate swaps under the Final Margin Rule, the Exclusion is not 
available if the market-facing transaction of the non-U.S. CSE (that is 
otherwise eligible for the Exclusion) is not subject to comparable 
initial margin collection requirements in the home jurisdiction and any 
of the

[[Page 34845]]

risk associated with the uncleared swap is transferred, directly or 
indirectly, through inter-affiliate transactions, to a U.S. CSE. As a 
consequence, the affected non-U.S. CSEs may be placed at a cost 
disadvantage relative to non-U.S. CSEs that can rely on the Exclusion 
as well as non-CFTC registered dealers operating in the foreign 
jurisdiction that are not subject to similarly rigorous initial margin 
collection requirements. The Commission, however, believes that this 
limitation is necessary to ensure that the Exclusion does not 
facilitate the transfer of risk to a U.S. CSE through the use of inter-
affiliate transactions that, per the Final Margin Rule, are generally 
not subject to the collection of initial margin.
c. Non-Segregation Jurisdictions and Non-Netting Jurisdictions
    The Final Rule includes a special provision for non-segregation 
jurisdictions, where custodial arrangements that comply with the 
Commission's requirements set out in Commission Regulation 23.157 \282\ 
are impracticable due to the legal or operational infrastructure of the 
foreign jurisdiction.\283\ Specifically, an FCS or a foreign branch of 
a U.S. CSE may, in certain circumstances, be excepted from the 
requirement to post initial margin for the uncleared swap in compliance 
with the custodial requirements of the Final Margin Rule in certain 
foreign jurisdictions where inherent limitations in the legal or 
operational infrastructure of the jurisdiction make it impracticable 
for the CSE and its counterparty to comply with that requirement, 
subject to certain conditions.
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    \282\ See 17 CFR 23.157.
    \283\ As used in this release, a ``non-segregation 
jurisdiction'' is a jurisdiction where inherent limitations in the 
legal or operational infrastructure of the foreign jurisdiction make 
it impracticable for the CSE and its counterparty to post initial 
margin pursuant to custodial arrangements that comply with the Final 
Margin Rule, as further described in section II.B.4.b.
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    The Commission understands from commenters that inherent legal and 
operational constraints in certain jurisdictions could make compliance 
with the custodial requirements of the Final Margin Rule impracticable. 
Accordingly, absent the exception, FCSs and foreign branches of U.S. 
CSEs would be unable to conduct uncleared swap business with clients 
based in such jurisdictions, contributing to further market 
inefficiencies. The Commission further agrees with commenters that an 
exception from the requirement to post (but not from the requirement to 
collect) initial margin when transacting with clients in non-
segregation jurisdictions will accomplish the goal of ensuring a CSE's 
safety and soundness but with less disruption to existing business 
relationships than the exchange of initial and variation margin would 
impose.
    After careful consideration, the Commission is adding a special 
provision so that FCSs and foreign branches of U.S. CSEs will not be 
foreclosed from engaging in uncleared swaps business in non-segregation 
jurisdictions, with appropriate conditions, including a 5 percent 
limitation, as discussed in section II.B.4.b above, to avoid 
compromising the safety and soundness of CSEs. The Commission does not 
believe a blanket de minimis exception from the Commission's margin 
requirements, as suggested by commenters, is appropriate. Rather, the 
Commission believes that carefully tailored relief from the Final 
Margin Rule's requirement to post initial margin and the custodial 
arrangement requirements that pertain to initial margin collected by a 
CSE will accomplish the goal of allowing FCSs and foreign branches of 
U.S. CSEs to carry on their swaps business in non-segregation 
jurisdictions without creating the risks that would attend wholesale 
exemption from margin requirements in these jurisdictions. In addition, 
in light of the importance of FCSs and foreign branches of U.S. CSEs to 
the U.S. financial system, the special provision includes certain 
conditions that are designed to appropriately limit the swap activities 
conducted by these CSEs in these jurisdictions in order to help ensure 
their safety and soundness. Although these conditions may place 
affected entities at a relative cost disadvantage when compared to non-
U.S. CSEs that can rely on the Exclusion and non-CFTC registered 
dealers engaged in swaps activity in non-segregation jurisdictions, and 
may limit the overall swap dealing activity of affected entities in 
these jurisdictions, the Commission believes that the special provision 
provides a substantial benefit to the affected entities by allowing 
them to conduct a limited level of swaps business in non-segregation 
jurisdictions where they would otherwise be foreclosed. While 
permitting FCSs and foreign branches of U.S. CSEs to carry on their 
swaps business in non-segregation jurisdictions in accordance with this 
special provision is not without some risk, in that the initial margin 
collected by FCSs and foreign branches of U.S. CSEs in reliance on this 
provision is not subject to the custodial arrangement requirements of 
the Final Margin Rule, the Commission believes that the conditions to 
using this provision (including the 5 percent limit in each of four 
broad risk categories set forth in Sec.  23.154(b)(2)(v)) should be 
sufficient to prevent undue risk arising from uncleared swaps by FCSs 
and foreign branches of U.S. CSEs relying on this provision.
    The Final Rule also includes a special provision for ``non-
netting'' jurisdictions.\284\ In order to avail itself of this 
provision, the CSE must treat the uncleared swaps covered by the 
netting agreement on a gross basis in determining the amount of initial 
and variation margin that it must collect, but may net those uncleared 
swaps in determining the amount of initial and variation margin it must 
post to the counterparty, in accordance with the netting provisions of 
the Final Margin Rule. The Commission agrees that, as suggested by 
commenters, without enforceable netting and collateral arrangements, 
there is a risk that a CSE may not be able to effectively foreclose on 
the margin in the event of a counterparty default, and a risk that the 
administrator of an insolvent counterparty will ``cherry-pick'' from 
posted collateral to be returned in the event of insolvency, which 
could result in an increase in the risk in posting collateral. As with 
the provision for non-segregation jurisdictions, this provision is 
carefully tailored to allow CSEs to conduct swap transactions in ``non-
netting'' jurisdictions without abandoning the key protections behind 
the netting requirement under the Final Margin Rule.\285\ If the 
Commission were not to adopt this special provision, then a CSE would 
have to collect and post margin on a gross basis, which would result in 
greater costs to the CSE and result in additional credit risk, and put 
them at a competitive disadvantage. It is possible that this would lead 
to CSEs

[[Page 34846]]

being effectively precluded from doing business in these jurisdictions.
---------------------------------------------------------------------------

    \284\ As used in this release, a ``non-netting jurisdiction'' is 
a jurisdiction in which a CSE cannot conclude, with a well-founded 
basis, that the netting agreement with a counterparty in that 
foreign jurisdiction meets the definition of an ``eligible master 
netting agreement'' set forth in the Final Margin Rule, as described 
in section II.B.5.b.
    \285\ The Commission considered a broader provision, including, 
as requested by commenters, excluding these transactions from its 
margin rule. However, as netting provisions are critical to the 
overall goal of margin requirements and the Commission is not 
requiring CSEs to post margin on a gross basis, the Commission 
believes that the regulatory gap that a broader provision would 
create would be inconsistent with the Commission's mandate to 
protect the safety and soundness of CSEs.
---------------------------------------------------------------------------

4. Comparability Determinations
    As noted in section II.C above, any CSE eligible for substituted 
compliance may make a request for a comparability determination. 
Currently, there are approximately 106 swap entities provisionally 
registered with the Commission. The Commission further estimates that 
of the 106 swap entities that are registered, approximately 54 are 
subject to the Commission's margin rules, as they are not supervised by 
a Prudential Regulator. However, the Commission notes that any foreign 
regulatory agency that has direct supervisory authority to administer 
the foreign regulatory framework for margin of uncleared swaps in the 
requested foreign jurisdiction may apply for a comparability 
determination. Further, once a comparability determination is made for 
a jurisdiction, it will apply for all entities or transactions in that 
jurisdiction to the extent provided in the determination, as approved 
by the Commission.
    Although there is uncertainty regarding the number of requests for 
comparability determinations that will be made under the Final Rule, 
the Commission estimates that it will receive applications for 
comparability determinations from 17 jurisdictions representing 61 
separate registrants, and that each request will impose an average of 
10 burden hours per registrant.
    Based on the above, the Commission estimates that the preparation 
and filing of submission requests for comparability determinations 
should take no more than 170 hours annually in the aggregate (17 
registrants x 10 hours). The Commission further estimates that the 
total aggregate cost of preparing such submission requests will be 
$64,600, based on an estimated cost of $380 per hour for an in-house 
attorney.\286\
---------------------------------------------------------------------------

    \286\ Although different registrants may choose to staff 
preparation of the comparability determination request with 
different personnel, Commission staff estimates that, on average, an 
initial request could be prepared and submitted with 10 hours of an 
in-house attorney's time. To estimate the hourly cost of an in-house 
attorney's attorney time, Commission staff reviewed data in SIFMA's 
Report on Management and Professional Earnings in the Securities 
Industry 2013, modified by Commission staff to account for an 1800-
hour work-year and multiplied by a factor of 5.35 to account for 
firm size, employee benefits and overhead. Commission staff believes 
that use of a 5.35 multiplier here is appropriate because some 
persons may retain outside advisors to assist in making the 
determinations under the rules.
---------------------------------------------------------------------------

    As summarized in section II.C.2, several commenters complained that 
the costs and burdens to market participants associated with the 
Commission's proposed framework and standard for making comparability 
determinations would be minimized if the Commission were to rely on the 
BCBS-IOSCO framework as the sole basis for its comparability analysis 
and take a ``holistic'' approach to determining comparability. As the 
Commission explained above, however, while the BCBS-IOSCO framework 
establishes minimum standards that are consistent with the objectives 
of the Commission's own margin requirements, consistency with 
International Standards is necessary but may not be sufficient to 
finding comparability.\287\ Furthermore, allowing for a comparability 
determination to be made based on comparable outcomes and objectives 
notwithstanding differences in foreign jurisdictions' requirements 
ensures that substituted compliance is made available to the fullest 
extent possible. While the Commission recognizes that, to the extent 
that a foreign margin regime is not deemed comparable in all respects, 
CSEs eligible for substituted compliance may experience costs from 
being required to comply with more than one set of specified margin 
requirements, the Commission believes that this approach is preferable 
to an all-or-nothing approach, in which market participants may be 
forced to comply with both margin regimes in their entirety.
---------------------------------------------------------------------------

    \287\ See supra notes 232 and 233 and accompanying text. Also, 
as the Commission noted above, the Final Margin Rule included 
substantial modifications from the Proposed Margin Rule that further 
aligned the Commission's margin requirements with International 
Standards and, as a result, the potential for conflict with foreign 
margin requirements should be reduced. See supra note 29.
---------------------------------------------------------------------------

5. Section 15(a) Factors
    Section 15(a) of the CEA requires the Commission to consider the 
costs and benefits of its actions before promulgating a regulation 
under the CEA or issuing certain orders. Section 15(a) further 
specifies that the costs and benefits shall be evaluated in light of 
five broad areas of market and public concern: (1) Protection of market 
participants and the public; (2) efficiency, competitiveness, and 
financial integrity of futures markets; (3) price discovery; (4) sound 
risk management practices; and (5) other public interest 
considerations. The Commission considers the costs and benefits 
resulting from its discretionary determinations with respect to the 
section 15(a) factors.
a. Protection of Market Participants and the Public
    As described above, CEA section 4s(e)(2)(A) requires the Commission 
to develop rules designed to ensure the safety and soundness of CSEs 
and the U.S. financial system. On the one hand, full application of the 
Commission's margin requirements to all uncleared swaps of CSEs would 
help to ensure the safety and soundness of CSEs and the U.S. financial 
system by reducing counterparty credit risk and the threat of 
contagion. On the other hand, extending substituted compliance to 
certain cross-border swaps reduces the potential for conflicting or 
duplicative requirements, which would, in turn, reduce market 
distortions and promote global harmonization. In addition, where 
exceptions have been permitted (i.e., under the Exclusion and the 
special provisions for non-segregation and non-netting jurisdictions), 
the Commission has limited their availability to strike a balance 
between international comity and the continuation of important business 
activity by qualifying CSEs, on the one hand, and limiting risk to CSEs 
and the U.S. financial system, on the other hand. While the Final Rule 
will allow CSEs to comply with foreign margin requirements as an 
alternative to the Commission's requirements in certain circumstances, 
such margin requirements must be comparable in outcome and objectives, 
and the Commission retains the authority to modify or condition the 
availability of substituted compliance as necessary. Furthermore, 
substituted compliance is available on a more limited basis for U.S. 
CSEs and U.S. Guaranteed CSEs. Additionally, while the Final Rule also 
excludes certain uncleared swap transactions involving non-U.S. CSEs 
whose obligations under the relevant swap are not subject to a U.S. 
guarantee from the Final Margin Rule and excepts qualifying CSEs from 
certain requirements in non-segregation jurisdictions and non-netting 
jurisdictions, the Exclusion and special provisions are narrowly 
tailored and include safeguards to protect market participants and the 
public. Overall, the Commission believes that the Final Rule takes 
proper account of significant, and sometimes competing, factors in 
order to effectively address the risk posed to the safety and soundness 
of CSEs while creating a workable cross-border framework that reduces 
the potential for undue market disruptions and promoting global 
harmonization, thereby benefiting market participants and the public.

[[Page 34847]]

b. Efficiency, Competitiveness, and Financial Integrity
    As discussed above, the Final Rule may have both a positive and 
negative effect on market efficiency and competitiveness. As an initial 
matter, substituted compliance and the Exclusion should improve 
resource allocation efficiency by allowing market participants to avoid 
potentially duplicative or conflicting requirements, reducing the 
aggregate cost to the market of dealing uncleared swaps. By granting 
this relief to some CSEs and not others, however, the Final Rule may 
afford such CSEs a cost advantage compared to other CSEs that may be 
required to comply with potentially duplicative or conflicting 
requirements. Non-U.S. counterparties may also be incentivized to 
transact with CSEs that are eligible for substituted compliance in 
order to avoid complying with more than one margin regime (or the 
Commission's margin regime alone), which could contribute to market 
inefficiencies. In addition, as the Exclusion is not provided to all 
CSEs, those that are not permitted to use the Exclusion may be at a 
competitive disadvantage when competing in foreign jurisdictions that 
do not have comparable margin rules. The Commission notes, however, 
that to the extent that non-U.S. CSEs are domiciled in jurisdictions 
with comparable requirements, this may mitigate possible regulatory 
arbitrage by these CSEs.
    At the same time, however, the Commission understands that if it 
did not provide special accommodations for certain CSEs to enter into 
certain markets, such CSEs would be disadvantaged and even prohibited 
from engaging in swaps in these jurisdictions.
    Furthermore, the Commission believes that the Final Rule ensures 
that substituted compliance and the Exclusion are extended in a 
tailored fashion that is consistent with protecting the integrity of 
the swaps market. Substituted compliance is only provided in the event 
that the relevant foreign jurisdiction has a comparable margin rule; if 
not, the CSE must comply with the Commission's margin rule. Even in 
instances where the Exclusion is available, the Commission notes that: 
(1) The Final Margin Rule will cover many of the swaps of the non-U.S. 
CSEs (eligible for the Exclusion) with other counterparties, namely, 
all U.S. counterparties; (2) the Exclusion is limited to a narrow set 
of swaps by non-U.S. CSEs; and (3) the excluded swaps may be covered by 
another foreign regulator's margin rule that is based on the BCBS-IOSCO 
framework.
c. Price Discovery
    The Commission generally believes that substituted compliance, by 
reducing the potential for duplicative or conflicting regulations, 
could reduce impediments to transact uncleared swaps on a cross-border 
basis. This, in turn, may enhance liquidity as more market participants 
may be willing to enter into uncleared swaps, thereby possibly 
improving price discovery--and ultimately reducing market 
fragmentation. Alternatively, if substituted compliance or the 
Exclusion were not made available, CSEs could be incentivized to 
consider setting up their swap operations outside the Commission's 
jurisdiction, and as a result, increase the potential for market 
fragmentation. Additionally, exceptions for non-segregation and non-
netting jurisdictions could increase price discovery in such 
jurisdictions by opening such markets to CSEs where, by virtue of the 
application of the Commission's margin requirements, such CSEs would 
otherwise be unable to deal uncleared swaps.
d. Sound Risk Management Practices
    The Commission believes that the Final Rule is consistent with 
sound risk management practices. The Final Margin Rule promotes sound 
risk management practices, and this Final Rule requires U.S. CSEs and 
U.S. Guaranteed CSEs to apply that rule in its entirety for most cross-
border transactions. To the extent substituted compliance is available 
in limited fashion to these entities and more broadly to non-U.S. CSEs, 
the foreign margin requirements must be comparable to the Commission's 
in outcome and objectives. That should ensure that margin's critical 
risk management function is unaffected. Although the Exclusion could 
potentially lead to weaker risk management for eligible non-U.S. CSEs 
to the extent that they are not otherwise subject to comparable foreign 
margin requirements, the Commission notes that in jurisdictions that 
are BCBS-IOSCO compliant, such CSEs will be subject to margin 
requirements that satisfy the minimum International Standards 
established by the BCBS-IOSCO framework.\288\ Furthermore, while the 
Commission recognizes that a special provision in the Final Rule will 
excuse CSEs that are FCSs and foreign branches of U.S. CSEs from the 
requirement to post initial margin pursuant to custodial arrangements 
that comply with the Final Margin Rule, the Commission believes that 
the impact to risk management will be mitigated by the relatively small 
volume of such transactions, the conditions required to rely on this 
special provision, including a limit on the overall swaps using the 
special provision, and the continued applicability of other 
requirements, including margin with respect to other uncleared swaps of 
such FCSs and foreign branches and broader capital requirements.\289\ 
The Commission similarly believes that the risk management implications 
of the special provision for non-netting jurisdictions will be limited. 
As explained above, CSEs will still be required to calculate and 
collect initial margin on a gross basis to ensure that the CSE can 
obtain the collateral posted with the counterparty in the event of 
counterparty default.
---------------------------------------------------------------------------

    \288\ As indicated in supra note 23, representatives of 26 
regulatory authorities participated in the WGMR that developed the 
BCBS-IOSCO framework.
    \289\ See Proposed Capital Rule, 76 FR 27802.
---------------------------------------------------------------------------

e. Other Public Interest Considerations
    The Commission has not identified any additional public interest 
considerations related to the costs and benefits of the Final Rule.

List of Subjects in 17 CFR Part 23

    Swaps, Swap dealers, Major swap participants, Capital and margin 
requirements.

    For the reasons discussed in the preamble, the Commodity Futures 
Trading Commission amends 17 CFR part 23 as set forth below:

PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS

0
1. The authority citation for part 23 is revised to read as follows:

    Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t, 
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.

    Section 23.160 also issued under 7 U.S.C. 2(i); Sec. 721(b), 
Pub. L. 111-203, 124 Stat. 1641 (2010).


0
2. Add Sec.  23.160 to read as follows:


Sec.  23.160  Cross-border application.

    (a) Definitions. For purposes of this section only:
    (1) Foreign Consolidated Subsidiary means a non-U.S. CSE in which 
an ultimate parent entity that is a U.S. person has a controlling 
financial interest, in accordance with U.S. GAAP, such that the U.S. 
ultimate parent entity includes the non-U.S. CSE's operating results, 
financial position and statement

[[Page 34848]]

of cash flows in the U.S. ultimate parent entity's consolidated 
financial statements, in accordance with U.S. GAAP.
    (2) Guarantee means an arrangement pursuant to which one party to 
an uncleared swap has rights of recourse against a guarantor, with 
respect to its counterparty's obligations under the uncleared swap. For 
these purposes, a party to an uncleared swap has rights of recourse 
against a guarantor if the party has a conditional or unconditional 
legally enforceable right to receive or otherwise collect, in whole or 
in part, payments from the guarantor with respect to its counterparty's 
obligations under the uncleared swap. In addition, in the case of any 
arrangement pursuant to which the guarantor has a conditional or 
unconditional legally enforceable right to receive or otherwise 
collect, in whole or in part, payments from any other guarantor with 
respect to the counterparty's obligations under the uncleared swap, 
such arrangement will be deemed a guarantee of the counterparty's 
obligations under the uncleared swap by the other guarantor.
    (3) International standards mean the margin policy framework for 
non-cleared, bilateral derivatives issued by the Basel Committee on 
Banking Supervision and the International Organization of Securities in 
September 2013, as subsequently updated, revised, or otherwise amended, 
or any other international standards, principles or guidance relating 
to margin requirements for non-cleared, bilateral derivatives that the 
Commission may in the future recognize, to the extent that they are 
consistent with United States law (including the margin requirements in 
the Commodity Exchange Act).
    (4) Non-U.S. CSE means a covered swap entity that is not a U.S. 
person. The term ``non-U.S. CSE'' includes a ``Foreign Consolidated 
Subsidiary'' or a U.S. branch of a non-U.S. CSE.
    (5) Non-U.S. person means any person that is not a U.S. person.
    (6) Ultimate parent entity means the parent entity in a 
consolidated group in which none of the other entities in the 
consolidated group has a controlling interest, in accordance with U.S. 
GAAP.
    (7) United States means the United States of America, its 
territories and possessions, any State of the United States, and the 
District of Columbia.
    (8) U.S. CSE means a covered swap entity that is a U.S. person.
    (9) U.S. GAAP means U.S. generally accepted accounting principles.
    (10) U.S. person means:
    (i) A natural person who is a resident of the United States;
    (ii) An estate of a decedent who was a resident of the United 
States at the time of death;
    (iii) A corporation, partnership, limited liability company, 
business or other trust, association, joint-stock company, fund or any 
form of entity similar to any of the foregoing (other than an entity 
described in paragraph (a)(10)(iv) or (v) of this section) (a ``legal 
entity''), in each case that is organized or incorporated under the 
laws of the United States or that has its principal place of business 
in the United States, including any branch of such legal entity;
    (iv) A pension plan for the employees, officers or principals of a 
legal entity described in paragraph (a)(10)(iii) of this section, 
unless the pension plan is primarily for foreign employees of such 
entity;
    (v) A trust governed by the laws of a state or other jurisdiction 
in the United States, if a court within the United States is able to 
exercise primary supervision over the administration of the trust;
    (vi) A legal entity (other than a limited liability company, 
limited liability partnership or similar entity where all of the owners 
of the entity have limited liability) that is owned by one or more 
persons described in paragraphs (a)(10)(i) through (v) of this section 
and for which such person(s) bears unlimited responsibility for the 
obligations and liabilities of the legal entity, including any branch 
of the legal entity; or
    (vii) An individual account or joint account (discretionary or not) 
where the beneficial owner (or one of the beneficial owners in the case 
of a joint account) is a person described in paragraphs (a)(10)(i) 
through (vi) of this section.
    (b) Applicability of margin requirements. The requirements of 
Sec. Sec.  23.150 through 23.161 apply as follows.
    (1) Uncleared swaps of U.S. CSEs or Non-U.S. CSEs whose obligations 
under the relevant swap are guaranteed by a U.S. person--(i) 
Applicability of U.S. margin requirements; availability of substituted 
compliance for requirement to post initial margin. With respect to each 
uncleared swap entered into by a U.S. CSE or a non-U.S. CSE whose 
obligations under the swap are guaranteed by a U.S. person, the U.S. 
CSE or non-U.S. CSE whose obligations under the swap are guaranteed by 
a U.S. person shall comply with the requirements of Sec. Sec.  23.150 
through 23.161 of this part, provided that the U.S. CSE or non-U.S. CSE 
whose obligations under the swap are guaranteed by a U.S. person may 
satisfy its requirement to post initial margin to certain 
counterparties to the extent provided in paragraph (b)(1)(ii) of this 
section.
    (ii) Compliance with foreign initial margin collection requirement. 
A covered swap entity that is covered by paragraph (b)(1)(i) of this 
section may satisfy its requirement to post initial margin under this 
part by posting initial margin in the form and amount, and at such 
times, that its counterparty is required to collect initial margin 
pursuant to a foreign jurisdiction's margin requirements, but only to 
the extent that:
    (A) The counterparty is neither a U.S. person nor a non-U.S. person 
whose obligations under the relevant swap are guaranteed by a U.S. 
person;
    (B) The counterparty is subject to such foreign jurisdiction's 
margin requirements; and
    (C) The Commission has issued a comparability determination under 
paragraph (c) of this section (``Comparability Determination'') with 
respect to such foreign jurisdiction's requirements regarding the 
posting of initial margin by the covered swap entity (that is covered 
in paragraph (b)(1) of this section).
    (2) Uncleared swaps of Non-U.S. CSEs whose obligations under the 
relevant swap are not guaranteed by a U.S. person--(i) Applicability of 
U.S. Margin requirements except where an exclusion applies; 
Availability of substituted compliance. With respect to each uncleared 
swap entered into by a non-U.S. CSE whose obligations under the 
relevant swap are not guaranteed by a U.S. person, the non-U.S. CSE 
shall comply with the requirements of Sec. Sec.  23.150 through 23.161 
except to the extent that an exclusion is available under paragraph 
(b)(2)(ii) of this section, provided that a non-U.S. CSE whose 
obligations under the relevant swap are not guaranteed by a U.S. person 
may satisfy its margin requirements under this part to the extent 
provided in paragraphs (b)(2)(iii) and (b)(2)(iv) of this section.
    (ii) Exclusion. (A) Except as provided in paragraph (b)(2)(ii)(B) 
of this section, a non-U.S. CSE shall not be required to comply with 
the requirements of Sec. Sec.  23.150 through 23.161 with respect to 
each uncleared swap it enters into to the extent that the following 
conditions are met:
    (1) The non-U.S. CSE's obligations under the relevant swap are not 
guaranteed by a U.S. person;
    (2) The non-U.S. CSE is not a U.S. branch of a non-U.S. CSE;

[[Page 34849]]

    (3) The non-U.S. CSE is not a Foreign Consolidated Subsidiary; and
    (4) The counterparty to the uncleared swap is a non-U.S. person 
(excluding a Foreign Consolidated Subsidiary or the U.S. branch of a 
non-U.S. CSE), whose obligations under the relevant swap are not 
guaranteed by a U.S. person.
    (B) Notwithstanding paragraph (b)(2)(ii)(A) of this section, any 
uncleared swap of a non-U.S. CSE that meets the conditions for the 
Exclusion set forth in paragraph (b)(2)(ii)(A) must nevertheless comply 
with Sec. Sec.  23.150 through 23.161 if:
    (1) The uncleared swap of the non-U.S. CSE is not covered by a 
Comparability Determination with respect to the initial margin 
collection requirements in the relevant foreign jurisdiction in 
accordance with paragraph (c) of this section; and
    (2) The non-U.S. CSE enters into an inter-affiliate swap(s), 
transferring any risk arising out of the uncleared swap described in 
paragraph (b)(2)(ii)(B)(1) of this section directly or indirectly, to a 
margin affiliate (as the term ``margin affiliate'' is defined in Sec.  
23.151 of this part) that is a U.S. CSE or a U.S. Guaranteed CSE.
    (iii) Availability of substituted compliance where the counterparty 
is not a U.S. CSE or a non-U.S. CSE whose obligations under the 
relevant swap are guaranteed by a U.S. person. Except to the extent 
that an exclusion is available under paragraph (b)(2)(ii) of this 
section, with respect to each uncleared swap entered into by a non-U.S. 
CSE whose obligations under the relevant swap are not guaranteed by a 
U.S. person with a counterparty (except where the counterparty is 
either a U.S. CSE or a non-U.S. CSE whose obligations under the 
relevant swap are guaranteed by a U.S. person), the non-U.S. CSE whose 
obligations under the relevant swap are not guaranteed by a U.S. person 
may satisfy margin requirements under this part by complying with the 
margin requirements of a foreign jurisdiction to which such non-U.S. 
CSE (whose obligations under the relevant swap are not guaranteed by a 
U.S. person) is subject, but only to the extent that the Commission has 
issued a Comparability Determination under paragraph (c) of this 
section for such foreign jurisdiction.
    (iv) Availability of substituted compliance where the counterparty 
is a U.S. CSE or a non-U.S. CSE whose obligations under the relevant 
swap are guaranteed by a U.S. person. With respect to each uncleared 
swap entered into by a non-U.S. CSE whose obligations under the 
relevant swap are not guaranteed by a U.S. person with a counterparty 
that is a U.S. CSE or a non-U.S. CSE whose obligations under the 
relevant swap are guaranteed by a U.S. person, the non-U.S. CSE (whose 
obligations under the relevant swap are not guaranteed by a U.S. 
person) may satisfy its requirement to collect initial margin under 
this part by collecting initial margin in the form and amount, and at 
such times and under such arrangements, that the non-U.S. CSE (whose 
obligations under the relevant swap are not guaranteed by a U.S. 
Person) is required to collect initial margin pursuant to a foreign 
jurisdiction's margin requirements, provided that:
    (A) The non-U.S. CSE (whose obligations under the relevant swap are 
not guaranteed by a U.S. person) is subject to the foreign 
jurisdiction's regulatory requirements; and
    (B) The Commission has issued a Comparability Determination with 
respect to such foreign jurisdiction's margin requirements.
    (c) Comparability determinations--(1) Eligibility requirements. The 
following persons may, either individually or collectively, request a 
Comparability Determination with respect to some or all of the 
Commission's margin requirements:
    (i) A covered swap entity that is eligible for substituted 
compliance under this section; or
    (ii) A foreign regulatory authority that has direct supervisory 
authority over one or more covered swap entities and that is 
responsible for administering the relevant foreign jurisdiction's 
margin requirements.
    (2) Submission requirements. Persons requesting a Comparability 
Determination should provide the Commission (either by hard copy or 
electronically):
    (i) A description of the objectives of the relevant foreign 
jurisdiction's margin requirements;
    (ii) A description of how the relevant foreign jurisdiction's 
margin requirements address, at minimum, each of the following elements 
of the Commission's margin requirements. Such description should 
identify the specific legal and regulatory provisions that correspond 
to each element and, if necessary, whether the relevant foreign 
jurisdiction's margin requirements do not address a particular element:
    (A) The products subject to the foreign jurisdiction's margin 
requirements;
    (B) The entities subject to the foreign jurisdiction's margin 
requirements;
    (C) The treatment of inter-affiliate derivative transactions;
    (D) The methodologies for calculating the amounts of initial and 
variation margin;
    (E) The process and standards for approving models for calculating 
initial and variation margin models;
    (F) The timing and manner in which initial and variation margin 
must be collected and/or paid;
    (G) Any threshold levels or amounts;
    (H) Risk management controls for the calculation of initial and 
variation margin;
    (I) Eligible collateral for initial and variation margin;
    (J) The requirements of custodial arrangements, including 
segregation of margin and rehypothecation;
    (K) Margin documentation requirements; and
    (L) The cross-border application of the foreign jurisdiction's 
margin regime.
    (iii) A description of the differences between the relevant foreign 
jurisdiction's margin requirements and the International Standards;
    (iv) A description of the ability of the relevant foreign 
regulatory authority or authorities to supervise and enforce compliance 
with the relevant foreign jurisdiction's margin requirements. Such 
description should discuss the powers of the foreign regulatory 
authority or authorities to supervise, investigate, and discipline 
entities for compliance with the margin requirements and the ongoing 
efforts of the regulatory authority or authorities to detect and deter 
violations of, and ensure compliance with, the margin requirements; and
    (v) Copies of the foreign jurisdiction's margin requirements 
(including an English translation of any foreign language document);
    (vi) Any other information and documentation that the Commission 
deems appropriate.
    (3) Standard of review. The Commission will issue a Comparability 
Determination to the extent that it determines that some or all of the 
relevant foreign jurisdiction's margin requirements are comparable to 
the Commission's corresponding margin requirements. In determining 
whether the requirements are comparable, the Commission will consider 
all relevant factors, including:
    (i) The scope and objectives of the relevant foreign jurisdiction's 
margin requirements;
    (ii) Whether the relevant foreign jurisdiction's margin 
requirements achieve comparable outcomes to the Commission's 
corresponding margin requirements;
    (iii) The ability of the relevant regulatory authority or 
authorities to

[[Page 34850]]

supervise and enforce compliance with the relevant foreign 
jurisdiction's margin requirements; and
    (iv) Any other facts and circumstances the Commission deems 
relevant.
    (4) Reliance. Any covered swap entity that, in accordance with a 
Comparability Determination, complies with a foreign jurisdiction's 
margin requirements, would be deemed to be in compliance with the 
Commission's corresponding margin requirements. Accordingly, if the 
Commission determines that a covered swap entity has failed to comply 
with the foreign jurisdiction's margin requirements, it could initiate 
an action for a violation of the Commission's margin requirements. All 
covered swap entities, regardless of whether they rely on a 
Comparability Determination, remain subject to the Commission's 
examination and enforcement authority.
    (5) Conditions. In issuing a Comparability Determination, the 
Commission may impose any terms and conditions it deems appropriate.
    (6) Modifications. The Commission reserves the right to further 
condition, modify, suspend, terminate or otherwise restrict a 
Comparability Determination in the Commission's discretion.
    (7) Delegation of authority. The Commission hereby delegates to the 
Director of the Division of Swap Dealer and Intermediary Oversight, or 
such other employee or employees as the Director may designate from 
time to time, the authority to request information and/or documentation 
in connection with the Commission's issuance of a Comparability 
Determination.
    (d) Non-netting jurisdiction requirements. Except as provided in 
paragraph (e) of this section, if a CSE cannot conclude after 
sufficient legal review with a well-founded basis that the netting 
agreement described in Sec.  23.152(c) meets the definition of 
``eligible master netting agreement'' set forth in Sec.  23.151, the 
CSE must treat the uncleared swaps covered by the agreement on a gross 
basis for the purposes of calculating and complying with the 
requirements of Sec.  23.152(a) and Sec.  23.153(a) to collect margin, 
but the CSE may net those uncleared swaps in accordance with Sec.  
23.152(c) and Sec.  23.153(d) for the purposes of calculating and 
complying with the requirements of this part to post margin. A CSE that 
relies on this paragraph (d) must have policies and procedures ensuring 
that it is in compliance with the requirements of this paragraph, and 
maintain books and records properly documenting that all of the 
requirements of this paragraph (d) are satisfied.
    (e) Jurisdictions Where Compliance with Custodial Arrangement 
Requirements is Unavailable. Sections 23.152(b), 23.157(b), and 
paragraph (d) of this section do not apply to an uncleared swap entered 
into by a Foreign Consolidated Subsidiary or a foreign branch of a U.S. 
CSE if:
    (1) Inherent limitations in the legal or operational infrastructure 
in the applicable foreign jurisdiction make it impracticable for the 
CSE and its counterparty to post any form of eligible initial margin 
collateral recognized pursuant to Sec.  23.156 in compliance with the 
custodial arrangement requirements of Sec.  23.157;
    (2) The CSE is subject to foreign regulatory restrictions that 
require the CSE to transact in uncleared swaps with the counterparty 
through an establishment within the foreign jurisdiction and do not 
accommodate the posting of collateral for the uncleared swap in 
compliance with the custodial arrangements of Sec.  23.157 in the 
United States or a jurisdiction for which the Commission has issued a 
comparability determination under paragraph (c) of this section with 
respect to Sec.  23.157;
    (3) The counterparty to the uncleared swap is a non-U.S. person 
that is not a CSE, and the counterparty's obligations under the 
uncleared swap are not guaranteed by a U.S. person;
    (4) The CSE collects initial margin for the uncleared swap in 
accordance with Sec.  23.152(a) in the form of cash pursuant to Sec.  
23.156(a)(1)(i), and posts and collects variation margin in accordance 
with Sec.  23.153(a) in the form of cash pursuant to Sec.  
23.156(a)(1)(i);
    (5) For each broad risk category, as set out in Sec.  
23.154(b)(2)(v), the total outstanding notional value of all uncleared 
swaps in that broad risk category, as to which the CSE is relying on 
this paragraph (e), may not exceed 5% of the CSE's total outstanding 
notional value for all uncleared swaps in the same broad risk category;
    (6) The CSE has policies and procedures ensuring that it is in 
compliance with the requirements of this paragraph (e); and
    (7) The CSE maintains books and records properly documenting that 
all of the requirements of this paragraph (e) are satisfied.

    Issued in Washington, DC, on May 24, 2016, by the Commission.
Christopher J. Kirkpatrick,
Secretary of the Commission.

    Note: The following table and appendices will not appear in the 
Code of Federal Regulations.

Table A--Application of the Final Rule

    The following table should be read in conjunction with the rest of 
the preamble and the text of the Final Rule, as well as the footnotes 
at the end of the table.

------------------------------------------------------------------------
                                                      Applicable margin
             CSE                  Counterparty          requirements
------------------------------------------------------------------------
U.S. CSE....................   U.S. person  U.S. (All).
or..........................   (including U.S.
Non-U.S. CSE (including U.S.   CSE).
 branch of a non-U.S. CSE      Non-U.S.
 and a Foreign Consolidated    person (including
 Subsidiary (``FCS'')) whose   non-U.S. CSE, FCS,
 obligations under the         and U.S. branch of
 relevant swap are             a non-U.S. CSE)
 guaranteed by a U.S. person.  whose obligations
                               under the relevant
                               swap are guaranteed
                               by a U.S. person.
                               Non-U.S.     U.S. (Initial Margin
                               person (including     collected by CSE in
                               non-U.S. CSE, FCS     column 1).
                               and U.S. branch of   Substituted
                               a non-U.S. CSE)       Compliance (Initial
                               whose obligations     Margin posted by
                               under the relevant    CSE in column 1).
                               swap are not         U.S. (Variation
                               guaranteed by a       Margin).
                               U.S. person.
FCS whose obligations under    U.S. CSE...  U.S. (Initial Margin
 the relevant swap are not     Non-U.S.      posted by CSE in
 guaranteed by a U.S. person.  CSE (including U.S.   column 1).
or..........................   branch of a non-     Substituted
U.S. branch of a non-U.S.      U.S. CSE and FCS)     Compliance (Initial
 CSE whose obligations under   whose obligations     Margin collected by
 the relevant swap are not     under the relevant    CSE in column 1).
 guaranteed by a U.S. person.  swap are guaranteed  U.S. (Variation
                               by a U.S. person.     Margin).

[[Page 34851]]

 
                               U.S. person  Substituted
                               (except as noted      Compliance (All).
                               above for a CSE).
                               Non-U.S.
                               person whose
                               obligations under
                               the swap are
                               guaranteed by a
                               U.S. person (except
                               a non-U.S. CSE,
                               U.S. branch of a
                               non-U.S. CSE, and
                               FCS whose
                               obligations are
                               guaranteed, as
                               noted above).
                               Non-U.S.
                               person (including
                               non-U.S. CSE, U.S.
                               branch of a non-
                               U.S. CSE, and a
                               FCS) whose
                               obligations under
                               the relevant swap
                               are not guaranteed
                               by a U.S. person.
Non-U.S. CSE (that is not an   U.S. CSE...  U.S. (Initial Margin
 FCS or a U.S. branch of a     Non-U.S.      posted by CSE in
 non-U.S. CSE) whose           CSE (including U.S.   column 1).
 obligations under the         branch of a non-     Substituted
 relevant swap are not         U.S. CSE and FCS)     Compliance (Initial
 guaranteed by a U.S. person.  whose obligations     Margin collected by
                               under the swap are    CSE in column 1).
                               guaranteed by a      U.S. (Variation
                               U.S. person.          Margin).
                               U.S. person  Substituted
                               (except as noted      Compliance (All).
                               above for a CSE).
                               Non-U.S.
                               person whose
                               obligations under
                               the swap are
                               guaranteed by a
                               U.S. person (except
                               a non-U.S. CSE
                               whose obligations
                               are guaranteed, as
                               noted above).
                               U.S. branch
                               of a non-U.S. CSE
                               or FCS, in each
                               case whose
                               obligations under
                               the relevant swap
                               are not guaranteed
                               by a U.S. person.
                               Non-U.S.     Excluded (except in
                               person (including a   connection with
                               non-U.S. CSE, but     certain inter-
                               not an FCS or a       affiliate swaps).
                               U.S. branch of a
                               non-U.S. CSE) whose
                               obligations under
                               the relevant swap
                               are not guaranteed
                               by a U.S. person.
------------------------------------------------------------------------
\1\ The term ``U.S. person'' is defined in Sec.   23.160(a)(10) of the
  Final Rule. A ``non-U.S. person'' is any person that is not a ``U.S.
  person.'' The term swap means an uncleared swap and is defined in Sec.
    23.151 of the Final Margin Rule. See Margin Requirements for
  Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 FR
  636 (Jan. 6, 2016).
\2\ As used in this table, the term ``Foreign Consolidated Subsidiary''
  or ``FCS'' refers to a non-U.S. CSE in which an ultimate parent entity
  that is a U.S. person has a controlling financial interest, in
  accordance with U.S. GAAP, such that the U.S. ultimate parent entity
  includes the non-U.S. CSE's operating results, financial position and
  statement of cash flows in the U.S. ultimate parent entity's
  consolidated financial statements, in accordance with U.S. GAAP. The
  term ``ultimate parent entity'' means the parent entity in a
  consolidated group in which none of the other entities in the
  consolidated group has a controlling interest, in accordance with U.S.
  GAAP.
\3\ Under Sec.   23.160(e) of the Final Rule, in certain foreign
  jurisdictions where inherent limitations in the legal or operational
  infrastructure of the jurisdiction make it impracticable for the CSE
  and its counterparty to post initial margin for the uncleared swap in
  compliance with the custodial arrangement requirements of the Final
  Margin Rule, an FCS (or non-U.S. branch of a U.S. CSE) may be eligible
  to engage in uncleared swaps with certain non-U.S. counterparties,
  subject to a limit, but only if certain conditions are satisfied.
  Under the limit, for each broad risk category set out in Sec.
  23.154(b)(2)(v), the total outstanding notional value of all uncleared
  swaps in that broad risk category, as to which the CSE is relying on
  Sec.   23.160(e), may not exceed 5% of the CSE's total outstanding
  notional value for all uncleared swaps in the same broad risk
  category. The specified conditions include collecting the gross amount
  of initial margin in cash, and posting and collecting variation margin
  in cash, in accordance with the Final Margin Rule. The CSE's
  counterparty must be a non-U.S. person that is not a CSE, and the
  counterparty's obligations under the swap must not be guaranteed by a
  U.S. person. This provision does not apply if the CSE that is subject
  to the foreign regulatory restrictions is permitted to post collateral
  for the uncleared swap in compliance with the custodial arrangements
  of Sec.   23.157 in the United States or a jurisdiction for which the
  Commission has issued a comparability determination with respect to
  Sec.   23.157. An FCS (or non-U.S. branch of a U.S. CSE) that relies
  on this special provision would not post initial margin in qualifying
  foreign jurisdictions, and would not be required to hold initial
  margin that they collect with one or more custodians that are not the
  CSE, its counterparty, or an affiliate of the CSE or its counterparty
  as would otherwise be required by Sec.   23.157(b) of the Final Margin
  Rule. CSEs that rely on this special provision must have policies and
  procedures to ensure compliance and maintain books and records
  properly documenting that all of the requirements of this provision
  are satisfied.
If a CSE cannot conclude after sufficient legal review with a well-
  founded basis that the netting agreement with a counterparty in a
  foreign jurisdiction meets the definition of an ``eligible master
  netting agreement'' set forth in the Final Margin Rule, the CSE must
  treat the uncleared swaps covered by the netting agreement on a gross
  basis in determining the amount of initial and variation margin that
  it must collect, but the CSE may net those uncleared swaps in
  accordance with the netting provisions of the Final Margin Rule in
  determining the amount of initial and variation margin that it must
  post to the counterparty. The CSE must have policies and procedures to
  ensure compliance and maintain books and records properly documenting
  that all of the requirements of this provision are satisfied.
\4\ In order to preserve the Commission's intent with respect to the
  treatment of inter-affiliate swaps under the Final Margin Rule, the
  Exclusion is not available if the market-facing swap of the non-U.S.
  CSE (that is otherwise eligible for the Exclusion) is not subject to
  comparable initial margin collection requirements in the home
  jurisdiction and any of the risk associated with the uncleared swap is
  transferred, directly or indirectly, through inter-affiliate swaps, to
  a U.S. CSE or a U.S. Guaranteed CSE. Under the Final Margin Rule, a
  CSE is not required to collect initial margin from its affiliate,
  provided, among other things, that affiliate collects initial margin
  on its market-facing swaps or is subject to comparable initial margin
  collection requirements (in the case of non-U.S. affiliates that are
  financial end-users) on their own market-facing swaps.


[[Page 34852]]

Appendices to Margin Requirements for Uncleared Swaps for Swap Dealers 
and Major Swap Participants--Cross-Border Application of the Margin 
Requirements--Commission Voting Summary, Chairman's Statement, and 
Commissioners' Statements

Appendix 1--Commission Voting Summary

    On this matter, Chairman Massad and Commissioner Bowen voted in 
the affirmative. Commissioner Giancarlo voted in the negative.

Appendix 2--Statement of Chairman Timothy G. Massad

    I am pleased that today, the Commission has adopted a cross-
border approach to our rule setting margin for uncleared swaps.
    Our margin rule is one of the most important elements of swaps 
market regulation set forth in the Dodd-Frank Act. Margin 
requirements help ensure that uncleared swaps, which will always 
remain a sizable portion of the market, do not generate excessive 
uncollateralized risk. Last December, the Commission adopted a 
strong and sensible margin rule. It requires swap dealers and major 
swap participants to post and collect margin in their transactions 
with one another, and with financial entities with which they have 
significant exposures.
    The risks our margin rule seeks to prevent do not only originate 
in the United States. The interconnected nature of the global swaps 
market means that risks created across the globe have the potential 
to flow back into the United States. We recognize that having a 
global swaps market is beneficial to all users. Therefore, one of 
the most important objectives we already accomplished was to ensure 
our margin rule is substantially similar to comparable international 
rules. Harmonization is critical to creating a sound international 
framework for regulation.
    We also recognize that not all jurisdictions will adopt strong 
margin rules. And even where rules are substantially harmonized, 
there will still be some differences. Because cross-border 
transactions are commonplace, we must clarify which rules apply in 
different situations. Today, the Commission has acted to provide 
that clarification.
    First, we have drawn a clear, reasonable line as to when the 
CFTC should take offshore risk into account. Today's action ensures 
that our rule, or a comparable international measure, applies to 
swap dealers that are foreign consolidated subsidiaries of a U.S. 
parent. This helps address the risk that can flow back into the 
United States from that offshore activity, even when the subsidiary 
is not explicitly guaranteed by the U.S. parent. This treatment of 
foreign consolidated subsidiaries--and our general cross-border 
approach--is also consistent with the approach taken by the U.S. 
prudential regulators.
    At the same time, to further our efforts toward harmonization, 
and to avoid conflicts with the rules of other jurisdictions, we 
have provided for a broad scope of substituted compliance. Not only 
will non-U.S. swap dealers be eligible for substituted compliance, 
so will U.S. swap dealers with respect to the margin they post to 
non-U.S. persons. This approach is an appropriate response to the 
complex world created by the swap industry, where global swap 
dealers can book a swap in a variety of ways. Dealers may book swaps 
through different subsidiaries, branches or affiliates all over the 
world, and they may do so based on a number of considerations, such 
as the most favorable legal treatment. Our approach is intended to 
protect our markets against risk coming from these cross-border 
transactions, while taking into account the interests of other 
regulators.
    The process for conducting a comparability assessment of another 
jurisdiction's rules is similar to what we have done in other areas. 
The rule specifies the various factors that should be considered, 
and indeed there is no reasonable way one can make a determination 
without evaluating those factors. One important consideration will 
be compliance with the international framework developed by the 
Basel Committee on Banking Supervision and the International 
Organization of Securities Commissions. Our approach will look at 
the elements of each jurisdiction's rule set with an eye towards a 
flexible, outcome-based determination. The process of making 
comparability assessments can take time. In light of the impending 
September 1 compliance date, I have asked the CFTC staff to work 
closely with other domestic and international regulators, as well as 
industry participants, and endeavor to effect a smooth transition.
    The approach we have finalized today helps ensure the safety and 
soundness of registered swap dealers, and reduces the potential for 
conflict with the rules of other international regulators. I thank 
all those who provided us with important feedback on these issues. I 
also thank CFTC staff for their work on this rule, and my fellow 
Commissioners for their careful consideration of this measure.

Appendix 3--Concurring Statement of Commissioner Sharon Y. Bowen

Margin and Capital as the Pillars of Market Safety

    Margin and capital are two of the most important tools for risk 
mitigation for the derivatives markets. Thus it is very important 
that we get our rules on margin and capital right in order to 
accomplish the reform required under the Dodd-Frank Wall Street 
Reform and Consumer Protection Act.\290\ As many of you know, last 
December, I voted against the final margin for uncleared swaps rule 
because I did not believe that it was strong enough to fully protect 
our system. As I said in December, adequate margin is fundamental to 
market safety as it is a ``critical shock absorber for the bumps and 
potholes of our financial markets and for the risk of contagion and 
spillovers.'' \291\ I am even more confident in that view today.
---------------------------------------------------------------------------

    \290\ Public Law 111-203, 124 Stat. 1376 (2010).
    \291\ http://www.cftc.gov/PressRoom/SpeechesTestimony/bowenstatement121615a.
---------------------------------------------------------------------------

    Today we vote on a critical supplement to that margin rule. 
Specifically, today's rule would allow registered dealers to 
substitute the margin rules of comparable jurisdictions for our 
rules, when dealing with non-US counterparties, under certain 
conditions. Needless to say, cross-border regulation is central to 
our margin rule functioning effectively since our markets are 
global.
    I intend to vote yes for this cross-border rule because I want 
to give the market legal certainty, as the first compliance date for 
our margin rules, as well as those of regulators across 
jurisdictions--September 1, 2016--looms.\292\ It is important that 
market participants have enough time to prepare in advance of this 
date so as to minimize market instability. We also want to minimize 
the risk of creating regulatory arbitrage across jurisdictions. 
While my concerns about our margin regime remain, I recognize that 
there is no opportunity in today's cross-border margin decision to 
remedy those errors.
---------------------------------------------------------------------------

    \292\ Margin Requirements for Uncleared Swaps for Swap Dealers 
and Major Swap Participants, 81 FR 636, 675 (Jan. 6, 2016).
---------------------------------------------------------------------------

    One of the major drawbacks of our margin rulemaking is that it 
was not done in conjunction with our capital rulemaking. Margin and 
capital are intertwined--if our margin rule is weak, our capital 
rule needs to be stronger to compensate. If both are strong, 
investors and consumers can be confident that we have learned the 
lessons of the past, and have placed adequate protections in place 
against future financial instability. But, if both are weak, we have 
surrendered our best defenses against contagion. We put the 
interests of our investors at risk when we view regulation in a 
piecemeal and non-comprehensive fashion, because we are not seeing 
the whole picture. So, as I vote today on cross-border margin, my 
mind is on our upcoming capital rule proposal.
    Any firm that aspires to be a swap dealer is aspiring to be a 
significant player in our economy. They must have the capacity to 
not only stand ready to be the buyer to each seller and the seller 
to each buyer, but to maintain those positions over years. Their 
creditworthiness must be above reproach. In that way, market 
participants, including commercial end-users who need to hedge, can 
be confident that their dealer will be there during times of 
stability and crisis. It is therefore critical to the health of our 
economy that the market trusts, and with good reason, that our 
dealers are robust and steadfast--that they are able to withstand 
the financial swings that are endemic to today's economy. Thus while 
strong capital rules may prevent some entities from entering the 
dealing business, they ultimately benefit the dealers, their 
customers and the whole economy.
    In order to create a capital rule that appropriately manages 
risk for the American people and our critical economy, our capital 
rule proposal must:
    (1) Not Be Weaker Than Our Comparable Prudential Regulators' 
Rule: The capital proposal, and subsequent final rule, must be as 
strong as those of the Prudential Regulators. We are required under 
law to establish minimum capital requirements that are 
``comparable'' to our Prudential Regulator counterparts ``to the 
maximum extent

[[Page 34853]]

practicable.'' \293\ Not only is this our legal obligation, but it 
is a sensible one as it prevents entities from gaming the system, 
and organizing their businesses in order to have the lowest capital 
requirements possible. We do not want our regulatory framework to be 
an escape hatch from strong risk management.
---------------------------------------------------------------------------

    \293\ Commodity Exchange Act (CEA) 6s(e)(3)(D).
---------------------------------------------------------------------------

    (2) Account for the Entire Risk to the Dealer: The capital 
proposal should also require dealers to hold sufficient capital to 
cover the entirety of the risk posed by the full gamut of 
derivatives products that they hold--including those products, 
which, for various reasons, we did not impose a margin requirement, 
such as inter-affiliate swaps and swaps with financial 
counterparties that are below the $8 billion threshold. This is 
consistent with our mandate under law to ``take into account the 
risks associated with other types of swaps or classes of swaps or 
categories of swaps engaged in and the other activities conducted by 
that person that are not otherwise subject to regulation. . . .'' 
\294\ This is an important requirement. The Congressional authors 
understood that just because a particular category of swaps that a 
dealer holds are not subject to a regulatory requirement, does not 
mean that the dealers, and therefore their customers, are not 
vulnerable to the risk posed by them.
---------------------------------------------------------------------------

    \294\ CEA 6s(e)(2)(C).
---------------------------------------------------------------------------

    (3) Include Effective Elements of Strong Capital Models: Our 
capital proposal should take into consideration respected, and 
effective capital models from other regulators. As of now, we have 
two well-regarded capital models: The Basel rules for banks, and the 
Securities and Exchange Commission's (SEC's) rule for Broker-
Dealers. The Basel rule has many positive attributes--including the 
fact that it not only has strong capital requirements but also a 
liquidity, leverage and funding ratio.\295\ We need look no further 
than financial companies before the 2008 crisis to understand the 
need for leverage requirements. For instance, it was estimated that, 
prior to the crisis, some firms had debt that was 30 to 40 times 
their net capital.\296\ And we have very present examples of 
commercial companies that evidence the need for funding 
requirements.\297\ The SEC's broker dealer rule also has its 
positives including that it does not allow for internal models, 
which came under fire after the crisis for allowing excessive 
leverage,\298\ and it is liquidity-based such that the dealer is 
obligated to maintain highly liquid assets to cover its 
liabilities.\299\ Our capital rule proposal should be as strong, if 
not stronger, than these models.
---------------------------------------------------------------------------

    \295\ With the exception of the capital charge to the segregated 
customer funds that have been set aside to secure cleared products. 
See ``Speech of Commissioner Sharon Y. Bowen at George Washington 
Law, 2016 Manuel F. Cohen Lecture,'' Feb. 4, 2016, available at 
http://www.cftc.gov/PressRoom/SpeechesTestimony/opabowen-8.
    \296\ E.g., Julie Satow, ``Ex-SEC Official Blames Agency for 
Blow-Up of Broker-Dealers,'' The New York Sun (September 18, 2008) 
(``[B]roker dealers . . . [had] debt-to-net-capital ratios, 
sometimes, as in the case of Merrill Lynch, to as high as 40-to-
1.''), available at http://www.nysun.com/business/ex-sec-official-blames-agency-for-blow-up/86130/; Alan S. Blinder, ``Six Errors on 
the Path to the Financial Crisis,'' New York Times (January 25, 
2009) (stating that in 2008, securities firms had leverage ratios of 
``33 to 1''), available at http://www.nytimes.com/2009/01/25/business/economy/25view.html?_r=0.
    \297\ Jasmine Ng and David Yong, ``Noble Group Gets $3 Billion 
in Credit Facilities,'' Bloomberg.com (May 12, 2016), available at 
http://www.bloomberg.com/news/articles/2016-05-12/noble-group-agrees-3-billion-credit-facilities-with-lenders. See also Sarah 
Kent, Scott Patterson, and Margot Patrick, ``Glencore Discloses More 
Details on Financing,'' The Wall Street Journal (October 7, 2015), 
available at http://www.wsj.com/articles/glencore-reveals-financing-deals-to-fend-off-critics-1444137982.
    \298\ See supra note 7.
    \299\ Securities Exchange Act (SEA) Rule 15c3-1.
---------------------------------------------------------------------------

    (4) Address Risks Posed by Swap-Dealing of Non-Financial 
Companies: Some commercial entities are also registered as swap 
dealers, and others may decide to do so in the future. Having 
commercial end-users that are engaging in more than a de minimis 
amount of swap dealing may increase market risk. Thus it is 
important that we are able to isolate their swap dealing business 
from the regular business, so that we can properly track their 
activities as a dealer.
    (5) Be Based on Data-Driven Risk Assessment, Not Industry 
Preference: As a regulator, anything that we propose needs to be 
based on our data-driven risk assessment, not on the desire to 
ensure that all entities that want to be dealers are able to 
maintain their current business models without any changes. In 
response to our proposal, market participants are then free to 
provide data to explain why our risk assessment may be inappropriate 
and to inform us of the pragmatic restraints. While encouraging more 
entrants into the market maybe a regulatory goal, doing all we can 
to prevent the next catastrophic financial crisis that wipes out 
pensions, is our fundamental goal.
    Experience has taught us that comprehensive, well-considered 
review is critical when considering major regulations. Ten years 
ago, too many people in industry did not engage in such well-
considered review when crafting complicated financial deals. In the 
end, that lack of consideration came back to haunt us all when the 
mortgage bubble burst and unexpectedly exposed many large financial 
institutions to massive losses that threatened the entire financial 
system. In the end, the American public had to save the system at 
great expense, and the ensuing rescue left many angry, alienated, 
and disaffected. Today, nearly eight years later, that anger still 
exists. We all pay a great price when we move forward in finance 
with insufficient analysis and review.
    Thus, for the sake of market certainty, I am voting yes to this 
rule. But I encourage my fellow Commissioners to work with me to 
develop a strong, comprehensive capital rule so that the American 
people can have the appropriate safeguards to secure our economy. 
Thank you.

Appendix 4--Statement of Dissent by Commissioner J. Christopher 
Giancarlo

    I respectfully dissent from the final rule on the cross-border 
application of margin requirements for uncleared swaps.
    In September 2009, the leaders of the G-20 countries agreed to 
launch a framework for ``strong, sustainable and balanced global 
growth'' to generate ``a durable recovery that creates the good jobs 
our people need.'' \1\ The agreement included a commitment ``to take 
action at the national and international level to raise standards 
together so that our national authorities implement global standards 
consistently in a way that ensures a level playing field and avoids 
fragmentation of markets, protectionism, and regulatory arbitrage.'' 
\2\
---------------------------------------------------------------------------

    \1\ G-20 Leaders' Statement, The Pittsburgh Summit, Preamble at 
par. 13 (Sept. 24-25, 2009).
    \2\ Id. at par. 12.
---------------------------------------------------------------------------

    In keeping with that agreement, representatives of more than 20 
regulatory authorities, including the CFTC, participated in 
consultations with the Basel Committee on Banking Supervision 
(``BCBS'') and the Board of the International Organization of 
Securities Commissions (``IOSCO'') to develop an international 
framework setting margin standards for uncleared derivatives 
(``BCBS-IOSCO framework'').\3\ That 2013 framework stresses the 
importance of developing consistent requirements across 
jurisdictions to avoid conflicting or duplicative standards.\4\
---------------------------------------------------------------------------

    \3\ Margin Requirements for Non-centrally Cleared Derivatives 
(Sept. 2013), available at http://www.bis.org/publ/bcbs261.pdf, 
revised Mar. 2015, available at http://www.bis.org/bcbs/publ/d317.pdf.
    \4\ Id. at 23.
---------------------------------------------------------------------------

    Today, instead of recognizing and building upon the strong 
foundation for mutual recognition of foreign regulatory regimes 
created by the G-20 commitments and the BCBS-IOSCO framework, as 
well as the CFTC's own history of using a principles-based, holistic 
approach to comparability determinations,\5\ the Commission is 
adopting a set of preconditions to substituted

[[Page 34854]]

compliance that is overly complex, unduly narrow and operationally 
impractical.
---------------------------------------------------------------------------

    \5\ The CFTC has a long history of working collaboratively with 
foreign regulators to facilitate cross-border business. For example, 
under Commission Regulation 30.10, adopted in 1987, if the CFTC 
determines that a foreign regulatory regime offers comparable 
protections to U.S. customers transacting in foreign futures and 
options, and there is an appropriate information-sharing arrangement 
in place, the CFTC has allowed foreign brokers to comply with their 
home-country regulations in lieu of Commission regulations. 
Similarly, since 1996 the Commission has permitted direct access by 
U.S. customers to foreign boards of trade (``FBOTs'') without 
requiring the FBOT to register with the CFTC as a derivatives 
contract market (``DCM''). In determining the comparability of the 
foreign regulatory regime the Commission does not engage in a line-
by-line examination of the foreign regulator's approach to 
supervising the FBOT it regulates. Rather, the Commission conducts a 
principles-based review to determine whether the foreign regime 
supports and enforces regulatory oversight of the FBOT and its 
clearing organization in a substantially equivalent manner as that 
used by the CFTC in its oversight of DCMs and clearing 
organizations. See Registration of Foreign Boards of Trade, 76 FR 
80674, 80680 (Dec. 23, 2011).
---------------------------------------------------------------------------

    First, the rule establishes a complicated matrix of potential 
cross-border counterparties under which substituted compliance is 
either not permitted, is partially permitted, or is fully permitted, 
depending upon the category in which the particular transaction 
fits. Next, where permitted, the CFTC will conduct an ``element-by-
element'' analysis of CFTC and foreign margin rules under which a 
transaction may be subject to a patchwork of U.S. and foreign 
regulation.\6\ The CFTC will follow this ``element-by-element'' 
approach instead of assessing a foreign authority's margin regime as 
a whole.
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    \6\ Such a result would be antithetical to element seven of the 
BCBS-IOSCO framework, which requires that there be no application of 
duplicative or conflicting margin requirements to the same 
transaction or activity. The framework advises that ``[w]hen a 
transaction is subject to two sets of rules (duplicative 
requirements), the home and the host regulators should endeavor to 
(1) harmonize the rules to the extent possible or (2) apply only one 
set of rules, by recognizing the equivalence and comparability of 
their respective rules.'' BCBS-IOSCO framework at 23.
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    In response to commenters who observed that today's approach 
will undermine the BCBS-IOSCO framework, the Commission acknowledges 
that consistency with the framework is necessary, but argues that 
the framework leaves certain elements open to interpretation by each 
regulator, including the CFTC.\7\ For these elements, the Commission 
undertakes to use an outcome-based analysis, but will also engage in 
a fact-specific inquiry of each legal and regulatory provision that 
corresponds to each element.
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    \7\ In footnote 232 of the preamble the Commission cites, for 
example, the definition of ``derivative,'' the list of assets 
eligible to post as collateral, the degree to which margin would be 
protected under the local bankruptcy regime, and how transactions 
with affiliates are treated.
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    In effect, the Commission's approach is somewhat principles-
based, except when it is rules-based and somewhat objective, except 
when it is subjective.
    Today's muddled methodology invites foreign regulators to 
respond in kind. It may well set us off down the same protracted, 
circuitous and uncertain path that the CFTC and the European Union 
took in the context of U.S. central counterparty clearinghouse 
equivalence. The approach is impractical, unnecessary and contrary 
to the cooperative spirit of the 2009 G-20 Pittsburgh Accords.\8\
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    \8\ I am also concerned about the Commission's unwillingness to 
delay the cross-border application of its margin rules until after 
it has made comparability determinations. This will bring into the 
CFTC's regulatory ambit many cross-border transactions over which 
U.S. jurisdiction is inappropriate and an undue drain on precious 
regulatory resources.
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    Rather than conducting a granular rule-by-rule comparison, the 
CFTC should focus on whether a foreign regulator's margin regime, in 
the aggregate, provides a sufficient level of risk mitigation in 
connection with the execution of uncleared swaps. The BCBS-IOSCO 
framework does just that. Compliance with it should be 
straightforward and unconditional to prevent the ``fragmentation of 
markets, protectionism, and regulatory arbitrage'' that global 
regulators were charged to avoid.
    As confusing as this rule is, what is important is not that hard 
to understand. American workers need quality American jobs. They 
need them in factories, farms and offices across the United States. 
The businesses that employ them want to sell their goods and 
services both here and abroad. To succeed globally, American 
businesses need U.S.-based financial institutions to support them 
around the world with competitively priced risk management services.
    Unfortunately, this complicated rule will make it harder for 
U.S. financial institutions to compete globally and serve American 
businesses. When businesses are placed at a competitive 
disadvantage, they hire fewer workers. With over 94 million 
Americans now out of the workforce,\9\ that is unacceptable. 
Therefore, I oppose this rule--it's that simple.

    \9\ Bureau of Labor Statistics, The Employment Situation--April 
2016, U.S. DEPARTMENT OF LABOR, May 6, 2016, http://www.bls.gov/news.release/empsit.nr0.htm.

[FR Doc. 2016-12612 Filed 5-27-16; 8:45 am]
BILLING CODE 6351-01-P